The Uncertain Future of Bitcoin Regulation
Many of us have closely followed or participated in the current frenzy surrounding Bitcoin, but how is Bitcoin regulated by the law? Does the regulation of oranges relate to the regulation of Bitcoin? Surprisingly enough, it does. In 1946, the decision in Securities and Exchange Commission v. W. J. Howey Co. et al. redefined the term “security.” The case involved an orange-growing business in Florida that offered citrus grove developments as well as contracts for raising and returning the proceeds to the investor. Interestingly, this case about oranges from almost half a century ago serves as a crucial precedent to the current regulatory environment surrounding cryptocurrency. Before this case, a security was defined in Section 2(a) of the Securities Act of 1933 as documents traded for investment, or an investment contract; the Act did not define the term “investment contract.” In his opinion for SEC v. W. J. Howey Co. et al., Justice Murphy defined an investment contract as the placement of capital or laying of money in a manner intended to secure profits from the efforts of a third party. An investment contract essentially entails one party giving money to another in order to grow and manage these profits; then, the money is relayed back to the original investor.[1] The case established the Howey Test, a four-pronged assessment that determines if a transaction is an investment contract. The four criteria outlined in the test include: an investment of money, an expectation of profits from the investment, the investment of money in a common enterprise, and profit from the efforts of a third party.[2] This definition is broad enough to theoretically include Bitcoin and other cryptocurrencies, and, if found legally permissible, it will allow the SEC to fully regulate the cryptocurrency market under the Act, which in turn would diminish its value.
Currently, Bitcoin’s reach is is beyond that of any national government, including the United States. Created in 2009 by an unknown group called Satoshi Nakamoto, Bitcoin was the first decentralized currency in the world. There are no middlemen in Bitcoin transactions: the owners are anonymous and all transactions are digital.[3] The cryptocurrency possesses several key characteristics tied to its value as a commodity including: lower transaction costs, protection from inflation, and independence from any policy or contemporary official currency. Its anonymity protects users from identity theft. Finally, Bitcoins and other digital currencies come to market through Initial Coin Offerings, or ICO’s. An ICO is a fundraising event where a digital “coin” is issued in exchange for payment. ICO’s are typically advertised online and involve the issuance of a “white paper” describing the nature of the coin. The investors will then transfer their money to the issuer’s account and receive coins in return.[4] As of yet, no ICO’s have been registered with the Securities and Exchange Commision (SEC), which has recently caused a great deal of controversy.
The majority of Bitcoin’s value stems from its independence from government regulation, but in the United States, more lawmakers are pushing to regulate this market, as many ICO’s have recently been fraudulent. According to a forthcoming MIT study, an estimated $270 to $317 million of ICO money has “gone to fraud or scams.”[5] There are two notable upcoming cases both involving fraudulent ICO’s which are vital to note, as they will likely determine whether cryptocurrencies like Bitcoin ought to be considered securities. Typical securities in the financial markets include stocks, bonds, and financial derivatives. Bitcoin and similar cryptocurrencies are officially considered commodities, which allows them to avoid regulations which affect the former group. In the first case, the SEC sued Brooklyn resident Maksim Zaslavskiy for falsely promoting digital currencies backed by investments in real estate and diamonds. The second case also involves an SEC suit against PlexCorps, an entity operated by Dominic Lacroix and his romantic partner, Sabrina Paradis-Royer. Lacroix violated the Securities Act by issuing a fraudulent ICO (PlexCoin Tokens). He accumulated $15 million in investments from thousands of investors who bought 81 million PlexCoin Tokens because of deceptive and misleading statements made online: Lacroix claimed that there is a global PlexCorp team (there is not), the investment proceeds would go towards PlexCorps products (it went to personal expenses), and investors could expect enormous returns (which did not materialize). These cases, as well as multiple subpoenas by the SEC, signal a crackdown of regulation in the cryptocurrency market. In fact, the Zaslavskiy case will determine if the SEC can even consider the digital coin a security. The government has until March 19 to file the argument, and the court will likely use Howey as precedent. If the SEC can ultimately consider digital coins securities via the Howey Test, then ICO’s will be regulated as Initial Public Offerings (IPO’s), which undergo heavy regulations prior to their approval.[6]
These cases follow a warning issued by the SEC in the summer of 2017 concerning the properties of ICO’s. The SEC found that the Decentralized Autonomous Organization (DAO) tokens issued in 2016 were securities. In their investigative report, the SEC concluded that the offer or sale of a digital asset by a virtual organization is subject to federal securities laws; offers and sales included ICO’s and Token sales. However, the SEC did not universalize this finding to apply to every ICO. This means that each ICO will be subpoenaed and evaluated on a case-by-case basis until the court rules on whether digital currencies are securities.[7]
Cryptocurrency investors and followers worry that increased regulation will result in a price crash from Bitcoin as well as other notable cryptocurrencies. Recently, the value of Bitcoin has fallen from a high of $19,343.04 in January to $9,960 today (March 8, 2018). This drop in value is in large part due not only to increased regulation in the U.S., but around the world as well. The increased domestic subpoenas, as well as the SEC probe, have destabilized Bitcoin’s price. Several other countries, including India, South Korea, and Japan, have cracked down on traders. This serious crackdown overseas has decreased Bitcoin’s value, and if the U.S. continues on this path to increased regulation, similar price drops may occur in the future. As these crackdowns seem likely, investors and the general public may need to think twice before buying more coins.
[1] Supreme Court. SEC v. Howey Co. 1946.
[2] “What Is the Howey Test?” Findlaw, consumer.findlaw.com/securities-law/what-is-the-howey-test.html.
[3] “What is Bitcoin?,” CNN Money, accessed June 5, 2017, http://money.cnn.com/infographic/technology/what-is-bitcoin/.
[4] Clayton, Jay. “Statement on Cryptocurrencies and Initial Coin Offerings.” SEC Emblem, 11 Dec. 2017, www.sec.gov/news/public-statement/statement-clayton-2017-12-11.
[5] Eaglesham, Jean, and Paul Vigna. “Cryptocurrency Firms Targeted in SEC Probe.” The Wall Street Journal, Dow Jones & Company, 28 Feb. 2018, www.wsj.com/articles/sec-launches-cryptocurrency-probe-1519856266.
[6] Pierson, Brendan. “New York Man Charged with Conspiracy to Defraud Investors.” Reuters, Thomson Reuters, 1 Nov. 2017, www.reuters.com/article/us-usa-crime-cryptocurrency/new-york-man-charged-with-conspiracy-to-defraud-investors-idUSKBN1D168G.
[7] “SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities.” SEC Emblem, 25 July 2017, www.sec.gov/news/press-release/2017-131.