“When you depart from the bitcoin or the ethereum, and you get into the tokens, the hallmarks become pretty clear.”
“It’s a complicated area. Because, as you said, there are different types of cryptoassets. Let me try and divide them into two areas.
A pure medium of exchange, the one that’s most often cited, is Bitcoin. As a replacement for currency, that has been determined by most people to not be a security.
Then there are tokens, which are used to finance projects. I’ve been on the record saying there are very few, there’s none that I’ve seen, tokens that aren’t securities.”
Whether tokens are securities or not, has not been decided by any court. SEC’s interpretation that they are, is just an interpretation by some lawyers. Other lawyers have different interpretations.
In the context of a criminal case, one such lawyer has put forth some strong reasons as to why some tokens are not a security.
It is a criminal case, and the judge sits in the FISCA court, and it is being heard in Wall Street’s New York, so it wouldn’t surprise us if the judge decides the token is a security.
However, as this is a new area, and the judge would in effect be making a new law by interpreting old law, it would probably, or at least hopefully, be appealed whichever way it goes up to the Supreme Court so that the most senior judges of the land give their verdict on this very important matter.
With that case in the background, cynicnodes would be faulted for thinking SEC might be playing games by recent suggestions they are to discuss tomorrow whether eth is a security.
They could be trying to “scare” us by bringing ethereum to the table and potential classification as security so that we “accept” that actual tokens are a security.
Although it may well be their discussion is following a request by a number of Silicon Valley based Venture Capitalists for “safe harbor” for tokens that then have a running network or functionality.
Generally speaking, there is no reason to accept tokens are a security without a Supreme Court judgment or by a new law from Congress.
That’s because it is not for SEC to make laws, nor interpret them. They often cite the Howey case, yet it is not for SEC to interpret that case and to apply it to very new things. It is for the court to do so.
SEC’s job is to enforce established law, not encroach upon the jurisdiction of the judiciary or Congress by making new law. If things were getting out of hand or if regulations were needed, then such regulations need to be democratically applied by debate and then a vote in Congress.
And if those arguments apply to tokens in general, where one can see the SEC’s point of view – and isn’t wholly without merit although it is misguided in applying same requirements to fundraising of $10 billion as $10 million – many more arguments apply in regards to ethereum.
The first argument is unconstitutional uncertainty of the law, which is a general argument in regards to all tokens, but in eth it is a very concrete argument.
Because Jay Clayton himself has said eth is not a security as we quoted above. So if one day it is not a security, and the next day it is, then how on earth does that law meet the constitutional requirement for clarity?
More generally, the Howey test comes from a case of that name where the Supreme Court said a security, or an investment contract, is:
“A contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
Current ethereum obviously does not meet that definition. There is no investment in a common enterprise, there is selling or buying eth like you sell or buy gold.
There is no common enterprise at all, there’s a network of nodes and miners that run code and decide what code to run.
People might hope for profit, but price goes up or down, there is no guarantee of profits. Moreover, plenty might not care about profits at all and instead want eth only because they want to use a dapp. That’s especially relevant as 53% of transactions are to smart contracts, suggesting considerable utility.
Any profit or loss does not come from a third party. Not anymore than it does when you decide to buy or sell gold.
Moreover, as far as the current network is concerned there are practical considerations as you would in effect be regulating open source code, which is effectively impossible.
Impossible because coders are technically volunteers. There may be companies paying them to open source code, there may be non-profits doing so, they may be doing it for free in their spare time, they may decide not to work on it, others may come in or go. It’s a commons. An open space.
You could hold the Ethereum Foundation responsible, but they don’t run the network, some 24,000 nodes do and some of those nodes get paid for it.
The Ethereum Foundation, moreover, pays only some of the developers. Plenty of others pay more. Plus, the network doesn’t have to listen to the Ethereum Foundation. Anyone can just fork the code.
Much of this applies to other aspects. For example, is Brave Browser a security? Is Dai a security? Is SEC really saying Cryptokitties are a security?
The only aspect they can try to hold onto is the Ethereum pre-sale, but that was undertaken after extensive consultation and legal advice, with the eth sold not much different than miners sell them today.
