The Subcommittee on Capital Markets, Securities, and Investment held a hearing, “Examining Cryptocurrencies and ICO Markets,” this past Wednesday, March 14, 2018.
The stated goal of the hearing was to achieve greater regulatory clarity in the cryptocurrency and ICO markets, especially as these markets continue to grow and attract attention from investors and enterprises in pursuit of capital. Members of the subcommittee indicated that achieving this regulatory clarity would be critical to ensuring that investors are protected without unduly stifling innovation.
Toward that end, the hearing discussed the regulatory approaches being taken by regulators, such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), to monitor and oversee cryptocurrencies and ICOs.
In many ways the hearing mirrored the discussions that took place in a Senate hearing last month, held by the Committee on Banking, Housing, and Urban Affairs. For more information on that hearing, please read our prior post.
This hearing, however, placed a much greater emphasis on distinguishing pure cryptocurrencies, which have no issuer and are not securities, from tokens issued in ICOs, which very well may be securities depending on the individual characteristics of the of the tokens and the manner in which they are issued.
All witnesses, for example, agreed that the issuance of contracts for future tokens, essentially a promise to provide a token in the future, is a sale of securities. The witnesses, however, were not in total agreement on the classification of currently functional tokens issued in an ICO. Peter Van Valkenburgh, director of research at Coin Center, took a simplified approach indicating that in his view, a fully operational token that provides a utility function behaves as a commodity, and therefore would not constitute a security. Robert Rosenblum, a partner at Wilson Sonsini, dismissed this automatic characterization, stating that even a fully operational token could still rely extensively on the efforts of the promoter for an expectation of profits, a key factor in the Howey test for an investment contract, a type of security.
Indeed, the SEC has previously stated in its DAO Investigative Report that the facts and circumstances of each individual ICO or token sale will determine whether U.S. securities law applies, and SEC chairman Jay Clayton has also stated that an important aspect of this analysis is whether the token or offering incorporates features or marketing efforts that emphasize the potential for profits based on the efforts of others. Chairman Clayton expressed this position in the Senate Banking Committee’s hearing noted above.
These ICO and utility tokens, however, can still be distinguished from pure cryptocurrencies like Bitcoin and Litecoin, which do not have any issuer, are decentralized, and are not issued to raise funds. Mike Lempres, chief legal and risk officer for Coinbase, stated that Coinbase allows only these types of cryptocurrencies on its exchange platform and expressly prohibits tokens issued through ICOs or token sales because the regulatory standards are too unclear.
A related and recurring theme from the witness panel was the need for greater clarity in this area from regulators. Mr. Lempres in particular noted that more definite guidance would help the industry as a whole to comply with any applicable obligations, while uncertainty could chill activity in this rapidly evolving industry.
For more information on the SEC’s prior actions and statements on ICOs and cryptocurrencies, please see our prior posts on these topics included below.