The SEC Speaks On Tokens
Yesterday the SEC issued a report of investigation finding that DAO Tokens are securities under U.S. law. This report sent shock waves across the crypto sector leading to roughly 10% declines in the major cryptocurrencies. I must have received a dozen or more emails from people saying that “ICOs are over.”
I don’t think ICOs are over. I think regulatory clarity is going to be good for the crypto sector long term and while this report does not give us total regulatory clarity, it does give us some very valuable insights into what the SEC is thinking about tokens.
Specifically, we now know that:
- The Howey test is the regulatory framework through which to evaluate whether a token is a security.
- A token that return profits to holders will be considered a security.
We likely know a lot more regarding jurisdictional issues and what the SEC is going to regulate and what they are not. But I will leave it to the lawyers and other SEC watchers to weigh in on that. I am not a professional and don’t want to pretend to be.
At USV, we have been urging our portfolio companies and others in the crypto sector to get good legal advice before embarking on an ICO, investing in ICOs, and more. That legal advice, given as far back as several years ago, more or less anticipated much of what was in this report.
You could see this coming if you did your homework. None of this is surprising to me and to most of the folks in the crypto sector who have sought legal counsel on these matters.
In fact, if you look at all of the regulatory actions that have been taken in the US over the life of cryptocurrencies, you will see that it has mostly been straightforward application of existing laws, on AML, KYC, taxes, securities, etc. Almost all of this could be, and in many cases, was anticipated by those who took the time to consider what the regulators might do and would do.
None of this means that the crypto sector in the US (or elsewhere) won’t be harmed by bad regulations. That has always been a big risk to the sector and remains one. Regulators must be careful to “do no harm”, here in the US and elsewhere. To date, I would say they have done a good job on that. I encourage them to continue that track record.
But mostly I would encourage all entrepreneurs, investors, and others who are actively participating in the crypto sector to get good legal advice before doing anything significant. The regulators are watching. Closely. So know the rules and play by them.
The SEC report is well balanced, and a breath of fresh air for the industry. They didn’t come out against ICOs, but they signaled strong guidance for elevating the standards of ICO delivery. They poured some cold water on two key aspects that were weak links in the ICO value chain: 1) the over promotional aspects in communicating ICOs, 2) the lack of transparency in disclosing essential and non-obfuse information for consumers. The whole approach is much in line with what I have been advocating in the past 6 months. The SEC position re-enforces the need for increased discipline in ICO practices.
it’s a good moment. it helps to warn off the fraudsters, the scammers, and the schemers by giving the market a framework by which to assess any future project’s credibility. I hope that projects already out of the gate will be retrospectively influenced too, with crypto communities building activist groups that apply pressure on founders to enact internal reforms.
I hope you are right. It feels like the Fraudsters are a far bigger threat to the future than the SEC at this moment.
my default position is that the space is occupied by fraudsters, scammers, and schemers, and that i have to prove to myself that a project is not being run by such people before i invest/ donate. the problem i’m finding is that the legal structures being used by both fraudster and authentic founder are essentially identical in form. it encourages the authentic founder to become the fraudster somewhere down the road when the going gets tough and building a successful business becomes harder than they had original imagined. the flesh is weak.
I have to be honest. We had fraudsters in the trading community. The community was mostly self policing and tossed them out on their arses. Bitcoin is no different. The community must police itself. The SEC, Dodd-Frank, CFPB, FINRA, CFTC, Fed or any other agency will always be late. By the way, regulations didn’t get in the way of Bernie Maddof or any other fraudsters. Regulations set the sidelines, and regulators mete out the punishments when they are violated.Put your faith in the community, and the market. Not a regulator.
The complexity of the maths of financial instruments can be beyond the knowledge base of regulators. Top maths & CS graduates opt to join the investment banks / hedge funds / quant startups rather than to become regulators.So that’s an example of information and knowhow asymmetry too.
