Overreaching Its Mandate: Why the Sec Lacks the Authority to Regulate Cryptocurrency Exchanges
48 Pages Posted: 24 Sep 2018 Last revised: 23 Feb 2019
Date Written: September 5, 2018
Both the SEC and private cryptocurrency attorneys assume that if a crypto token – for example, a bitcoin – is a security when issued, then it is a security when traded on exchanges like Coinbase, Gemini, and Circle. Based on that assumption, the SEC regularly threatens exchanges with enforcement for unlicensed trading in securities. Indeed, that assumption appears so widespread that neither the literature nor the caselaw have questioned it. This Article concludes that assumption is incorrect. A fundamental difference separates a token when issued by a developer from a token when traded on an exchange: An issuer not only provides the token but promises further development and price appreciation. The exchange promises neither. Unlike stocks and bonds, crypto tokens fall under a different category in the securities laws, regulating “investment contracts.” To be an “investment contract,” a commodity like a crypto token must be accompanied by this extra promise for further development or price appreciation. For that reason, when traded on exchanges, tokens are no longer securities.
This conclusion – that exchanges are not subject to the securities laws – has profound practical implications. The crypto market is worth hundreds of billions of dollars. To avoid SEC jurisdiction, exchanges like Coinbase, Gemini, and Circle have significantly limited the tokens they will trade. Coinbase offers just five options – Bitcoin, Ether, Ether Classic, Litecoin, and Bitcoin Cash – while the broader market contains more than a thousand crypto tokens. If exchanges are not subject to SEC jurisdiction, then the breadth and volume of business conducted by these exchanges could increase substantially and immediately. The method this Article uses to reach this conclusion – an interpretation of the securities law term “investment contract” – also suggests that contract law principles apply when interpreting the securities laws. This may have broader effects on the securities laws themselves, extending well beyond the crypto industry.
Keywords: Bitcoin, Blockchain, Cryptocurrency, Securities Regulation
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