In February, United States Securities and Exchange Commission Commissioner Hester Peirce was asked to give her opinion on the SEC’s case against Telegram. She declined to comment at the time, as SEC officials do not speak publicly about ongoing enforcement actions. In late July, however, with the Telegram case settled, Commissioner Peirce gave a speech titled “Not Braking and Breaking” that pointedly questioned the approach taken by the SEC in the Telegram case. Concluding her remarks, Commissioner Peirce asked:
“Who did we protect by bringing this action? The initial purchasers, who were accredited investors? The members of the public, many of whom are outside the United States, who would have bought the Grams and used them to buy and sell goods and services on the TON Blockchain? Did they really look to U.S. securities laws for protection? Would-be innovators, who will now take additional steps to avoid the United States?”
With this speech, Commissioner Pierce made a powerful case for re-examining the way in which securities regulation in the U.S. is applied to the sale and subsequent transfer of the digital tokens necessary for open blockchain networks to operate. There are a number of ways this can be accomplished, including through the creation of the “safe harbor” for crypto projects Commissioner Peirce proposed back in February this year. The safe harbor would give projects a three-year grace period before federal securities laws could potentially be applied to them. Were the safe harbor to be adopted by the full Commission, innovators seeking to establish decentralized open blockchain networks would have a lengthy period for their projects to gain community support before either potentially bearing the full burden of SEC compliance or demonstrating that such compliance is not necessary.
Had the safe harbor been in place last year when Telegram was preparing to launch, this grace period would have been a game-changer and perhaps led to a very different result for the Telegram Open Network, or TON. Many have observed that five years ago, the Ethereum network launched in a manner similar to what Telegram proposed. A skeptic might argue that the key difference between the Ethereum and Telegram launches was their timing (or, more specifically, the stage of network development the two projects had reached when they caught the attention of the SEC).
So, what can we conclude about blockchain network launches from these two signal examples — one a tremendous success, the other snuffed out before users could have the opportunity to make their views known?
When do securities laws apply to token sales?
In mid-2018, the director of the SEC’s corporate finance division, William Hinman, gave a speech at a crypto summit that caught many market observers by surprise. In his speech, Hinman sought to address the question of “whether a digital asset offered as a security can, over time, become something other than a security.” Throughout his speech, Director Hinman took pains to focus on the transactions in which digital assets are sold as well as whether these transactions are “securities transactions” and thus subject to compliance with federal securities law.
When and whether securities laws apply to transactions in blockchain tokens remains an essential question for the sector. Categorizing the sale of a digital token as a securities transaction would have an outsized impact on how the token can be offered, who can purchase it, how it is traded, its tax implications and beyond.
On the one hand, if a token can be sold without the transaction implicating federal securities laws, it is just like any other asset we are familiar with — a pair of sneakers, say — and it can be traded between any two users privately at any time and in any amount without any particular securities law compliance required, albeit subject to commercial and common law norms and expectations and statutory fraud laws.
But if the sale of a token is considered a securities transaction, this changes the situation for everyone involved. For example, those facilitating these transactions may be treated as “broker-dealers,” meaning that they have to meet a variety of complex legal requirements. On top of that, every transaction by a broker-dealer must be recorded, which requires comprehensive record-keeping and customer information-gathering.
More confusion, less clarity
In addition, the venues where these transactions occur may be treated as securities exchanges — a classification bringing with it an onslaught of regulation. At a minimum, this approach would likely dramatically reduce the token’s liquidity and usability. In some cases, applying securities laws to transactions within a token could potentially crush the blockchain project altogether.
Although the SEC have released a Section 21(a) report, two no-action letters and a “framework” document, most of the SEC’s guidance on this question has been in the form of enforcement actions — telling blockchain proponents what they can’t do, rather than what they can do.
