Truth in Crypto

What if Cryptocurrencies are Classified as Securities by Regulators?

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Andrew Elliott

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It’s every crypto asset investors nightmare. We wake up one morning to read that the Securities and Exchange Commission (SEC) and other regulators are seeking to immediately shutdown crypto exchanges and projects for operating outside of existing legal frameworks. Given zero time to adjust the entire market dumps, taking a generation of tech innovation and our investments with it.

For anarchists (believing governments to be obsolete) or internet trolls (who always claim to be “in it for the tech”) this ominous regulatory environment may not be concerning. Yet serious investors must examine the ramifications of securities regulations being applied to the crypto space.

So… What if cryptocurrencies are classified as securities by regulators?

To answer the question in depth, we need to review the regulatory process. If you’re short on time, skip to the last section of this article.

The Howey Test

The Securities and Exchange Commission (SEC) has a broad definition of the term “security.” Under law, a security includes many familiar investment instruments such as notes, stocks, bonds, and investment contracts. For our purposes we must focus on “investment contracts”.

What is an investment contract? Glad you asked.

In SEC vs. Howey (how we got the “Howey Test”), an investment contract was defined as:

  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 or third party

These attributes are why recent statements by SEC Chairman Clayton and former Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler have many in the crypto space concerned that regulators may classify a large number of existing (and therefore non-compliant) cryptocurrencies as securities.

How the Top 3 Crypto Assets Align with the Howey Test 

Let’s now examine the top 3 crypto assets (Bitcoin BTC, Ethereum ETH, and Ripple XRP) and see how they align with the four attributes of an investment contract per the Howey Test.

sec regulators cryptocurrencies

SEC Chairman Clayton is on record saying, “I believe every ICO I’ve seen is a security.” Ethereum having conducted an initial coin offering (ICO) seems to place it firmly within his comments.

Former CFTC Chairman Gensler thinks Ripple (XRP) in particular is most likely a security. Although he does NOT believe Bitcoin is a security.

Requirements of Compliance

Being classified as a security would require certain compliance actions on the part of issuers (in this case crypto projects). Issuers would have to register with the SEC and disclose certain information:

Honestly it doesn’t seem like a huge deal at first glance, but cryptocurrency projects aren’t an easy fit for these disclosure requirements.

Most cryptos aren’t “managed” by a company. Audited financial statements are costly and kind of laughable in the context of crypto. For example, would we ever say that “Ethereum earned $1 per coin this quarter”? – The answer is NO.

Reconciling the Crypto Asset Class to Compliance Requirements

As previously stated, crypto assets aren’t a perfect fit into existing regulatory frameworks. Because of this mismatch, we at CoinSavage see three possible scenarios playing out:

  1. The SEC and other regulators demand immediate compliance by crypto exchanges and projects to existing law. This is the NIGHTMARE SCENARIO. We have not heard any regulator pushing this course of action.
  2. All cryptos must register but registration is easy and regulators pursue a “light touch” to encourage continued innovation.
  3. Cryptos are given a clear and favorable timeline to come in line with compliance. 

Given that NO regulators have exhibited a willingness to completely ruin the innovation taking place in the crypto space, we believe that some combination of scenario two and three is highly likely.

Crypto Exchanges Positioning for Securities Listing

Recently Coinbase was reported to be in talks with the SEC over registration as a securities dealer. The report was dated April 6th 2018. The timeline is important because per SEC guidelines, the SEC has 45 days to respond by:

  1. Granting registration
  2. Beginning proceedings on whether to deny registration
  3. Granting registration on the condition that Coinbase obtain membership in a Self Regulating Organization (SRO). That organization would most likely be the Financial Industry Regulatory Authority (FINRA). FINRA seems to be friendly to a crypto exchange like Coinbase.

If Coinbase completed a full application to the SEC on April 6th, then we could see movement on its status as a securities dealer by May 21st.

This is EXTREMELY important because if a crypto exchange that can list securities is in place BEFORE regulators declare crypto assets securities, then the market turmoil will be mitigated. 

In Summary

If you skipped the regulatory walk through above, here are the key takeaways:

  1. Bitcoin is most likely NOT a security
  2. Ethereum MIGHT be a security
  3. Ripple (XRP) is PROBABLY a security, but also has the resources to come into compliance
  4. Regulators don’t want to destroy crypto but do want to protect consumers and investors
  5. Coinbase is in the process of gaining a securities dealer license
  6. If Coinbase is successful then the negative consequences of many cryptos being labeled securities would be greatly mitigated (would avoid a mass dump scenario as exchanges scramble to unload “securities” from their non-registered exchanges)

Disclaimer- We are long Bitcoin, Ethereum, and Ripple … and will continue to be long.

Invest Savagely.