Warren Buffet put it simply, and I will mangle the math:- avg mortgage has 50 pages- you ‘collateralize’ 1500 mortgages- that means there are 75000 pages to read (yeah, right, I read them)People leading Wall St firms were very close to their results / bonuses, but had no actual idea what they were selling.
the technical composition of these communities makes collective policing a much less effective force in this space. online, virtual, anonymous/ pseudo anonymous, sock puppetry, decentralised, fractured, these characteristics don’t make for a cohesive constituency that counter balances the power of founders. i think it will take the strong willed individual to stand up and call people out for their behaviour before change will come.I would like to see the SEC charge someone with fraud. it would create a storm. it would help to cleanse the space and reset the terms.
We can start with someone actually going to jail for the 2008 credit/housing bubble fiasco.
.Therein lies the raw political power of Wall Street and their wallets.A Democrat administration was not going to punish a Democrat ruled state with Democrat Senators with a huge vein of Democrat political contributions.The outlandish impact of contributions from Wall Street was more powerful than the outcry from Main Street added to by the fact that Treasury under both Republicans and Democrats was a wholly owned subsidiary of Goldman Sachs.But, hey, you knew all of that, right?JLMwww.themusingsofthebigredca…
Yep. My comment was rhetorical.
This is one of the advantages of white men that golf together, or go to the same charity balls, no?In my (very small world) I remember telling my ex wife to be nice to her competitor (who ran a much bigger operation) because he would have a harder time screwing her if he knew her personally…Things they don’t teach you in a classroom in the Ivy League …
cons always early
The community was mostly self policing and tossed them out on their arses. Bitcoin is no different.I think it’s a bit more like trying to control spam (and now spam phone calls). Nobody in charge meets whack a mole.The framework to police wasn’t built in from the start (or near start) and things move to quickly. For example realtors police their ranks as do lawyers and physicians. It’s a well oiled machine. But here how would you propose to do the same given the ease of a bad actor setting something up? I am not seeing it.
And regulators didn’t do a heck of a lot leading up to or after 2008. And I still don’t see much in regards to Wells Fargo, either, relatively speaking.
.Different set of regulators and one could argue that the bankruptcy of Lehman (Dick Fuld and Hank Paulson not being friends) and the shotgun marriage of Merrill Lynch with B of A was punishment.Why was Lehman forced to walk the plank while ML got to go on a honeymoon with B of A?Throw in the debacle with AIG for good measure.JLMwww.themusingsofthebigredca…
Yep. Did you see the Hank Paulson documentary on Netflix, with him explaining his decisions? I wouldn’t want to be in his shoes, but still so much stink.ML was ‘lucky’ to survive and how Thain is still allowed in the room is a mystery to me.
.Paulson and Fuld were fierce competitors when Paulson ran Goldman and Feld Lehman. Feld was a hard edged guy who did a lot of sack dances. People forget he came up through the trading desks.On Sunday before the hanging, he called Paulson and begged for time and a bailout. No bueno.On the next Monday, Merrill and B of A were exchanging vows.Why?It was very, very, very personal and Paulson got his revenge. Big time.JLMwww.themusingsofthebigredca…
What hasn’t been talked about is that if an ico is a security, insider trading is in the table. To date, this is an insiders game. Best to bone up on the dos and donts.
.Not just insider trading — trading on material non-public information — but, also, Reg FD which requires certain disclosures being widely disseminated rather than tightly held.That sound you hear? That’s the can of worms being opened.JLMwww.themusingsofthebigredca…
From a trading perspective, I believe you’re right. But it’s not all red tape through and through.One of the benefits not being discussed is that these offerings can now, theoretically, take advantage of traditional safe harbors for issuance (Rule 506 offerings, etc…). That’s a positive development for legitimate issuances, regardless of token type or usage.
.No theory to it. Anybody who can meet the issuer criteria and get the docs done can do a traditional offering or a Rule 506 offering. I don’t think that has ever been at issue.The question is will such an offering be as successful as a naked ICO?It is the results that matter.BTW, did you and Wm M make contact?JLMwww.themusingsofthebigredca…
What is considered proof of wide dissemination of information by the SEC?
.A US SEC Form 8K, a public release on something like PR Newswire, a company website with sufficient traffic and supported by one more means of identifying the information.Many public companies meet their burden by making a Press Release on a regional or industry PR Newswire list plus an 8K which says, “Today XYZ company released the following information.”The SEC looks for a uniform method. If you do a PR Newswire release then keep doing them.JLMwww.themusingsofthebigredca…
Thank you JLM.