Commissioner Peirce criticized this approach in her recent speech. Analogizing blockchain innovators with the man who invented roller skates (and who had a very public humiliation by crashing into a mirror while demonstrating his invention), Commissioner Peirce noted:
“I would prefer that we not only hold accountable the reckless innovators who skate among mirrors while playing the violin, but also attempt to provide the more cautious innovators some guidance on how to avoid the hall of mirrors and on what we consider to be adequate braking technology.”
So how are we to know when securities laws apply to transactions in which blockchain tokens are sold?
Initial sales of tokens
As a starting point, it is important to understand the basics of the U.S. concept of an “investment contract.” An investment contract is a transaction (or “scheme”) that at first glance appears to be a normal commercial sale of some asset or another between two private parties. However, as the now-famous Howey case made clear, when examined more closely, these schemes differ from most commercial asset sales — the buyer is not buying the asset for the buyer’s own “consumptive” use of the asset. Rather, the buyer is looking to profit from the transaction due to the seller’s efforts where the buyer and seller have formed some sort of “common enterprise.”
Examples of assets sold in transactions characterized as investment contracts by courts include beavers, whiskey and bank CDs. When a commercial transaction does not work out as hoped for, crying “Investment contract!” is a much more likely way for the buyer to get some money back from the seller.
When an asset that initially has little or no functional use (like the typical blockchain token prior to network launch) is being sold not to persons who have a genuine reason to use the token for its stated purpose following launch but, rather, to those who expect to hold the tokens for a period of time in order to profit from price appreciation resulting from efforts of the developers of the token promoting the benefits of the network, the scheme will likely satisfy the Howey test and would generally be considered an “investment contract” and thus a type of securities transaction. Almost all blockchain networks will likely need an initial source of funding for development and this pattern is one that has been used to get started.
One way we know that the securities laws likely apply to most blockchain network launches is that even Commissioner Peirce feels that a “safe harbor” is needed for these initial token sales to avoid the securities laws otherwise applying to these transactions. Where it gets interesting is when an initial purchaser of tokens from the development team seeks to resell those tokens.
Secondary token transactions
It is at this point that the 70-plus years of case law following the Supreme Court’s decision in Howey fails us. Why? Because case law arises as the result of the resolution of a dispute. The many cases looking at when a purported commercial sale of a given asset should be treated as an “investment contract” (and therefore a securities transaction) almost always arise from a failed transaction where the buyer did not receive the return they had expected from the asset, and thus sued the seller to get their money back. Therefore, courts have not had to consider whether secondary transactions in relevant assets (e.g., the beavers, whiskey or bank CDs) by the purchaser not involving the original seller and not transferring any of the original seller’s promises about the asset are also “securities transactions.”
Many blockchain projects raise just that question, though: Should resales of the relevant asset — the blockchain token — without a transfer of any promises made by the development team to the initial purchaser also be treated as securities transactions? If the underlying asset was any of those involved in the many post-Howey “investment contract” cases on record (the beavers, etc.), we doubt that the question would even arise, much less be answered in the affirmative. Should blockchain tokens be any different?
The SEC position
The enforcement staff of the SEC certainly think so. In the Telegram litigation as well as in numerous other enforcement actions by the SEC, papers filed in court make clear that the enforcement staff believe that not only are these transactions “securities transactions” (as suggested by director Hinman), but also that the blockchain tokens themselves are “securities” and that the development teams are the “issuers” of these securities. Interestingly, though, Judge Castel in the Telegram case did not endorse this position, stating in contrast:
“But focusing upon the Initial Purchasers and their Gram Purchase Agreements misses one of the central points of the Court’s Opinion and Order, specifically, that the “security” was neither the Gram Purchase Agreement nor the Gram [token] but the entire scheme that comprised the Gram Purchase Agreements and the accompanying understandings and undertakings made by Telegram, including the expectation and intention that the Initial Purchasers would distribute Grams into a secondary public market.”
