Corporate Finance & Securities

SEC says cryptocurrencies Bitcoin and Ether are not securities

The regulation of cryptocurrencies is rapidly changing, filled with shades of gray, and offers companies very little certainty. That’s why it was noteworthy when William Hinman, the Director of the Division of Corporate Finance for the Securities Exchange Commission (SEC), said last week that Bitcoin, Ether, and other cryptocurrencies are not securities: “Based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value. Over time, 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.”

Bitcoin is the largest cryptocurrency, with an estimated market cap of about $111 billion, and Ether is the second largest cryptocurrency—it is believed to have a market cap of about $50 billion. Ether is supported by the Etheruem Foundation, a Swiss nonprofit company.

You can check out director Hinman’s comments in this video:


What does this mean for federal regulation of Bitcoin, Ether, and other cryptocurrencies?

While federal officials from the Commodity Futures Trading Commission (CFTC) have been clear since 2014 that the CFTC considers cryptocurrencies to be commodities within the definition of the Commodity Exchange Act, the SEC has not been as definitive in saying whether cryptocurrencies are not securities.

Even though Bitcoin and Ether are not securities, the vast majority of tokens are securities
In the last six months or so, SEC officials have been consistent in saying that the SEC would treat most cryptocurrencies offerings as securities offerings. Deciding that Ether is not a security is not necessarily inconsistent with prior statements that most ICOs are going to be securities offerings. Director Hinman laid out the SEC’s general approach to regulating cryptocurrencies. “The digital asset itself is simply code. But the way it is sold – as part of an investment; to non-users; by promoters to develop the enterprise – can be, and, in that context, most often is, a security – because it evidences an investment contract. And regulating these transactions as securities transactions makes sense.” Director Hinman pointed out that when an investor is relying on a third party’s efforts to see a return on their investment, the securities regulatory framework that requires disclosure of relevant information to investors offers significant protection for investors.

Bitcoin and Ethereum Securities ICOTwo clear ends of the spectrum with a lot of uncertainty in between
There are now two ends of the spectrum that have been clearly defined by the SEC: At the one end, an ICO for a crypto startup that doesn’t yet have a functioning network is clearly a securities offering. And at the other end of the spectrum, Bitcoin and Ether—tokens on massive decentralized networks—are not securities.

Securities regulation of cryptocurrency going forward: facts and circumstances test

So we know about the two ends of the spectrum, but where does that leave us for all the cryptocurrency deals in between the two ends of the spectrum? Moving forward, Director Hinman said the question of whether or not cryptocurrencies will be treated as a securities will “always depend on the facts and circumstances.” And while he didn’t offer any “bright line” rules, he did suggest a list of factors to consider when analyzing whether a cryptocurrency is a security:

  1. Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value?

  2. Has this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset? Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their investment in the digital asset?

  3. Has the promoter raised an amount of funds in excess of what may be needed to establish a functional network, and, if so, has it indicated how those funds may be used to support the value of the tokens or to increase the value of the enterprise? Does the promoter continue to expend funds from proceeds or operations to enhance the functionality and/or value of the system within which the tokens operate?

  4. Are purchasers “investing,” that is seeking a return? In that regard, is the instrument marketed and sold to the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or service in the network?

  5. Does application of the Securities Act protections make sense? Is there a person or entity others are relying on that plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors? Do informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset?

  6. Do persons or entities other than the promoter exercise governance rights or meaningful influence?

Bitcoin and Ethereum could still be a part of a securities contract

Director Hinman also cautioned that Bitcoin and Ethereum contracts could still constitute securities, “Even digital assets with utility that function solely as a means of exchange in a decentralized network could be packaged and sold as an investment strategy that can be a security. If a promoter were to place Bitcoin in a fund or trust and sell interests, it would create a new security. Similarly, investment contracts can be made out of virtually any asset (including virtual assets), provided the investor is reasonably expecting profits from the promoter’s efforts.”

Money services businesses

In addition to being concerned about CFTC’s commodities regulations, people in the business of buying and selling or exchanging Bitcoin and Ether still need to be concerned about complying with state and federal regulation of money services businesses.

If you have questions or concerns about an initial coin offering or an initial token offering, please feel free to contact us.

Photo | Stock Catalog | Flickr


Kyle Hulten

When I'm not in the office I enjoy cooking, gardening, and watching my toddler son explore his little universe.