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The United States Securities and Exchange Commission has its attention focused on the growing cryptocurrency markets, both nationally and globally.

Earlier today, the SEC praised the North American Securities Administrators Association (NASAA) for its statement today urging investors to exercise caution while considering any cryptocurrency investment.

According to the NASAA statement:

A NASAA survey of state and provincial securities regulators shows 94 percent believe there is a “high risk of fraud” involving cryptocurrencies. Regulators also were unanimous in their view that more regulation is needed for cryptocurrency to provide greater investor protection.

Please note that this is the opinion of regulators, many of whom probably don’t completely understand cryptocurrencies.

“The recent wild price fluctuations and speculation in cryptocurrency-related investments can easily tempt unsuspecting investors to rush into an investment they may not fully understand,” said Joseph P. Borg, NASAA President and Director of the Alabama Securities Commission. “Cryptocurrencies and investments tied to them are high-risk products with an unproven track record and high price volatility. Combined with a high risk of fraud, investing in cryptocurrencies is not for the faint of heart.”

The Bitcoin Coaches echo that statement from the standpoint that we do not advise ever investing in something you don’t understand. We believe that in this case, the regulators are taking positions on something they don’t completely understand, which is almost as dangerous.

SEC Chairman Jay Clayton said in December that most cryptocurrencies claim that they are currencies, and therefore not securities — and therefore not falling under the SEC’s purview.

“Whether that assertion proves correct with respect to any digital asset that is labeled as a cryptocurrency will depend on the characteristics and use of that particular asset,” Clayton said. “In any event, it is clear that, just as the SEC has a sharp focus on how U.S. dollar, euro and Japanese yen transactions affect our securities markets, we have the same interests and responsibilities with respect to cryptocurrencies.  This extends, for example, to securities firms and other market participants that allow payments to be made in cryptocurrencies, set up structures to invest in or hold cryptocurrencies, or extend credit to customers to purchase or hold cryptocurrencies.”

Clayton mentioned the growing number of ICO’s (initial coin offerings), which he said appear to have the characteristics of a security.

“A key question for all ICO market participants: ‘Is the coin or token a security?’ As securities law practitioners know well, the answer depends on the facts,” Clayton said. “For example, a token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders.

“In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come.  It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens,” Clayton continued, adding:

Prospective purchasers are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the efforts of others.  These are key hallmarks of a security and a securities offering. 

“By and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws.  Generally speaking, these laws provide that investors deserve to know what they are investing in and the relevant risks involved,” he said.

The United States Securities Act of 1933 defines a “security” as:

“any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘security,’ or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”

The definition was written in the 1930s, so cryptocurrencies are not addressed by name. Much like initial public offerings (IPOs), ICOs are often advertised as an opportunity to get in on the ground floor of a new entity before the sale is opened to the general public. It is this similarity to stock that cryptocurrency creators and holders should keep in mind moving forward. It is what regulators are likely to seize upon as they try to create rules to change the way ICOs are executed.

It appears that ICOs are in the regulators’ crosshairs, but eventually, all cryptocurrencies will be the target.

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