Notwithstanding the above wording, other statements by Judge Castel in his Telegram opinions were sufficiently vague so as to sow some confusion as to his ultimate position on this crucial point. Importantly, because the Grams were never distributed, Judge Castel only had to deal with the initial distribution scheme. This allowed him to find that the scheme constituted an investment contract without having to address the SEC’s argument that the Grams themselves were securities in order to decide the matter. Although Judge Castel declined to find that the Grams themselves were securities, he did leave room for the SEC to continue to take the position that secondary transactions in tokens are securities transactions (and the tokens themselves are securities).
Blockchain tokens as traditional assets
However, there is another point to consider. One thing all “securities” must have is an “issuer.” This is a crucial distinction between a security and a more traditional asset. In the case of a security, if the issuer of the security — whether debt or equity — is liquidated and ceases to exist, the security ceases to exist as well. You can’t have one without the other.
Likewise, in the investment contract context, if a promoter that made the undertakings to a buyer to induce a purchase by the buyer of a given asset being sold by the promoter in connection with the scheme ceases to exist, so too does the “investment contract” between the promoter and the buyer.
However, the “object” of the promoter’s scheme (i.e., the asset the promoter sold) will continue to live on, as is the case with other traditional assets once created. Whether tangible or intangible, “non-security” assets exist long after their creator may have shuffled off this mortal coil — literally or figuratively. For example, a patent right for a drug created by a pharmaceutical company will continue to exist — and may be sold and transferred — even if the company that developed the drug was dissolved.
Looking again at many typical blockchain tokens (including the Grams to be used on the TON network), most seem to rather clearly look more like traditional (non-security) assets in this respect — the initial development team for a blockchain project that was deemed the “issuer” of the tokens may be liquidated or may just disband and move on, but the relevant tokens will continue to exist as long as there are computers maintaining nodes for the relevant blockchain.
The SEC’s distinction between a security and a non-security
So how does the SEC reconcile this distinction? Through a novel and, to date, untested theory — that at some point a blockchain token can “morph” from being a “security” and become a traditional “non-security” asset based on factors extrinsic to the token. A number of factors are put forward by the SEC for this purpose including, most pertinently, whether the management of the network is “sufficiently decentralized,” and whether the token has a bona fide commercial purpose.
Although the commissioners and staff of the SEC have worked hard to elucidate these concepts through the Token Framework and other written statements, various enforcement actions, many public appearances, and countless private meetings with market participants, the standards put forward by the SEC for distinguishing token sale transactions that should properly be considered securities transactions from those that should not are still unclear.
By importing new concepts like “sufficiently decentralized” and “commercial purpose” into federal securities jurisprudence without any history of case law support, we should not be surprised that confusion and uncertainty result.
Is it all about the timing?
So where did things go wrong for Telegram? Why is it that the SEC considered Grams securities and Ether not — at least by the time director Hinman gave his speech? The key difference could appear to be timing.
Regulators looked at the Ethereum network roughly three years after its launch, whereas with Telegram, the scrutiny came before launch. Those three years made a huge difference. That time gave the Ethereum network a chance to become more decentralized and to build up a significant consumer usage of its token.
Meanwhile, Telegram’s TON network never had the opportunity to prove itself. It was not given the time to achieve decentralization — whatever that may have meant for the project — or to build up an economy around its tokens. Because of that, the project was over before it began. No wonder Commissioner Pierce raised the questions she did.
The timing issue makes it too easy for the skeptics in the blockchain community to argue that the only way to proceed after Telegram is to build as fast as possible with the hope of following the Ethereum model and “outrunning” SEC enforcement activity. This is not a good result for both the SEC, who will increasingly find themselves playing “whack-a-mole” with blockchain projects trying to slip under its radar, and for blockchain projects, who must live with the possibility that they may wake up one day to find themselves the target of the next Telegram-style enforcement action.
Only time will tell how the question of whether secondary sales of tokens will be considered securities transactions — and the tokens themselves will be considered securities — will be resolved. Courts considering the issue will need to balance the legitimate concerns around investor protection put forward by the enforcement staff of the SEC with the pressing questions raised by Commissioner Peirce in her aforementioned speech.