In return for BTC, individuals were given eth, eth which was effectively mined before the network for mining opened to all.
So if that eth mined was a security, then btc miners are issuing securities every time they sell the btc they mine. Which shows how ludicrous SEC’s extension of its jurisdiction even in tokens like Brave Browser can be, let alone in decentralized networks like eth run by some 24,000 nodes across the globe.
Although Clayton says he hasn’t seen any utility ICO, that doesn’t mean there actually haven’t been utility ICOs. As stated previously, he is just one lawyer, with his own interpretation. He does not make law, nor does he interpret law, as far as doing so legitimately and in line with the constitution is concerned.
An investment contract is something where you give money to someone else to invest in buying things to say create a company or to buy houses to rent, with the expectation of making profits from labor.
Giving someone money for a token is not an investment contract by common sense. It is instead buying a token. Company shares are different because the only use of company shares is the hope their value increases due to good management growing the company by buying things cheaper and selling them for more or by providing services cheaper or better.
While with a token, you can actually use it for things. You can’t use company shares for things. You can’t use an investment certificate or whatever right the investment contract gives you for things. That’s why there is the securities law, because you give others money and in return you receive nothing except for a promise by others that they will do what they said.
In tokens however, if you receive a token, then you are not receiving nothing, you are instead buying a token, which you can use for things, including paying others for things, like advertising slots on trustnodes.
As such, instead of a company share, a token is not much different than buying a car. Someone produces the token, in this case instead of through raw materials, does so through intellectual work, then they sell the token which now can be used to do whatever.
It is therefore unclear why SEC should have any jurisdiction even for actual tokens, let alone for decentralized currencies like eth or bitcoin.
Arguably, if the token does not yet exist but is promised to exist, you can say there that one is relying on others to do what they promised, so there should be some enforceable responsibility.
That should be laddered, so if they raising say $5-$10 million then perhaps only basic requirements of as low as general contractual law in regards to fraud and misleading, or slightly higher by requiring disclosure of revenue figures and backgrounds.
While say $20-$100 million you can require audits of figures as well as notarization of backgrounds and perhaps detailed quarterly updates of progress until the token launches or the project is finished in line with their promises.
Then, above that amount you can require all that is currently required because at those levels there should be a much higher level of responsibility.
Another way would be to cap the amount invested to say $1,000 or $10,000 per individual. Something which could fairly easily be implemented by ICOs whitelisting as plenty of them already do.
The difficult question here would be determining when that responsibility ends. In a company it never does until the company ceases to exist because otherwise there is a management that is responsible.
In an open source token that is running, however, say something like BAT, that responsibility should arguably cease as soon as the token and the network around it is running.
That’s because there is no CEO that can be replaced, you don’t have a person who is actually responsible for much once the network is up and running. There would be the devs who raised the money in the ICO, but god forbid they all for whatever reason vanish, new devs would come in either paid by companies or voluntarily and contribute code and improve the network gradually like they contribute code to linux or other open sources systems for absolutely free or without any obligation.
In short, SEC has to think this matter a lot more thoroughly, its staff needs to do its work a lot better than it already has, and they need to take into consideration the many very real differences rather than apply a century old discriminatory law enacted at a time when only the very rich, when only white, and when only men, could vote.
For if we are to be honest, and if SEC is to be honest with itself, they have been far too hasty, a bit like a bull in a China shop, and they have done so while having no real understanding of this space as Jay Clayton himself admitted by stating SEC has no coders and no tech expertise to provide advice but only economists.
How do you regulate a code based network that runs globally in a decentralized manner solely due to some code without having any advise from tech experts?
Very badly, that’s how. So far anyway. But there are signs that may change as they gain a wider understanding. However, in the meantime they should stop playing games if they want to retain any good-will from this space.
Because we’re not children, we obviously don’t want to be defrauded, scammed or misled. Some regulation is clearly needed where promises are made, but it needs to be reasonable regulation that makes sense, otherwise it’s not really regulation and can’t really be enforced either as law does ultimately depend on consent.