Cryptocurrency Regulation Update (October 2018)
This piece is part of a monthly series covering regulatory updates related to cryptocurrencies (here are the updates from July, August, and September). This piece provides important regulatory updates since the September piece, broken down by developments in the United States and the rest of the world.
United States
- A federal judge ruled that U.S. securities laws may cover an initial coin offering (Sept 11th), potentially giving securities regulators the legal purview to regulate the large initial coin offering market. Coinschedule.com estimates that more than $18 billion has been raised via ICOs so far in 2018, a figure that more than triples the $5.6 billion raised in ICOs over the entire year of 2017. The case dealt with a man charged with promoting digital currencies backed by investments in real estate and diamonds. According to Bloomberg, “U.S. District Judge Raymond Dearie in Brooklyn, New York, said on Tuesday that the government can proceed with a case alleging that an initial coin offering is a security for purposes of federal criminal law.” While the case is interesting given that it is linked to the fundraising mechanism of an ICO, the sale conducted in this scenario clearly resembles a security given that the tokens being sold represent a claim on physical assets (real estate and diamonds in this case) rather than a sale of tokens that provide “utility” in a network. This second category of “utility tokens” that do not represent a claim on assets or cash flows from a business is a much more interesting scenario that implicates large existing cryptocurrencies, like Ethereum. Earlier this year in June, SEC Director of Corporate Finance William Hinman stated that he did not believe that Ethereum should be treated as a security. Additionally, he suggested that an asset could be born via an ICO process and transition from being a security to not be a security. Future editions of this series will provide updates on the case and implications for the ecosystem.
- Chris Giancarlo, Chairman of the CFTC, advocated for avoiding regulation that may unnecessarily hamper the growth of the cryptocurrency industry (Sept 14th). Chairman Giancarlo made an analogy to the early days of the internet, which he says flourished in part because the government avoided stepping in too heavily when it instead applied a “do no harm” approach. Relating this analogy to cryptocurrencies, he explained that he is “advocating the same approach to cryptocurrencies and all things having to do with this new digital revolution of markets, and of currencies, and of asset classes.” He was direct in addressing malicious behavior, however, and made clear that “when it comes to fraud and manipulation, we need to be strong. When it comes to policy making, I think we need to be slow and deliberate and well informed.” The CFTC ruled in 2015 that virtual currencies should be considered commodities and regulated under the existing legal framework. Given that many aspects of the cryptocurrency space are novel, it will be difficult for regulators to separate fraud from innovation early on. It will be interesting to see where regulators land on the balance between protecting investors and allowing creators of cryptocurrency projects to experiment with crowdfunding and incentive structures for holders and participants in cryptonetworks.
- A group of cryptocurrency industry members met with members of Congress to express the collective desire for greater regulatory clarity in the industry (Sept 25th). Representatives from firms like Fidelity, Nasdaq, State Street, Andreesen Horowitz, and 40+ other industry participants lobbied for greater regulatory clarity while expressing the urgency for action due to the risk of losing innovation in the space to other regions of the world that offer more concrete regulatory policies. Jesse Powell, CEO of crypto exchange Kraken, explained the advantage that foreign competitors have in the capital raising process by explaining that “foreign companies are able to outraise their U.S. competitors and often whoever raises the most money is who wins. Not only are U.S. companies not able to raise enough to compete globally, U.S. investors are not able to invest in these global companies.” Darren Soto, one of the Congressional representatives at the hearing, offered hope to the industry members by saying “I’m sensing we may need an entirely new category that treats this like a new asset, so that we’re not trying to squeeze a square peg into a round hole. There needs to be some streamlining based on the definitions of digital assets.” This coordinated effort adds pressure on regulators who may be pushed to take action sooner rather than later. Indeed, it complicates the guidance given by CFTC Chairman Giarcarlo in the section above to be patient and avoid overregulating; it may be possible that the strategy of “wait and see” is insufficient for US participants who are deeply concerned about potential ramifications if they overstep boundaries.
Rest of the World
- European Union officials are not in a rush to regulate the cryptocurrency market (Sept 8th). As reported by Fortune, “Finance ministers gathering in Vienna agreed that they won’t rush with steps to further regulate the market, and that they’ll wait for the outcome of a thorough analysis by European authorities before deciding on any steps, according to officials involved in the talks.” For now, the Financial Stability Board continues to feel strongly that cryptocurrencies do not pose a threat to the larger financial system. Bruegel, a Brussels-based think tank, suggested that it could be beneficial for each country to take an independent approach to regulation before moving to a coordinated approach with a central supervisor via the EU.
- French regulators are working towards a legal framework for initial coin offerings (ICOs) (Sept 14th). Earlier this year, France significantly reduced the taxes paid on cryptocurrency gains. Now, French lawmakers are working to produce a legal framework for initial coin offerings (ICOs). The plans are reportedly part of President Emmanuel Macron’s larger efforts to improve business and technology growth within the country, and the framework is meant to give clarity to project creators and investors. The legal framework would require ICOs to register with the Authorité des Marchés Financiers (AMF) to receive a permit to solicit investment. In the context of the above section regarding the larger EU, it will be interesting to see if other countries follow in France’s path and work to create an amenable environment for cryptocurrency projects. If policy is enacted at the national level within Europe, it will also be interesting to see if projects flock to desirable regulatory regions like they have in Asia.
- A Japanese regulator released an updated report on the state of the cryptocurrency market (Sept 18th). The Financial Services Agency released a series of documents related to its ongoing surveillance and regulation of cryptocurrency exchanges operating in the country. Regulation for exchanges is being guided both by the FSA as well as an industry self-regulation group known as the Japan Virtual Currency Exchange Association. The report released suggested that the FSA will conduct regular on-site examinations of the exchanges that it extends licenses to. To carry this out, the FSA will develop its own crypto team internally. There have been numerous exchange hacks in Japan, including the hack of Coincheck in January 2018 that led to a reported $500 million in stolen funds.
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Note: I do not and will not provide investment advice or recommendation.
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