When Is A Digital Asset A Security?

September 28, 2021 10:00 AM
Crypto Story of the Day

Crypto Story of the Day




The SEC has responded to a policy recommendation to ‘clarify the status of digital assets to make clear when it is a security’–the response suggests the regulator believes it has offered clarity on the issue.

Crypto Story of the Day

The SEC released a summary of proceedings from the 40th Annual Small Business Forum held in May. The summary included responses to policy recommendations made during the event, one of which was ‘[clarifying] the status of digital assets to make clear when it is a security.’ The SEC’s response explains that in determining the applicability of securities laws to crypto, a central consideration is whether or not the token ‘is a security.’ 

The response notes that in the 2017 DAO Report, the agency explained how the ‘Howey test’ applies to cryptocurrencies, and in 2019 the SEC’s ‘FinHub’ published a framework for analyzing whether a token is a security. The DAO report, released in July 2017 and ahead of the ICO market’s peak and subsequent collapse in December/January 2017/2018, ‘[cautioned] market participants that offers and sales of digital assets are subject to the requirements of the federal securities laws….’ The report also explains that ‘securities exchanges providing for trading in these securities must register….’ 

In 2019, FinHub, the SEC’s body for overseeing and responding to emerging tech, published the Framework for ‘Investment Contract’ Analysis of Digital Assets. The guidance was written for those ‘engaging in the offer, sale, or distribution of a digital asset.’ The framework discusses the Howey test prongs: a) the investment of money; b) the existence of a common enterprise; c) a reasonable expectation of profits derived from the efforts of others. 

For example, the guidance explains that when a crypto network is ‘still in development, the network or digital asset is not fully functional. Therefore, purchasers would reasonably expect an [active participant of the network] to further develop’ its functionality. This, according to the SEC, is indicative of a ‘reliance on the efforts of others.’ 

The guidance also explains that if a token gives ‘the holder rights to share in the enterprise's income or profits or to realize a gain from capital appreciation,’ among other factors, ‘the more likely it is that there is a reasonable expectation of profit.’ 

Earlier this month, Coinbase CEO Brian Armstrong criticized the SEC’s approach to regulating crypto. The CEO alleged the agency is ‘refusing to offer any opinion in writing to the industry on what should be allowed and why, and instead are engaging in intimidation tactics behind closed doors.’ The SEC has maintained a practice of not revealing which assets were deemed securities when bringing charges against businesses for securities-related violations. For example, when the SEC charged ICO listing website Coinschedule with ‘unlawfully touting digital asset securities.

In response to the Coinschedule charges, SEC Commissioners Hester Peirce and Elad Roisman described the omission of which tokens were deemed securities as ‘symptomatic’ of a reluctance to offer guidance on which tokens triggered the enforcement action. However, the SEC’s response to the policy recommendation from May suggests that such criticisms are not affecting the agency’s view that existing guidelines are sufficient for crypto businesses to adhere to securities laws. The response also indicates that crypto’s technical novelty does not prevent existing financial rules from applying to the space.

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