According to a recent speech in San Francisco, earlier this month by Securities and Exchange Commission (SEC)’s William Hinman, Ether – the cryptocurrency behind the Ethereum network – should not be regulated in the same way as stocks and bonds.
These comments, by Hinman, the SEC’s director of the division of corporate finance, speaking at the Yahoo Finance All Markets Summit, come less than a month after similar comments made by SEC chair Jay Clinton. Hinman’s speech offers insight into how the U.S. securities regulator regards Initial Coin Offerings (ICOs) and Initial Token Offerings (ITOs), which are almost always seen by regulators in both Canada and the U.S. as securities, versus the actual cryptocurrencies themselves, which are not.
“Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?” asked Hinman. “I believe in these cases the answer is a qualified ‘yes.'”
Hinman explained that through ICOs and ITOs, some promoters, in order to raise capital to develop networks that will operate digital assets, will often sell coins and tokens much in the same way securities are sold. Funds are raised through token offerings, he said, with the expectation that the promotors will successfully build their system and the investors can make a return. That kind of economic transaction, says Hinman, passes the SEC’s sniff test of whether there is an investment contract and therefore the coin or token offering is a security.
Whether a coin or token offering constitutes an investment contract is the same test used by Canadian regulators to determine if an offering is a security.
Hinman noted while some industry participants may prefer a blockchain mediated crowdfunding model in order to reach a global audience, he thinks that some may now be finding it easier to start a blockchain-based enterprise the more conventional way. “In other words,” he said, “conduct the initial funding through a registered or exempt equity or debt offering and, once the network is up and running, distribute or offer blockchain-based tokens or coins to participants who need the functionality the network and the digital assets offer.”
When it comes to the tokens themselves, he says, it’s different. Tokens – the digital assets – he observed, “is simply code.” It’s the how those assets – the tokens – are used, he said, that provides the all-important context that determines, whether there is an investment contract – and therefore a security involved. “The way it is sold,” Hinman said, “as part of an investment to nonusers by promoters to develop the enterprise – can be in that context, and most often is, a security – because it evidences an investment contract.”
It’s this logic, he noted, that could lead to a point when a digital asset transaction may no longer represent a security offering. “If the network on which the token or coin is to function is sufficiently decentralized, where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts, the assets may not represent an investment contract.”
From a regulatory standpoint, Hinman added, increased network decentralization may also pose its own share of issues. “As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult and less meaningful.”
When Hinman looks at cryptocurrencies like Bitcoin and Ether, he said he doesn’t see a third-party who is a central actor filling that key managerial or entrepreneurial role. Therefore, applying securities laws to the offer and resales of Bitcoin, he said would have “little value,” while he believes the current offer and sales of Ether “are not securities transactions.”
“Over time,” he added, “there may be other sufficiently decentralized networks and systems where regulating the tokens or coins that function on them as securities may not be required.”
For more information, please call Barbara Hendrickson at BAX Securities Law (416) 601 -1004.
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