If you like the Wild West vibe of cryptocurrency trading, the Securities and Exchange Commission has bad news for you. Last week, the SEC issued long-awaited guidance on the conditions under which a “digital asset” (including cryptocurrencies like Bitcoin) qualifies as a security under U.S. federal law. This represents arguably the most significant development yet in clarifying the regulatory structure around crypto-coins.
The security label matters a lot; any cryptocurrency that qualifies for that distinction must abide by the SEC’s registration and disclosure requirements. (It’s worth pointing out here that the guidance is characterized as a “framework” and explicitly not “a rule, regulation or statement of the Commission.” That conceivably leaves some wiggle room to argue about the weight of the guidance, but only the slimmest amount.) According to the new guidance, a cryptocurrency qualifies as a security if it meets the definition of a so-called investment contract. The SEC noted case law dictates that “an ‘investment contract’ exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Importantly, the investment contract test can apply to “any contract, scheme, or transaction, regardless of whether it has any of the characteristics of typical securities.”
A subsequent decision by the SEC offers insight into how its view of digital tokens will play out in practice going forward. On April 3, the SEC Division of Corporation Finance issued a no-action letter to air charter company TurnKey Jet on its request to sell the tokens issued during its initial coin offering (ICO) without registering them with the SEC. The SEC noted in its letter that TurnKey will restrict tokens from being transferred to wallets outside of its platform and that the tokens will be immediately usable for purchasing charter services at the time they’re sold.
Of course, that still leaves some important questions to be answered about how cryptocurrencies will be regulated. Bloomberg columnist Matt Levine raised a few of them: “The securities laws are written for companies that issue stocks and bonds; it is not clear how you would write securities disclosure for a decentralized ecosystem of buyers and sellers who convene on a blockchain, or how you’d gather the data to write that disclosure, or how you could get lawyers and accountants to sign off on it.”
In any case, with the guidance now in place, it’s worth keeping an eye on how often ICO promoters raise funds using Form D, a “back door” method of selling tokens without waiting to register the offerings with the SEC. According to an analysis published last week by MarketWatch, it would appear fewer companies are entering the crypto market through this method. The Commission accepted 33 ICO registrations with a total value of almost $2 billion in the first quarter of 2019. That was well off the pace of 2018, in which MarketWatch estimates that the agency accepted 287 ICO-related fundraisings worth a stated value of $8.7 billion.