>That sound you hear? That’s the can of worms being opened.Some of your quotes  should be trademarked / monetized / preserved for posterity. Anyway, thanks for sharing them :) “Strong. Strong. Stronger than an acre of garlic.” being another one.
Is it too simple-minded to think of ICOs splitting into non-securities and securities based on whether the token buyers are substantially responsible for value creation? That is, token-denominated P2P networks where participants are the key part of value creation vs. simply tokenized equity/revenue/profit sharing in a third party where the token buyer has no material, active role?
@wmoug:disqus while the SEC may be applicable to the US. Their jurisdiction is limited there right? Mostly what this will do, is shift ICOs to favourable jurisdictions – places like Switzerland or Singapore where they are not out to just tax profits. What do you think?
But their job is to protect the US consumer, and they can reach almost any company almost anywhere in the world.
a lot of the initial appeal of these new technologies is regulatory arbitration; P2P lending, crypto, Airbnb, even uber/lyft show what a pain industries have become as a result of regulation.While they end up (for good reason) having to adopt some of this regulation, but they also showcase the innovation and cost efficiency afforded by a temporary free market island.
i will read the report.Securities Exchange Act 1934. https://www.youtube.com/wat…
CFTC also approved Ledger X. https://ledgerx.com/ I think that anyone trading Bitcoin should know the market is still small. Compared to other markets it’s teeny. It’s growing, but it’s teeny.
Not that size is everything, but …https://uploads.disquscdn.c…
Blogged about this today. This chart omits things like debt markets.
Good post. Still internalizing.More curious how you see this all impacting you not as a trader but as a VC.
Notional value of global OTC derivatives is at $483 trillion as at H2 2016 with gross market value at $15 trillion.I was watching a video on ‘AI is the future of fintech’ from the Applied AI conference and there was commentary from Visa on how they have microseconds to detect for fraud on transactions and they can do that quickly because they have lots of data points, more powerful machine learning algorithms and GPUs.That made me think about whether the same is true for blockchain.
The “outside-in” view.JLM has made this point about Bitcoin here a few times (I did too, but JLM has the “elegant” turn of phrase…something about something not being a pimple somewhere). He got critiqued that he had no idea how big Bitcoin had already become.Assume you are closely involved in Bitcoin since say 2010 or 2011. It is absolutely incredible to you how far Bitcoin has come, how big Bitcoin has become. You have watched it closely, you were right there as it happened. And you are right about how far it has come.You get a different perspective when you take the “outside-in” view.
I hear you and I believe in innovation. Going to $100+ billion in 8 years is no mean feat.I just didn’t jump on the bandwagon because, well, I’m solving a different problem and blockchain didn’t offer the right tools to do that so I focused on tools that might, e.g. quantum computing.
$85T is also global GDP. What is the GDP that bitcoin and crypto transactions are supporting?
Re: “This report sent shock waves across the crypto sector..”Really ? If somebody was modestly surprised, never mind shocked, by this, its a sign that they might not understand financial markets, regulations or, for that matter, nation-states.A duck on a blockchain is a duck. “When I see a bird that walks like a duck and swims like a duck and quacks like a duck, I call that bird a duck” – James Whitcomb Riley.
^ this guy gets it.There are some people out there who have been calling this out ever since the ICO wave came sweeping in.The ICO bubble has been one over run by fraudsters who were racing to make bank before it burst. Sure ICO can be an above board method of fundraising, but let’s be real, that wasn’t the intention of the many, many ICOs we’ve seen pumped so far.For the simple task of creating a cheap wix.com website, a few page long whitepaper, a dictionary of buzzwords and an Ethereum wallet, you too could be a millionaire from your bedroom. Course a few people were saying that these actions could land people in prison, but everyone else was doing it, why should you miss out, no one yet has gone to prison, but people have been made into millionaires.
“If it looks like a duck, and quacks like a duck, we have at least to consider the possibility that we have a small aquatic bird of the family Anatidae on our hands.”
Volatility will remain and is the hallmark of a very thinly traded market. This will help and maybe deter outright scams.Someone should come up with a VIX for these markets.
http://pointsandfigures.com… Tom might agree
Great read, thanks.
