Over the last year, cryptocurrencies, virtual currencies, initial coin offerings, and token sales (collectively “cryptocurrencies”) have taken off within the traditional venture capital space and among new market participants looking to take advantage of Blockchain technology.
There appears to be a race to get funds in the door.
“We don’t need to be perfect, we just need to be first!”
“Everyone else is doing this without jumping through all of these hoops!”
This attitude misses the mark and demonstrates a fundamental misunderstanding of regulation within the cryptocurrency space.
Government regulators are applying sometimes very old existing statutes and regulations to this new technology.
The SEC is applying the definition of “security” enacted as part of the Securities Act of 1933. 15 U.S.C. § 77b. That definition has been amended over the years and further defined through regulations and case law, including the “Howey Test.” The Howey Test was articulated by the U.S. Supreme Court in 1946 in SEC v. W.J. Howey & Co., and sets forth a four-part test to determine whether an agreement constitutes a security. The 70+ year old Howey Test is alive and well in recent SEC matters such as the The Dao Report and In re Munchee, Inc.
Similarly, the CFTC exercises jurisdiction over non-security cryptocurrencies as “commodities in interstate commerce” for matters involving fraud and manipulation. This includes the CFTC’s traditional fraud and manipulation authority, which was part of the agency’s original charge when it was created in 1974, pursuant to amendments to the Commodity Exchange Act, and authority granted for deceptive devices and other manipulative conduct as part of Dodd-Frank. But even the relatively modern Dodd-Frank, which was enacted a year after the creation of the Bitcoin network, failed to adequately consider cryptocurrencies. Still, the CFTC is using these older statutes and regulations in cases such as CFTC v. McDonnell, CFTC v. Dean. The CFTC has also overseen self-certification of Bitcoin futures contracts on both the Chicago Mercantile Exchange and CBOE Futures Exchange and registration of a swap execution facilities intending to offer virtual currency derivatives such as swaps and options.
The Department of Treasury’s FinCEN, which regulates money service businesses (e.g., Western Union, currency exchangers, check cashers) and whose mission is to combat money laundering, has also exercised jurisdiction in the cryptocurrency space. FinCEN has issued guidance and administrative rulings (similar to a “no action letter”) making clear that it views certain participants in the cryptocurrency space to be acting as money service businesses requiring registration where failure to register can constitute a criminal violation. FinCEN has also fined registered money service businesses such as BTC-e for allegedly facilitating money laundering.
A number of states have also applied pre-existing laws to cryptocurrencies. States like New York and Wyoming have adopted new laws generally regulating cryptocurrencies, while others have focused on amending requirements regarding state registration as a money transmitter business for certain cryptocurrency market participants. These include but are not limited to Georgia, Kansas, New York, North Carolina, Vermont, and Washington.
With federal and state agencies considering new cryptocurrency and Blockchain specific regulations ranging from clarification of jurisdictional elements to laws related to the use of Blockchain technology for traditional recordkeeping purposes, it is important abreast of new proposed regulations. However, it is equally if not more important to focus on the agencies’ applications and interpretation of existing laws.
At Shulman Rogers, we’re utilizing our past agency experience to review our clients’ proposals and make educated guesses about how the various agencies will treat different aspects of their ICOs. It’s a quickly moving landscape and those who fail to tread with caution do so at their peril.