SEC Latest Developments with Blockchain and Cryptocurrencies

While the markets for cryptocurrencies has continued to struggle in terms of valuations and prices, lots of development continues to progress around the ecosystem as many projects continue to secure funding. While retail investors have continued to focus on the cryptocurrencies themselves, larger investors like institutions and venture capital have continued to deploy capital into the companies and projects building the infrastructure and technology to improve adoption of the ecosystem. While numbers are still unofficial and uncertain, it is said that despite the decrease in prices over the last year, more than $10 billion have been invested in blockchain projects. This has led to the increased attention of regulators, the SEC in particular, on how to ensure participants are adequately protected under the current frameworks. However, this continues to be a grey area as regulation is clear under securities laws but the development of Utility tokens has led to uncertainties as to how far do they go to establish the differences between the two.

This has led the SEC to consider the understanding of fintech in general as one of their top priorities over the next couple of years as stated in their Strategic Plans going forward. This focus will not only lead to more focus on looking at the potential impacts of the technological development in these areas but will also add talent and resources to ensure that they create an appropriate balance between investor protection and innovation for the financial markets. This is great as the need to better understand the technology is critical in order to not burden regulators into more restrictive frameworks that could lead to the exodus of the technological advances that many fintech projects could bring to the United States financial markets.

An example of how they are approaching this is some of the recent news they have released regarding working groups within the SEC and findings from recent investigations into certain Initial Coin Offerings. First, the SEC announced in October that they were launching a Strategic Hun for Innovation and Financial Technology or FinHub. The purpose of this Hub will be to serve as a resource for public engagement on the fintech related issues such as blockchain, digital assets, artificial intelligence, machine learnings, among others. They intend to do this by:

• Developing a portal for industry and the public to engage directly with SEC staff
• Being more transparent by releasing information on SEC activities
• Interacting with the public through events and publications
• Creating a platform for internal SEC staff for fintech related informaiton
• Serving as a liaison the other regulators globally

An example of these efforts will be a FinTech Forum that will focus on blockchain and cryptocurrencies that they have planned for 2019. They hope that they can create more engagement between public and private sectors to seek a balance between regulation and financial innovation. The SEC Chairman himself said:

"The SEC is committed to working with investors and market participants on new approaches to capital formation, market structure, and financial services, with an eye toward enhancing, and in no way reducing, investor protection. The FinHub provides a central point of focus for our efforts to monitor and engage on innovations in the securities markets that hold promise, but which also require a flexible, prompt regulatory response to execute our mission.”

However, while they were creating this Hub they have continued to investigate many Initial Coin Offerings. Unfortunately, they have made their first moves regarding some ICOs that launched in 2017 by determining that they were in fact securities. By being cataloged securities, it opens the target projects to a number of sanctions and penalties given that the assets were not registered as securities. This is the first time that the SEC finalizes investigations of ICOs that were not considered fraudulent. Until now, they had online shutdown and prosecuted projects that had the elements of being fraudulent and risking investor assets.

The two projects in their announcement where CarrierEQ, Inc. (Airfox) and Paragon Coin Inc. Between the two, approximately $27 million were raised by investors using the ERC-20 framework. The results of the investigation was a settlement between the parties in which the tokens issued were deemed securities which are thus unregistered and contrary to securities laws. As part of the settlement, these projects must offer all investors the opportunity to refund them the amounts invested in addition to registering the tokens as securities. Lastly, the will also pay a penalty of $250,000.

While this may seem straightforward, in reading the actual administrative proceeding many interesting interpretations were given by the SEC in the review of the Initial Coin Offering. The following are examples of those interpretations that led the SEC to deem the tokens securities:

• Despite stating that they were buying utility tokens, the fact that they were purchased with “anticipation that the value of the tokens would rise through future managerial and entrepreneurial efforts” made them securities.
• The promotional efforts mostly took place to investors instead of the anticipated users of the token.
• Whitepaper stated that the developers would ensure that they would seek listings on exchanges to provide secondary listings for the tokens.
• In an exchange listing application, the management team answered how and why they expected the tokens to increase in value over time.

These are interesting interpretations that honestly concern me as they make the line between utility and security tokens very thin in my opinion. It will be interesting to see if more ICO projects will fall along these lines and what the potential impacts to the projects themselves we could see. The administrative burden of registering these securities while offering refunds to investors after the losses seen in crypto prices this year could be onerous to many projects which could lead to a true wipe out of many tokens listed on exchanges.

In looking at these developments, I am concerned about the inherent contradictions seen as they seem to want to support growth and innovation in the financial system but are penalizing those tried to innovate using new technologies to raise funds for new technology in many cases. The fact that the SEC is generalizing that the expectation of profits from investing in the token equals it being a security is a strict interpretation that is still unclear as there are many factors that could also apply for expecting token appreciation. I have a feeling that we will soon be seeing more of these settlements and agreements with the SEC that could establish a framework where the line between securities and non-securities could be created.

What are your thoughts on these latest updated from the SEC? Do you think they help clarifying the uncertainty that has held back ICOs this year? Let me know your thoughts and feedback in the comments below. I look forward to engaging with the community!

Sources:
https://www.sec.gov/news/press-release/2018-240
https://www.sec.gov/news/press-release/2018-264

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