I’m not sure it has deterred scams.
no sheriff right now.
We will be able to calculate the VIX once we have options. No options, no VIX.
I’m surprised the terrorist/money laundering argument had not been trotted out with more vigor by the feds, as it had in so many previous instances of alternate currencies. I still expect it to come, or perhaps it to come in a selective form; ie use the approved government blockchain coin or get prosecuted as a money laundering enabler. It will be vital to stand your ground if/when this battle comes.
It’s out there, but at the moment, it’s confined to the realm of media jackals and fake news. It’s completely unfounded (the assertion that it’s only use is by criminals) and many professionals in the space know it, so it will have limited effectiveness.The Joe and Jane Smith’s of the world can be silly, but they’re not that dumb, particularly when they realize they can make money with it, too.
sure, though the reality of the problem is of little relevance to whether or not government will claim it is a problem in the interest of preserving dollar hegemony (or more broadly, nation-state hegemony). i believe this is the key battle that will determine the long term impact of virtual currencies, and i worry that the virtual currency community will find selective enforcement against such currencies not sanctioned by nation-state governments to be an acceptable compromise.
It will be part of the story as it unfolds, for sure. I’d like to see a conversation emerge about how money needs to be denationalized. Separation of money and state, will be as important as separation of church and state.
I think the Feds actually do not think that large amounts of anything will be distributed via Blockchains.
There was a debate ‘Crypto-economics is the paramount concept of this century’ last week and, afterwards, I listened to some non-engineer guys “mansplain” how the banks have never had P2P and distributed systems etcetcetc.Hmmn. given that I contributed to the blueprint of ECNs across the industry in my 20s and they were all P2P, distributed and #-secured, it was really funny to hear 20-something non-engineers talk out of their arses.In any case, early on I was trying to figure out if Merkle Trees would help with validating natural language understanding. https://uploads.disquscdn.c…It’s just SO INEFFICIENT structurally that I don’t bother with it.
Good on you to just enjoy the show rather than tune their ignorant behinds.
Does anyone think the SEC got it wrong? That their decision shows some sort of gross misunderstanding of crypto/blockchain/tokens etc? As a layman, this decision feels right but wondering if people who know more feel otherwise.
A factor that hopefully isn’t in play – it might depend how much crypto-assets the people in charge of these decisions currently own/control.
Yes, that is an agency issue which is not specific to crypto. Greed can factor into any decision and I imagine SEC has controls in place for this.I am more wondering if this call by the SEC shows gross misunderstanding of the technology in any ways.
This falls in the “no free lunch” category. I’m not a regulator, but people aren’t going to be able to trade “digital widgets” that fluctuate by +/- 100% a day, make/lose massive amounts of money, without some regulatory scrutiny. This seems like a very reasonable ruling.
Agree. This is a long-term positive.Many have noted that the true value of ICOs is in aligning incentives of investors, developers and users — i.e., advancing the FUNCTIONAL VALUE of the network the ICO is developing and creating strong network effects.The reality has been that ICO growth has been fueled by the SPECULATIVE VALUE of ICOs. The short-term incentives of whales and day-traders work against the long-term interests of solid network growth.This SEC guidance will help separate the wheat from the chaff.
Can anyone explain how the SEC would protect domestic markets from an ICO issuer that is domiciled in a foreign jurisdiction?
I would agree, and also say the it puts US firms at a disadvantage in the inverse. If you follow the SEC guidelines and register your security, then issue it on a blockchain, it can end up in the hands of Canadians, British, French, etc.Now you have declared that you consider what you issued a security (no deniability), AND you did not register it in those foreign jurisdictions.
Good question, largely unanswered. A few thoughts:1) Deterrent value likely significant. “Fear” of SEC prosecution will inhibit ICOs located in US or w/ ties to US, e.g., a) Larger/sophisticated ICOs will avoid US investors, e.g., EOS. b) Difficult for at least some ICOs to become mainstream w/o US investors and/or ties. While technically possible for U.S. investors to invest in non-U.S. ICO, this is beyond the sophistication of most. NOT a mainstream activity.2) SEC can go after exchanges w/ US location and/or ties.3) Some (a lot?) of ICO innovation will be offshored. SEC can still claim success here.
