After the great recession that affected the US in 2008, a lot of residents of the country lost the trust they’d put in the country’s economic system and laws. This is one of the main reasons why cryptocurrencies thrived in the country in the few years that came afterward. Blockchain-based currencies are an alternative that was born as a response to financial frameworks that were perceived as a failure by many and a lot of them as surely showing some success in their mission of empowering entrepreneurs and other individuals towards a more stable financial environment.
Ironically, the US Securities and Exchange Commission (SEC), responsible for most of the policies that some think led to the recession almost a decade ago, has recently released a series of documents that are now looking to regulate the way cryptocurrencies are being traded in the US. This has many consequences that can be good or bad depending on the point of view, but before we discuss them, let’s get in context.
Securities and Exchange Commission
To be more specific, the SEC is an independent agency in charge of regulating all economic activity related to the concept of ‘securities’. In case you’re not familiar with it, a security has many definitions, but the most common way to treat them is as some sort of equity, like shares, stock or investment contracts.
This agency was created after what’s called the US ‘Great Depression’ in 1932 to establish a more robust regulatory system for this part of the US economy and this way prevent such an event from repeating itself. They have a lot of legal tools that have been developed over the years to protect the country’s economic activity from big frauds and investment disasters.
For instance, to determine if a certain transaction can be qualified as a security, the SEC has created a mechanism commonly referred to as the ‘Howey test’. It consists of a list of requisites and if the transaction meets all of them, then it is qualified as an investment contract and, therefore, a security. This distinction is important because all securities in the US, save for very specific exceptions, have to be registered, and this is a process that takes a lot of time and resources and makes the whole trading of the assets a complicated process.
How This Affects Cryptocurrencies
On July 25, the SEC released a document that detailed the process that led them to determine that the tokens offered by an entity that called itself the “Decentralized Autonomous Organization” (DAO) qualified as investment contracts. The company made the headlines last year because of a big breach in their system that led to the theft of dozens of millions of US dollars in cryptocurrencies, and that is most likely the reason why the SEC decided to investigate them in the first place.
To get to the conclusion that the digital tokens were securities, the SEC basically performed a Howey test that resulted positive. For that, the performers of the test have to evaluate if the transaction falls in all of the following categories:
1. It is an investment of money.
2. There is an expectation of profits from the investment
3. The investment of money is in a common enterprise
4. Any profit comes from the efforts of a promoter third party
As it seems, the DAO tokens turned out positive. But the real concern about this should be that from this point on, all digital currencies offered in the US that find themselves in a similar situation as the DAO tokens will now be considered as securities too. This applies whether or not the company is based in the US. Undoubtedly, this will force many cryptocurrencies to either register themselves for the SEC or just block US citizens from trading with their currency, which is, in fact, something that’s becoming more common on trading platforms every day.
This affects Initial Coin Offerings as well. Every currency going through such a process will have to restrain US citizens from buying tokens, or they may end up facing legal issues with the SEC. This forces all cryptocurrency startups to register with the SEC, a measure that may have an impact in the flourishment of this innovative market.
According to an article from Harvard Law School Forum on Corporate Governance and Financial Regulation, the remedies for violations of the SEC rules regarding IPOs include “rescission of the offering, cease-and-desist orders, fines and penalties, bans from participating in the securities industry, bans on serving as an officer or director of a public company, and, in the most egregious cases, referral to the local U.S. Attorney for possible criminal prosecution.”
There is, however, one way in which cryptocurrency startups could save themselves the issue of registering with the SEC. The SEC has an exemption contemplated in their rules that’s commonly called the “private placement” exemption. It allows a company to make an offering of securities to what they call “accredited investors” which are selected individuals and institutions accredited by the SEC to make big investments. This kind of offering does not require any specified disclosures or financial statements from the party making the offering.
With the new rules, ICOs would have to behave pretty much like a regular company’s IPO, meaning that startups might want to opt for this option if they want to save themselves some of the inconveniences of an IPO and if it suits their financial needs. Nevertheless, this is still a very specific kind of exemption to the rules and there is still a registration process involved, so this can’t be really thought of as an overwhelming alternative.
The Implications of the New Rules
The thing about US regulations over the cryptocurrency market is that they are not made with bad intentions. They’re objective is to create a safer environment for investors and the US economy above all. Some might consider this to be a positive thing since it can give them some sort of certainty that their investment is more or less protected from certain immoral activities.
However, this also creates a contradiction. Cryptocurrencies are created to be universal currencies. This means they’re not meant to be tied to any country’s legislation and their existence is a way of escaping the flaws perceived by many in the banking systems and the economic scene of their nations. By embracing the regulations of the Securities and Exchange Commission, any blockchain based startup is falling into the game that justified their existence in the first place.
Still, it is up to investors and startups to decide whether or not they want to take part of this. Besides, these regulations are still not bulletproof. Cryptocurrencies that block US citizens from their online trading platforms can still be reached by these with the right tools (such as a VPN) and bypassing these restrictions seems to be in a grey area, legally speaking. On top of this, a lot of the new considerations of the SEC aren’t very clear and they’re still encouraging startups who aren’t sure if they’re infringing the law to contact them and discuss their situation.
It is also important to know that most of these startups are formed by little groups with small capitals that are most likely missing legal representation. The sudden change of rules can quickly turn into a witch hunt if it is not handled carefully and could discourage new companies from being created.
All these aspects make it clear that the SEC still has a long way to go when it comes to the new ways the digital era is handling money. While the regulations get to a more stable state, the best thing to do is to play safe and stick to SEC approved cryptocurrencies.
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