The SEC is throwing a damper on ethereum madness – The Edge

The SEC is throwing a damper on ethereum madness

Photo by Drew Angerer / Getty Photos

The Securities and Exchange Commission is taking an interest in the best craze in cryptocurrency, the initial coin suggesting (ICO), and evidently the SEC is not into the hype. The commission published a report on Tuesday advising that ICOs, or token sales, are subject to securities laws. It concluded that a certain multimillion-dollar ICO last year — the very first of its kind — violated securities law.

An ICO — an acronym that intentionally mirrors “IPO” — is a fresh way to raise money for a startup, using the cryptocurrency Ethereum. Like Bitcoin, Ethereum runs on blockchain technology. But one of the many differences inbetween Bitcoin and Ethereum is that the latter offers “smart contracts” — automatically executed code that can take the form of a financial transaction — that are built right into the technology. One result is that Ethereum can be a platform to raise ether (a crypto asset that can be traded for state-issued currency like dollars) in exchange for “tokens” that might suggest the token holder voting rights, or a financial stake in an enterprise.

ICOs have been compared to crowdfunding, which is exempt from the registration requirement for securities. On Tuesday, the SEC flapped aside that comparison, instead concluding that tokens — in some cases at least — were securities.

The 18-page investigative report specifically analyzes the Decentralized Autonomous Organization’s (DAO) ICO in 2016, and concludes that DAO tokens are securities. The DAO has been described as “a fresh sort of venture capital fund that works without the need for human administrators.” According to the SEC, the DAO violated section five of the Securities Act by failing to register with the Commission. The SEC has declined to pursue an enforcement activity against the DAO or Slock.it (a German startup that the SEC credits with “creating” the DAO), but does not explain why in either its report or press release.

Because the DAO — as described in its name — is decentralized, it’s a little unclear who the SEC would have gone after in the very first place. The SEC report clarifies that its investigation looked into not only the DAO (which it calls an “unincorporated organization”), but also Slock.it, Slock.it’s co-founders, and the very nebulous category of “intermediaries.”

A security is a tradable financial asset that, in the United States, is regulated by the federal government. The SEC has determined that the tokens sold in DAO’s ICO meet the legal definition of a security, noting that “investors who purchased DAO Tokens were investing in a common enterprise and reasonably expected to earn profits through that enterprise when they sent ETH to The DAO’s Ethereum Blockchain address in exchange for DAO Tokens.” Investors were also given limited voting and ownership rights.

The idea that an automated, distributed financial entity is subject to securities laws might strike some as a little strange. The decentralized nature of the DAO also led some — including Christoph Jentzsch, one of the co-founders of Slock.it, who was evidently a subject of the SEC investigation — to compare it to a crowdfunding campaign. Crowdfunding is exempt from section five of the Securities Act. The SEC dismissed the possibility that the DAO might be crowdfunding in a cursory footnote, noting that crowdfunding is subject to certain requirements, like being “a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority (‘FINRA’).”

The SEC’s investigation also concluded that the DAO wasn’t a general partnership made up of its various token holders, because there was a layer of management that intermediated inbetween the fund and its investors. Any investment proposal for the DAO had to be approved by a group called the Curators, who were picked by Slock.it. On top of that, buying a DAO token meant that the token holder had certain voting and ownership rights, which certainly starts to look exactly how stock in a company works.

Albeit the report is specific to DAO, the report cautions against ICOs in general. “The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, co-director of the enforcement division of the SEC.

In July 2016, the DAO was hacked for millions of dollars in ether, resulting in a controversial decision to fork Ethereum and undo the harm, essentially resetting the network to what it was before the heist occurred.

What the fresh SEC report means for future ICOs is unclear. Some ICOs might be found in disturbance of securities law, and some might be different enough to be in the clear. Peter Van Valkenburgh of the cryptocurrency think tank Coin Center said, “What the SEC did not say is that all tokens are securities. Rather, they suggest a facts and circumstances test but only analyze the facts and circumstances surrounding last year’s DAO token sale.”

But the SEC’s press release cautions “market participants” about ICOs in general, suggesting that the Commission keeping a suspicious eye on this space. Four years after the Department of the Treasury’s Financial Crimes Enforcement Network released its very first guidance on Bitcoin, the federal government is still fighting to keep up with the rapid evolution of cryptocurrency. Tuesday’s report comes a year after the DAO’s token sale, but it’s arriving just in time to cast a chill on the craze around ICOs.

There are still open questions around whether the SEC would ever bring an enforcement act with respect to an Ethereum token sale, and whether they’d even be able to find a specific person or group to pin the securities disturbance on. But Tuesday’s report is a sign that the government is at least attempting to meet the challenge of regulating the Wild West of cryptocurrency.