Naval nailed it on The Twitter last night: 4/ Blockchains are distributed ledgers which track tokens. The tokens can represent securities, currencies, assets, rights… case by case.— Naval Ravikant (@naval) July 26, 2017 <script async=”” src=”//platform.twitter.com/widget…” charset=”utf-8″></script>If your token quacks like a security, it will be subject to the SEC.
I would encourage all entrepreneurs, investors, and others who are actively participating in the crypto sector to get good legal advice before doing anything significant. The regulators are watching.Also lobbying. Noting both @fredwilson and @wmoug:disqus here:https://coincenter.org/aboutBut any individual or company can do this as well by setting up meetings with regulators and other government officials, congress and so on. Not hard to do at all.
.If you have never had a reason to read an SEC report, this is a good one to start with as it is extremely well written. Absent the securities discussion, it is the best explanation of what happened with DAO, the theft, and the solution — which was a nifty bit of maneuvering by DAO. Well played.Those who are suggesting it is a “breath of fresh air for the industry” must have been breathing some very nasty air up until this point.This report says that cryptocurrency is a security and, therefore, subject to the 1933, 1934, and 1940 Acts. This is the same regimen of securities laws which governs the issuance of stock by companies such as Exxon/Mobil. It is why you hire Goldman Sachs or another top flight investment bank to handle your IPO. It does not get any more regulated than this. This is the big leagues.The issuance of a security requires the preparation of a prospectus (offering memorandum) which has to be submitted to the SEC for review and comment. Make no mistake, there are preliminary docs which never make it across the finish line. It is a huge hurdle. An issuance under the SEC obviates the necessity for an issuer to obtain individual state approvals. It is a “blue sky” provision.There are a number of exceptions, such as private offerings, which are modestly complicated but they have a limitation as to how much one can raise.If you are a bit of a student of the SEC, this is a methodology they use to put folks on notice, give them a chance to get right with the SEC, before beginning enforcement actions against specific issuers. This has happened with a number of “new” ideas and is often done in concert with the IRS when their are income tax implications.It also does something else very important — it signals the magnitude of the penalties for those who ignore or violate the rules. The SEC will ban a transgressor from the securities business for life at the drop of a hat. It will be interesting to see what they consider to be “the securities business” when they start going after people.Look to guys like Mike Millken, et al, who were banned for life from the securities business on the tail end of the junk bond business.JLMwww.themusingsofthebigredca…
What happens to the ones that Bill Burley has been banging out. Are they then subject to SEC regs going forward and for the past offering?
.As a general proposition, when you screw up with the SEC, you go meet with them and get a letter telling you exactly what you have to do to rehabilitate your prior actions.When I was running an SEC reporting company, I used the term “EBITDA” in either a 10K or 10Q which is not a GAAP defined term. The SEC sent me a letter chastising me with the advice that I had to in the future “derive” the term from GAAP defined terms.The letter was 3-4 pages and was like reading a DIY manual on taking out your own appendix. I made it a point to comply with their requirements and never heard another word from them.I suspect there will be a lot of meetings with the SEC trying to sort this stuff out.I never found them to have a sense of either perspective or humor, but they would tell you exactly what they wanted you to do in excruciating detail. I just used to do it and move on.JLMwww.themusingsofthebigredca…
That’s an important judgement call to be able to make.As part of our move to The Great State, I became embroiled in Dodd / Frank regulations with a bank. They were doing everything they could to complete what we were trying to complete, but the things they had to have in the file were surreal.Late in the game, Michele started to ask a couple of questions (we’re talking Day 66 of a 72 Day process). I said to her:’ I stopped asking question about 3 weeks ago, other than – what do we need to do. ‘If you started to ask Why, you were DOA.
I don’t see the big deal in it. It was expected, and anyone who didn’t include this possibility in their business plan was naive.But the SEC has limited reach on this global tech. Anyone, anywhere, who really wants to participate in an ICO will find a way to do it.As to their U.S. jurisdiction, no laws or regulations will prevent anyone from making poor decisions with their money be it gambling, stock market, credit cards, credit default swaps, real estate, or Ethereum ICO’s.One way people learn, is by letting them get burned once or twice.On the other hand, if the blockchain networks – particularly Ethereum – are less congested by scammy ICO’s now, then good. To paraphrase MyEtherWallet.com, “It’s like none of you have ever heard of a Nigerian prince before.”Side note: South Korea just legalized BitCoin. So has Japan, Australia… who else? The U.S. has to be careful to not isolate itself with a great regulatory firewall, weakening our global competitiveness on this emerging technology.
