If a cryptocurrency or altcoin is a security, it must be offered to US investors in an offering registered with the Securities and Exchange Commission ("SEC") or fit into an exemption.
Registration can cost anywhere from hundreds of thousands of dollars to well over a million, and requires that you disclose a lot of information you may not want public. So finding an exemption is usually the preferred route.
Right now, the main exemptions for securities offered in the US are: Reg D, Reg A+ and Reg CF. There is also Reg S for foreign securities offerings, and you’ll read about that in a separate post.
Preemption & Disclosure
Two quick notes before you learn about the exemptions:
Private offerings are the most common security exemption. The key feature that makes private offerings “private” is that you can’t “generally solicit” your offering, meaning you can’t publicly market it.
There is a broad “private offering” exemption via Section 4(a)(2) of the Securities Act of 1933. But Section 4(a)(2) is open-ended and determined on a case-by-case basis, so most private offerings are done through Regulation D ("Reg D").
The digital asset industry is experiencing increased regulatory scrutiny.
For example, Jay Clayton, Chairman of the Securities and Exchange Commission (“SEC”) bluntly said in his Congressional testimony: “I believe every ICO I’ve seen is a security.”
The upside of this attention is that you should want the Bitconnects of the world gutted by regulators.
The downside is blockchain-based businesses need to start treating their native cryptoassets as securities. Even tokens created pursuant to a SAFT aren’t likely safe based on recent SEC stances and statements.
As a result, you will likely see digital asset issuers increasingly relying on securities law exemptions.
One option is for ICOs that wish to be compliant is to qualify as an exempt securities offering under Regulation Crowdfunding (“Reg CF”). Indeed, some ICOs, like Indeco, have already used this option since late 2017.
Increasingly, traders use automated algorithms to execute trades, or at least track and flag indicators. And the use of this kind of code likely won’t slow down anytime soon.
In 2015, the Commodity Futures Trading Commission (“CFTC”) proposed Regulation Automated Trading (“Reg AT”) to deal with this trend.
Reg AT Rules
Reg AT is aimed at reducing market disruptions from automated trading. The best example is probably the May 6, 2010 “Flash Crash” when automated trading caused the S&P 500, Dow Jones and Nasdaq to crash and rebound almost 10% in 36 minutes (...tame compared to crypto, I know).
If implemented, Reg AT could require pre-trad risk controls by:
The "pre-trade risk controls" would include requirements like:
The rule would also impose registration requirements on traders that electronically submit orders directly to a DCM, without routing them through a member of a derivatives (aka, futures) clearing organization.
Crypto-famous CFTC Chairman Christopher Giancarlo has expressed concern over Reg AT potential chilling effects.
In legal context, "chilling" refers to the fact that too much regulation may slow or kill the development of innovation. E.g., regulation of crowdfunding is considered to have been implemented too quickly, stagnating the development of crowdfunding.
Given Chairman Giancarlo’s favorable treatment of crypto, it’s not surprising he’s hesitant to clamp down before the CFTC has more time to watch the development of relatively new technology develop.
Automated trading is valuable in and of itself, but all the algorithms, code and lessons learned in its development could transfer to other fields. It’s possible that a trading algorithm can pick up certain patterns that may surface in diseases, for example.
In early 2017, the CFTC extended the time period in which it was accepting comments on the proposed Reg AT to May 1, 2017. That day has come to pass, and no public developments have happened with Reg AT.
Given that the Trump administration is keen on less regulation, and Chairman Giancarlo’s is hesitant to regulate new tech too quickly, we may not see any form of the proposed Reg AT implemented at all.
It’s safe to say automated trading isn’t going anywhere. Eventually, regulations will need to be imposed to protect against flash crashes and fraud. But it doesn’t look like that will be happening any time soon.
You can read about the history of non-government money like Bitcoin here
You can read about Arizona's proposal to allow residents to pay taxes in crypto here
Crypto regulation stems from a few key sources:
What Are Commodities?
In everyday terms, commodities are raw materials or products. They are goods that are typically transformed into more consumable products or uses. Common examples are steel, coffee beans or pork bellies.
In the pork bellies context, Eddie Murphy gives some deep insight in Trading Places on how commodities investing works.
The Arizona Senate has passed a bill that would allow state residents to pay their taxes in cryptocurrency
Senate Bill 1091 still needs to pass in Arizona’s House of Representatives, but the fact a bill like this has passed in the Senate is unprecedented in the US. Under the bill, the Arizona Department of Revenue would convert the crypto tax payments into US dollars within 24 hours.
Fiat & Taxes
Ok, great, so Arizona is open to experimenting with crypto. So what? Why does it matter, especially if Arizona would just immediately convert the crypto to dollars?
Because there are convincing arguments that what makes fiat money valuable as “fiat” is the fact it’s the only currency the government you live under will accept for tax payments.
Colorado House Representative Jared Polis has petitioned the Congressional House Committee on Ethics to require that members of Congress should disclose any ownership of cryptocurrencies. Awesome.
Members of Congress are required to make certain disclosures about income and investments.
Right now most ICOs are for currencies or utility tokens. But there’s a third category that many believe will be more widespread and useful: security tokens.
What Is A Security Token?
A "security token" is a blockchain-based asset that functions like a traditional security. Instead of owning stock in a company, you would own a security token. That token would come with voting rights, distribution rights, and/or liquidation rights.
Security tokens are a way to bring blockchain efficiencies to traditional equity. Companies can issue tokens instead of stock, and have an up-to-date blockchain ledger of its shareholders at all times.
What Is A Money Transmitter?
Generally, a money transmitter is an entity that provides money transfer or payment services. Common examples include PayPal, Western Union and Barclays.
Federal Money Transmitter Laws
The Bank Secrecy Act and its related regulations impose anti-money laundering (“AML”) regulations on money service businesses (“MSBs”), which include money transmitters. If FinCEN determines an entity is a money transmitter, the consequences are that you must:
On March 18, 2013, FinCEN published guidance that it would not distinguish between fiat currency and digital currencies for money transmission law purposes. On January 30, 2014, FinCEN published additional guidance.
Generally, whether a person or entity handling crypto counts as a money transmitter depends what the cryptocurrency is used for, and for whose benefit. It does not depend on how it is obtained or how it labels itself.
Further, FinCEN distinguishes between “exchanges”, “administrators”, and “users”:
Based on FinCEN’s releases, activities must involve either “acceptance” or “transmission” of crypto to trigger the regulations:
State Money Transmitter Laws
Under state laws, a money transmitter must apply for a license. At the federal level, if you meet the above requirements, you can register with FinCEN. That is to say, FinCEN doesn’t exercise discretion over whether you get a license. But at the state level, even if you meet all of a state’s requirements, the state has discretion to deny your license. In other words, state money transmitter licenses are more difficult to obtain and less guaranteed.
State licenses typically have higher standards, like requiring audited financials, personal financial records of key personnel of the transmitter, background checks, fingerprinting, and bond posting requirements.
Importantly, state money transmission laws can apply to businesses that have no physical presence in the state if that business solicits or services any state citizens.
Many states have issued guidance. The below is a general summary as of August 2018. Please note that each state’s laws may have unique definitions of crypto or other nuances, and thus should be analyzed individually.
Reginald Young is a licensed attorney and practices in San Francisco, California, where he works with private investment funds and startups in the crypto industry. You can connect with him here.