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Waiting on You, SEC

March 4, 2018

WAITING ON YOU, SEC: ARE CRYPTOCURRENCIES SECURITIES OR NOT?

By: William Paterson, Volume 102 Staff Member

Love it or hate it, cryptocurrency[1] is likely here to stay. Although confusing to many, entirely unknown to some, or disdained by others, cryptocurrencies have found a niche.[2] This niche has led to popularity and like other commodities,[3] such popularity has played out in the markets.[4] For the benefit of some and detriment of others, the market for cryptocurrencies has been volatile to say the least. This volatility has made many regulators determined to find a way to control these online currencies and secure market stability. For now, however, regulatory options are limited. Before determining when, how, or by whom cryptocurrencies can be regulated, we need to determine what they are. Unfortunately for those wanting a clear answer, the SEC Chairman Jay Clayton instead declared that “the answer depends on the facts.”[5]

I. FEDERAL GOVERNMENT’S CRYPTOCURRENCY AUTHORITY

Before exploring regulatory options, it is important to understand the epicenter of the cryptocurrency regulatory problem. The problem arises from the nature of cryptocurrencies. If the federal government were to regulate cryptocurrencies, it would do so through the SEC.[6] To promote control and stability, the SEC can require disclosure of information pertaining to a security[7] that is necessary to protect investors.[8] The SEC’s power is thus largely restricted to instruments classified as securities.

Broadly speaking, securities “include the commonly known documents traded for speculation or investment.”[9] These commonly include stocks, notes, and the catch-all—investment contracts.[10]

Classifying cryptocurrencies as a security is thus essential to federal regulation. This is where the problem lies—cryptocurrencies do not neatly fit this definition and therefore may not be securities.[11] If the SEC, which regulates based on what constitutes a security, finds cryptocurrencies to fall outside its authority, then the other regulatory option is state blue sky laws.[12] Although the federal legislation preserved state jurisdiction over securities regulation, the problem is that blue sky laws have substantial overlap with federal regulation.[13] Thus the question reverts back to the beginning: how does the SEC define a security?

II. DISAGREEMENTS OVER DEFINING CRYPTOCURRENCIES

The sides of the argument are easier to identify—some say cryptocurrencies are securities and others say they are not. The problem for the SEC is which argument to side with and why. The SEC’s current answer—it depends—provides more questions than answers and leaves investors unsure of how to proceed. The SEC’s predicament, however, is understandable: find cryptocurrencies to be securities would perhaps unnecessarily broaden the SEC’s rule, but to leave them as non-securities would let the rollercoaster ride continue.

Those who argue that cryptocurrencies are securities focus on the catch-all security term—investment contract.[14] Courts have interpreted investment contract to include any scheme intended to secure profit off the efforts of others.[15] Supporters of this argument note the investment prospects of cryptocurrencies, as the investment of money is the foundation of an investment contract.[16] This argument is strengthened by the goal of many cryptocurrency holders to make money, along with the reality that any profit gained will be the result of others’ efforts.[17] Furthermore, the essential purpose of the SEC supports the idea of regulating these new digital currencies. Investors far too frequently act with too little information. Allowing the SEC to regulate cryptocurrencies and emphasize substance over form (that is, regulating cryptocurrency due to its characteristics despite the fact that it is not a security on its face) could help protect those susceptible to these new opportunities.[18]

The SEC’s decision to not declare a cryptocurrency itself as a security has left the door open for opposing arguments. These arguments not only deny cryptocurrencies’ fit as an investment contract, but also attempt to highlight the other aspects of the digital currency. To combat the qualification as an investment contract, commentators have noted the lack of a common enterprise in which investors pool money.[19] Additionally, although the value of Bitcoin may change based on outside efforts, it is not the efforts of the sellers on which investors rely but rather the market for Bitcoin as a whole.[20] A retailer accepting Bitcoin has a much greater effect on Bitcoin’s market value than whether a Bitcoin holder buys or sells as the market fluctuates. Along with the anti-investment-contract arguments, there is some basis for stating that the definition of a security under the Securities Exchange Act of 1934 itself eliminates classifying cryptocurrencies as securities. The definition of “security” clearly states that it “shall not include currency.”[21] Bitcoin and other cryptocurrencies are tagging themselves as “completely digital money.”[22] Although the value can increase with market performance, cryptocurrencies are arguably just that—currency. Similar to the dollar or euro, cryptocurrencies are arguably just currencies used in the exchange of goods. The volatility and popularity of this new digital currency, however, has led some to reject this premise on the ground that this new form of money is much more than that.[23]

III. DECISION TIME FOR THE SEC

The overall consensus is that leaving cryptocurrencies as unregulated is both unrealistic and irresponsible. Properly addressing this problem, however, is easier said than done. New legislation or finding ways to regulate cryptocurrencies through existing laws are options that have been proposed.[24] Such options, however, avoid the basic question at stake: is cryptocurrency a security? Until the SEC takes a firm position on the matter, investors, regulators, and cryptocurrency providers will be left waiting to see what happens.