The whole statement is bizarre. I suppose it could be twisted into being called a “security” in the pure financial definition of the word, but there is no equity. I own no shares of a company nor have voting rights, simply for owning a few Random ICO tokens. Unless you’re riverboat gambling with the college fund, the risk is minimal and quite trivial.This is far from the last word. It will and should be challenged. I welcome it. Let the broader conversation begin.
.The definition of a security is broad and inclusive. I assume you are using the word “equity” in the traditional sense meaning the ownership of something of direct and tangible value, such as common stock in a company (public or private).There are simple promises which are securities under the law — a stock option is an example.There are debt securities — bonds — which are securities under the law.A promissory note can be a security.The second something is a security the issuance, representations, warranties, disclosures, suitability of investors (accredited v non-accredited), sponsorship become legal issues.JLMwww.themusingsofthebigredca…
It seems to be an interesting decision tree. I wanted to ask your opinion about it:1. Register securities or not? If one registers the tokens as securities, it seems they are simply in the same boat in terms of requirements as any publicly traded company.2. If not, then how far does one get situating the corporation in Zug or Israel? The USA seems to require some disclosures for foreign companies. But if the securities are traded on a foreign exchange, it seems a new rule in 2008 removed the requirement to register them!3. On the Federal level, you’re totally right that the Howey test is the main thing. Perhaps one can argue that their crypto-tokens are not securities, and hope that a federal court agrees, or that by the time the thing ever gets to a federal court, you have enough capital to handle the heat (the Uber mentality).4. But which provisions of the Howey test will most likely be different for most cryptos? Very few crypto-tokens will be able to “prove” that no one can reasonably expect them to appreciate in value as they get more and more usage from network effects. So, it has to be something else. Perhaps the idea of a “common enterprise” can be redefined by some precedent, which determines that “decentralized control” by consensus of the majority of all participants is different than an enterprise run by a management team. I would like to see some sort of bill passed amending the 1933 Securities Act before case law is established by some court.5. How relevant do you think the Risk Capital Test will be? At the state level, there are many Western states including California which have a much broader view of what constitutes a security, ever since Silver Hills. It’s been endorsed, though not adopted, by the SEC and other states. So state courts may still have a complaint. And I can’t think of a good way to make *any* ICO not qualify as a security under that test.
Oh yeah, there’s also another option: make a Decentralized Autonomous Corporation so no one can really go after you, and anonymously sell all your shares in it 😛
.There is a presumption under Federal law that an agency of the US gov’t is usually correct in their interpretation about matters within their purview.JLMwww.themusingsofthebigredca…
1. “The Howey test is the regulatory framework through which to evaluate whether a token is a security.”2. “A token that return profits to holders will be considered a security.”I (not a lawyer) don’t think #2 is necessarily true… I think it has to do with whether value (profits) are derived materially from investors’ activity. I could start a band, create a bandcoin, advertise for a drummer and zither player, require them to buy bandcoins to join the band, and then distribute all the proceeds from our MSG gigs proportional to coin ownership. I don’t think that violates Howey and is therefore not a security.At least I hope that’s the case because we just brought on an awesome zither player.
Does anyone believe this will encourage US companies to launch a Token / ICO outside the US and simply assert in their white paper that it’s not open to people in the US – knowing full well that people will use VPNs to get around IP blocking should companies decide to take the extra effort to demonstrate that they are close for business in the US.
Fred, I think this test is oversimplification. The real test should be to consider whether this is like a rewards based crowdfunding or an equity based crowdfunding. I think Tim Drapers recommendations sound good:1.If the purpose of a token is for investment, it must register with the SEC. 2.If the purpose of a token is for societal transformation, and all proceeds go to the support and development of the token, it need not register.3.If the purpose of a token is to raise money for a company, and the money is used to support the company, it must register with the SEC.see: https://www.linkedin.com/fe…