Meet 125 Mgmt Teams
Long Story Short: Should Cryptocurrency be regulated like stocks?
Cryptocurrency and the Howey Test: Are They Securities?
(Note: companies that could be impacted by the content of this article are listed at the base of the story [desktop version]. This article uses third-party references to provide a bullish, bearish, and balanced point of view; sources are listed after the Balanced section.)
Are Cryptocurrencies securities? Should cryptocurrencies be regulated? Why? If so, by whom? These are just some of the questions with which regulators and the cryptocurrency industry are struggling. One of the key drivers behind the success of blockchain is its libertarian, anti-establishment set of beliefs. Fitting in with the regulatory bodies would seem to go against the beliefs upon which the blockchain ecosystem was built. (1) Historically, the so-called Howey Test has been used by the Securities and Exchange Commission (SEC) to determine if something is a security and, therefore, subject to securities regulation. (2) In 1946, the Supreme Court in S.E.C. v. W.J. Howey Co. stated that “an investment contract for the purposes of the Securities Act mean a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” (3) The SEC has used the Howey test to declare various items as securities, significantly outside the typically stock and bond realm. In fact, Howey involved a Florida citrus grove farmer who was selling portions of the acreage with investors to immediately lease back the acreage to Howey. (2) Nonetheless, cryptocurrency still lacks a single regulatory body. (3)
Cryptocurrencies Fit the Definitions According to the Howey Test. The SEC has deemed that cryptocurrencies pass the Howey Test and therefore are securities and subject to regulation. (2)
Investor Protection Is a Legitimate Concern. The Initial Coin Offering (ICO) craze that marked the end of 2017 highlights the importance of investor protection. (1) Many ICO’s operated outside the securities laws, to the chagrin of investors when numerous ICOs failed, costing investors their investments and with no place to turn for any potential recourse. Like many new, exotic investments, ICO’s and cryptocurrencies have attracted a fair number of hucksters and plain criminals playing on investors’ hopes to ride the next ICO to riches. In fact, cryptocurrency losses due to crime hit some $4.4 billion in the first nine months of 2019, up more than 150% from all of 2018. (4) Protecting investors is a key mission of the S.E.C.
Ongoing Uncertainty. There remains uncertainty about the “pooling of assets” test as a cryptocurrency investor simply exchanges money or services for an alternative form of payment. (3)
Fourth Test Hard to Determine. The nature of cryptocurrency makes the “efforts of the promoter or third party” test hard to determine. There is no “effort” or “work” in the background of a cryptocurrency which affects value. (3) Rather, value will depend on such issues as political and economic upheaval, government regulation, and media and trader enthusiasm. According to some, the “profit” and “efforts of others” prongs of the Howey Test substantially fail to consider both the economic purpose and the decentralized architecture of many blockchains hosting tokens. (5)
Not Clear All Tokens are Securities. Critics argue that the SEC’s report was worded in such a way that certain cryptocurrencies are securities but not necessarily all cryptocurrencies are securities. Some may fall short of the Howey Test. (2) According to the SEC, there is no defined black and white way to determine whether a digital asset can be classified as a security. The onus of proof depends on the type of transaction. (6)
U.K Taking a Different Approach. The U.K. Financial Conduct Authority issued consultative guidance that only digital tokens with clear contractual rights to cash flows or claims on assets should be subject to regulation and registration. (5)
Defining cryptocurrencies is an ongoing process. Currently, there remain blurred lines between the SEC and the Commodity Futures Trading Commission and conflicting state and federal regulations. (5) Investor protection is a laudable goal but at what cost? Continued reliance on a 1946 court decision could end up stifling innovation in the crypto space and push the economic benefits of public blockchains and cryptocurrencies outside of the U.S. (5)
- https://www.bitcoininsider.org/article/56434/pros-and-cons-more-regulated-blockchain-ecosystem, John Wu, January 22, 2019
- https://blockonomi.com/howey-test/, Oliver Dale, July 31, 2019
- https://jolt.richmond.edu/2019/03/11/application-of-the-howey-test-to-cryptocurrency/, Florian Uffer, March 11, 2019
- https://www.reuters.com/article/us-crypto-currencies-crime/cryptocurrency-crime-surges-losses-hit-4-4-billion-by-end-september-ciphertrace-report-idUSKBN1Y11WH, Gertrude Chavez-Dreyfuss, November 27, 2019
- https://www.fticonsulting.com/~/media/Files/us-files/insights/articles/2019/jul/what-howey-test-misses-about-crypto-assets.pdf, Boris Richard, June 28, 2019
- https://eng.ambcrypto.com/in-the-era-of-bitcoin-what-is-the-relevance-of-howey-test/, Aakash Athawasya, November 6, 2019