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The original virtual currency, Bitcoin, started in 2009 as a private form of currency to use in lieu of fiat currency (such as the US dollar or the euro) for online transactions. Largely due to its wide price volatility--in 2017 the price of Bitcoin soared from $1,000 to almost $20,000 then back to $12,600, and in the first quarter of 2018 the price declined by almost 50%-- Bitcoin’s role as a medium of exchange has diminished while its use in capital formation and trading has increased. For years, the Securities and Exchange Commission (SEC) was cautious in its approach to virtual currencies, but given an environment where virtual currencies may be offered and sold like securities, the SEC has been compelled to take action. The SEC has voiced its approval of efforts by state securities regulators and industry groups like the National Association of Securities Administrators (NASAA) to implement coordinated crackdowns on fraud in the virtual currency arena, such as “Operation Cryptosweep” announced May 21, 2018.
The SEC’s Mission and Jurisdiction. The proclaimed mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. For the scope of this article, the SEC’s primary areas of regulatory enforcement deal with (i) offerings and sales of securities, (ii) fraud or misleading disclosure involving securities and (iii) regulation of exchanges on which securities are traded. The SEC does not have direct oversight of transactions in currencies or commodities. The determinative question for the SEC is whether, in a particular situation, a virtual currency is a “security”, i.e., whether it involves an investment of money or value in a business or operation where the investor has a reasonable expectation of profits based upon the efforts of others.
The SEC Looks at ICOs. An Initial Coin Offering (ICO) is a fundraising activity whereby new ventures sell a “coin” (often referred to as a “token”) often in exchange for virtual currency (like Ether) and in some cases fiat currency as well. A token offering may resemble a traditional offering of securities, depending on how the tokens are structured and marketed and what rights the tokens represent. Some ICOs are offered to limited numbers of accredited investors in “private placements” that are exempt from SEC registration requirements, while others are offered publicly.
SEC Actions on ICOs. The SEC has taken multiple actions against parties involved in ICOs. In particular, the SEC has:
In addition, there have been recent press reports that the SEC has issued dozens of subpoenas and information requests to companies involved in ICOs, requesting information about the structure for sales and pre-sales of the ICOs. On May 16, 2018, the SEC launched a mock ICO website (HoweyCoins.com) to educate investors about the types of deception and fraud that may exist in hotly marketed ICOs.
Registration of ETFs? In December 2017, the Commodity Futures Trading Commission (CFTC) cleared trading of Bitcoin futures through the CBOE Futures Exchange and The CME Group, and several new Bitcoin ETF applications were quickly filed to capitalize on this development. In January 2018, the SEC staff requested the withdrawal of several of those applications, however, citing concerns about liquidity and valuation. The SEC Chair later elaborated concerns about custody of the fund holdings and creation, redemption and arbitrage issues in the ETF market. On March 23, 2018, the SEC announced its consideration (and request for public comments) on a rule change to allow NYSE Arca to list two Bitcoin futures ETFs, so the matter is far from closed.
Trading Platforms or “Exchanges”. There is a multitude of trading platforms or exchanges for virtual currencies. Many of them (such as BTCChina and Bitstamp) are located overseas, while others (like Coinbase and Cryptsy) are based in the United States.
On March 7, 2018, the SEC Divisions of Enforcement and Trading and Markets issued a “Statement on Potentially Unlawful Online Platforms for Trading Digital Assets,” where they reminded that “if a platform offers trading of digital assets that are securities and operates as an ‘exchange,’ as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.” Under the Securities Exchange Act of 1934, an “exchange” is broadly defined to include “a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange”. As with the SEC’s jurisdiction over ICOs, its regulation of virtual currency exchanges is dependent upon whether securities are involved.
Looking Forward. The SEC’s increasing focus on virtual currencies and ICOs will likely bring more oversight, guidance and enforcement in the coming months.