The SEC is throwing a damper on ethereum madness – The Brink

The SEC is throwing a damper on ethereum madness

Photo by Drew Angerer / Getty Pictures

The Securities and Exchange Commission is taking an interest in the greatest craze in cryptocurrency, the initial coin suggesting (ICO), and evidently the SEC is not into the hype. The commission published a report on Tuesday advising that ICOs, or token sales, are subject to securities laws. It concluded that a certain multimillion-dollar ICO last year — the very first of its kind — violated securities law.

An ICO — an acronym that intentionally mirrors “IPO” — is a fresh way to raise money for a startup, using the cryptocurrency Ethereum. Like Bitcoin, Ethereum runs on blockchain technology. But one of the many differences inbetween Bitcoin and Ethereum is that the latter offers “smart contracts” — automatically executed code that can take the form of a financial transaction — that are built right into the technology. One result is that Ethereum can be a platform to raise ether (a crypto asset that can be traded for state-issued currency like dollars) in exchange for “tokens” that might suggest the token holder voting rights, or a financial stake in an enterprise.

ICOs have been compared to crowdfunding, which is exempt from the registration requirement for securities. On Tuesday, the SEC flapped aside that comparison, instead concluding that tokens — in some cases at least — were securities.

The 18-page investigative report specifically analyzes the Decentralized Autonomous Organization’s (DAO) ICO in 2016, and concludes that DAO tokens are securities. The DAO has been described as “a fresh sort of venture capital fund that works without the need for human administrators.” According to the SEC, the DAO violated section five of the Securities Act by failing to register with the Commission. The SEC has declined to pursue an enforcement act against the DAO or Slock.it (a German startup that the SEC credits with “creating” the DAO), but does not explain why in either its report or press release.

Because the DAO — as described in its name — is decentralized, it’s a little unclear who the SEC would have gone after in the very first place. The SEC report clarifies that its investigation looked into not only the DAO (which it calls an “unincorporated organization”), but also Slock.it, Slock.it’s co-founders, and the very nebulous category of “intermediaries.”

A security is a tradable financial asset that, in the United States, is regulated by the federal government. The SEC has determined that the tokens sold in DAO’s ICO meet the legal definition of a security, noting that “investors who purchased DAO Tokens were investing in a common enterprise and reasonably expected to earn profits through that enterprise when they sent ETH to The DAO’s Ethereum Blockchain address in exchange for DAO Tokens.” Investors were also given limited voting and ownership rights.

The idea that an automated, distributed financial entity is subject to securities laws might strike some as a little strange. The decentralized nature of the DAO also led some — including Christoph Jentzsch, one of the co-founders of Slock.it, who was evidently a subject of the SEC investigation — to compare it to a crowdfunding campaign. Crowdfunding is exempt from section five of the Securities Act. The SEC dismissed the possibility that the DAO might be crowdfunding in a cursory footnote, noting that crowdfunding is subject to certain requirements, like being “a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority (‘FINRA’).”

The SEC’s investigation also concluded that the DAO wasn’t a general partnership made up of its various token holders, because there was a layer of management that intermediated inbetween the fund and its investors. Any investment proposal for the DAO had to be approved by a group called the Curators, who were picked by Slock.it. On top of that, buying a DAO token meant that the token holder had certain voting and ownership rights, which certainly starts to look exactly how stock in a company works.

Albeit the report is specific to DAO, the report cautions against ICOs in general. “The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, co-director of the enforcement division of the SEC.

In July 2016, the DAO was hacked for millions of dollars in ether, resulting in a controversial decision to fork Ethereum and undo the harm, essentially resetting the network to what it was before the heist occurred.

What the fresh SEC report means for future ICOs is unclear. Some ICOs might be found in disturbance of securities law, and some might be different enough to be in the clear. Peter Van Valkenburgh of the cryptocurrency think tank Coin Center said, “What the SEC did not say is that all tokens are securities. Rather, they suggest a facts and circumstances test but only analyze the facts and circumstances surrounding last year’s DAO token sale.”

But the SEC’s press release cautions “market participants” about ICOs in general, suggesting that the Commission keeping a suspicious eye on this space. Four years after the Department of the Treasury’s Financial Crimes Enforcement Network released its very first guidance on Bitcoin, the federal government is still fighting to keep up with the rapid evolution of cryptocurrency. Tuesday’s report comes a year after the DAO’s token sale, but it’s arriving just in time to cast a chill on the craze around ICOs.

There are still open questions around whether the SEC would ever bring an enforcement act with respect to an Ethereum token sale, and whether they’d even be able to find a specific person or group to pin the securities disturbance on. But Tuesday’s report is a sign that the government is at least attempting to meet the challenge of regulating the Wild West of cryptocurrency.

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