Bitcoin broke into mainstream contention a little less than a decade ago and since then has kicked off a financial storm with the cryptocurrency market valued at over $400 billion today. Companies have scurried across creating altcoins - the alternatives to Bitcoin - in a mad race to capture the digital currency market, which to an extent looks like the 21st century California Gold Rush.
As blockchain started captivating the attention of potential investors, businesses started to branch out from initial public offerings (IPOs) to creating initial coin offerings (ICOs) doling out tokens which acted as the stock of the company. ICOs work quite like the IPOs, but instead of public stocks, it creates cryptocurrency tokens, that would be sold to investors in return for a FIAT currency or an established virtual currency (like Bitcoin). Companies creating an ICO campaign would initially publish a white paper, listing what the project is about, and the amount to be raised to complete the project.
There has been a lot of confusion with regard to regulations on ICOs, and Jay Clayton, the chairman of Securities and Exchange Commission (SEC) went on CNBC to insist that the selling of security-like tokens in an ICO must obey the rule of law.
"If you have an ICO or a stock, and you want to sell it in a private placement, follow the private placement rules,” he said. “If you want to do any IPO with a token, come see us, file financial statements, file disclosure, take the responsibility that our laws require, and we are happy to help you do that public offering.”
But the definitions surrounding a token is still hazy, as it is not very clear when a cryptocurrency token would be considered a security. Clayton cleared it up by explaining what constitutes a token that acts as security. “A token, a digital asset, where I give you my money and you go off and make a venture, and in return for giving you my money I say ‘you can get a return’ that is a security and we regulate that,” he said. “We regulate the offering of that security and regulate the trading of that security.”
Thus in the eyes of the SEC, this would mean that a lot of ICOs would fall under the realm of securities. Then again, Clayton refused to comment on specific crypto assets like XRP of Ripple Labs or Ether of Ethereum, if they would count as security. What he kept insisting though was that the SEC would not go against the tide and try changing the traditional definition of securities to suit the cryptocurrency debate.
But as the cryptocurrency market is seeing a growth explosion every year, it is imperative to clearly see the divide on the type of coins that fall under securities. For instance, Ripple Labs has been under fire lately, being sued by an investor who claims to have incurred losses while trading XRP coins - the cryptocurrency token offering of Ripple Labs - accusing the company of violating federal and state securities laws. In defense, Ripple Labs argues that the XRP should not be classified under security, but also maintains that the SEC should be the final authority on the decision.
The solution to this predicament rests in the Securities Act of 1933 and the Securities Exchange Act of 1934, that outline the government’s view towards financial regulation. The “Howey Test” of 1946 constituted by the U.S. Supreme Court has been used to determine the type of transaction that can be considered as an investment contract. It classifies a security as an investment of money in a common enterprise in which the investor expects profits mainly from the efforts of others.
Though the SEC is treading carefully on the cryptocurrency turf, it does not plan to ban the ICO method of fundraising, which was clarified by Robert Jackson, the Commissioner of SEC. The agency is wary of pump-and-dump schemes that are particularly common in ICOs, and declaring every ICO as a security would help dissuade bad actors from taking advantage of what still remains to be a largely unregulated system.
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