  1. What is Cryptocurrency. Guide for Beginners, Cointelegraph, https://cointelegraph.com/bitcoin-for-beginners/what-are-cryptocurrencies#history (last visited Feb. 12, 2018) (“A cryptocurrency is a digital or virtual currency designed to work as a medium of exchange. It uses cryptography to secure and verify transactions as well as to control the creation of new units of a particular cryptocurrency.”); See Cryptocurrency, Investopedia, https://www.investopedia.com/terms/c/cryptocurrency.asp (last visited Feb. 12, 2018) (“A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.”). ↑
  2. Andrew Medal, 10 Incredible Uses for Cryptocurrency and Blockchain You Probably Haven’t Thought of, Entrepreneur (Dec. 11, 2017), https://www.entrepreneur.com/article/305859 (describing the various uses of cryptocurrencies including wealth management and travel). Contra Leo Garnier, The Bad Sides of Cryptocurrencies, The Circular (Dec. 8, 2017), http://thecircular.org/cryptocurrencies-bad-sides-bitcoin/ (discussing the possibility of money laundering and extortion with cryptocurrencies). ↑
  3. The IRS has defined cryptocurrencies as property. IRS Virtual Currency Guidance: Virtual Currency Is Treated as Property for U.S. Federal Tax Purposes; General Rules for Property Transactions Apply, IRS (Mar. 25, 2014), https://www.irs.gov/newsroom/irs-virtual-currency-guidance. ↑
  4. See Charles Bovaird, Cryptocurrency Markets Gripped by Wait-and-See Mentality, Forbes (Feb. 12, 2018), https://www.forbes.com/sites/cbovaird/2018/02/12/cryptocurrency-markets-gripped-by-wait-and-see-mentality/#c8eb35937122 (“The cryptocurrency market’s total value rose to as much as $433 billion today. . . .”). ↑
  5. John Clayton, Chairman, SEC, Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), https://www.sec.gov/news/public-statement/statement-clayton-2017-12-11. ↑
  6. Securities Act of 1933, ch. 38, 48 Stat. 74 (codified as amended at 15 U.S.C. § 78d (2006)). ↑
  7. “The term ‘security’ means any note, stock, treasury stock, security future, security-based swap, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract. . . .” Securities Exchange Act of 1934, 48 Stat. 881 (codified as amended 15 U.S.C. § 3(a)(10) (2006)). ↑
  8. Securities Exchange Act of 1934 § 12(b). ↑
  9. SEC v. Howey, 328 U.S. 293, 297 (1946). ↑
  10. Securities Exchange Act of 1934 § 3(a)(10). ↑
  11. For a detailed explanation as to why Bitcoin is not a security see Jeffrey E. Alberts & Bertrand Fry, Is Bitcoin a Security?, 21 B.U. J. Sci. & Tech. L. 1 (2015). “While no court or government agency has yet opined on whether Bitcoin is a security, based on an analysis of case law applying the definition of “security” under the Securities Act, it appears that Bitcoin is not a security.” Id. at 21. ↑
  12. Before the Securities Act of 1933 or the Securities Exchange Act of 1934, securities were regulated on the state level. Jonathan R. Macey & Geoffrey P. Miller, Origin of the Blue Sky Laws, 70 Tex. L. Rev. 347, 348 (1991). These state laws were named to “indicate[] the evil at which [they were] aimed;. . . ‘speculative schemes which have no more basis than so many feet of “blue sky. . . .”’” Hall v. Geiger-Jones Co., 242 U.S. 539, 550 (1917). ↑
  13. Mark J. Astarita, Introduction to State Securities (Blue Sky) Laws, SECLaw.com, http://www.seclaw.com/introduction-to-state-securities-laws/ (last visited Feb. 13, 2018). ↑
  14. For an argument to treat Bitcoin as an investment contract, see Benjamin Akins et al., The Case for the Regulation of Bitcoin Mining as a Security, 19 Va. J.L. & Tech. 669, 686–97 (2015). It is relatively clear that cryptocurrencies are not stocks or notes. See SEC v. Shavers, 2013 WL 4028182 (E.D. Tex. 2013) (finding shares of Bitcoin to be a security). ↑
  15. SEC v. Edwards, 540 U.S. 389, 395 (2004). ↑
  16. Howey, 328 U.S. at 298. ↑
  17. Id. ↑
  18. J. Scott Colesanti, Trotting out the White Horse: How the SEC Can Handle Bitcoin’s Threat to American Investors, 65 Syracuse L. Rev. 1, 59 (2014) (discussing the need for the SEC to remain true to its protective purpose). ↑
  19. Alberts & Fry, supra note 11, at 16–17. ↑
  20. Id. ↑
  21. Securities Exchange Act of 1934, 48 Stat. 881 (codified as amended 15 U.S.C. § 12(b) (2002)). ↑
  22. Frequently Asked Questions, Bitcoin, https://bitcoin.org/en/faq#what-is-bitcoin (last visited Feb. 13, 2018). ↑
  23. Sarah Jane Hughes & Stephen T. Middlebrook, Feature, Advancing a Framework for Regulating Cryptocurrency Payments Intermediaries, 32 Yale J. Reg. 495, 528–29 (2015). ↑
  24. Id. at 507–11. ↑
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