Of even more pressing interest to the blockchain community is the difficult question of how a new decentralized blockchain network can be launched following the Telegram decision. Commissioner Peirce’s safe harbor proposal is still out there — will the other Commissioners be open to giving that approach serious consideration? If not, is a new legislative framework needed? Although U.S. regulators have generally not been friendly toward a “sandbox” concept (where novel business models can be tested in a relaxed regulatory environment with a high level of oversight), could this break the logjam?
What can be said now, though, is that the uncertainty as to how these issues will be resolved is hampering innovation without a clear case having been made for concomitant investor protection benefits. We believe that the vast majority of innovators and technologists in the blockchain community want to comply with the law and do things the “right” way. The time has come for policymakers and regulators to step up, engage in more dialogue, and provide a workable pathway that allows blockchain technology to develop and grow here in the U.S.
The unwary among us need and deserve appropriate protections, especially where potentially confusing new technologies are involved, but these protections must not unduly interfere with the equal need to foster critical and necessary innovation. Other jurisdictions are finding ways of balancing these competing concerns. We believe that the U.S. can, too.
Now is the time for a new relationship to be forged among crypto projects, their advisors, trade groups, policymakers and regulators to achieve this goal. And we should all take a moment to applaud Commissioner Pierce for leading the way.
The views, thoughts and opinions expressed here are the authors’ alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This article was co-authored by Dean Steinbeck and Lewis Cohen.
Dean Steinbeck is a U.S. corporate lawyer with a focus on data privacy and technology. He is the general counsel for Horizen, a blockchain platform that enables data privacy via a fully decentralized sidechain ecosystem.
Lewis Cohen is a partner and co-founder at DLx Law, a law firm that focuses on the use of blockchain and tokenization across all aspects of the capital markets. Lewis is a frequent public speaker on the topic of blockchain and the financial markets and was recently named in “Band 1” as one of three top-ranked lawyers in the blockchain space in the United States by leading independent firm, Chambers & Partners.
Ethereum: Is the HODLing in yet?
When it comes to the altcoin market, the past few months have shown how important a cryptocurrency Ethereum is. With DeFi growing substantially in 2020, the gains have been felt by ETH in many ways. While ETH has miles to go before it can challenge the market cap and dominance of Bitcoin, its remarkable growth thanks to DeFi and the proposed ETH 2.0 shift cannot be overlooked. With Ethereum’s use cases diversifying, users and investors within the ecosystem are reaping its benefits too.
According to recent network data provided by Glassnode, Ethereum balances on centralized exchanges have fallen substantially over the past few weeks. In fact, the aforementioned data showed a drop from over 18,750K to around 16,750K, resulting in Etherum balances on exchanges falling to their lowest level for the year 2020, at the time of writing.
While this drop may seem alarming to some, it also illustrates a silver lining of sorts for the cryptocurrency. A fewer number of users are now holding their Ethereum on exchanges. Instead, they are moving them to cold storage or cold wallets – a sign commonly associated with increased hodling sentiment. As more users hold on to their Ethereum, the price of the cryptocurrency is also likely to be positively impacted.
One of the reasons why many users are feeling inclined to do so can be due to its recent performance, as well as its ability to derive growth from a booming DeFi ecosystem that is based on its platform.
In fact, it is also interesting to note that over the same timeframe, Ethereum addresses with greater than 10 ETH have also seen a significant rise. According to network data provider Glassnode, such addresses have risen from 275K to 283K in the last three months alone.
One of the key reasons behind the aforementioned drop in Ethereum stored on exchanges ties back to increased hodling sentiment within the Ethereum community, as highlighted above. This, coupled with a rise in Ethereum locked in smart contracts (Since investors are looking to generate greater returns at a time when Etherum’s price is consolidating on the charts), bodes well for the cryptocurrency’s ecosystem.
Brace for it – Bitcoin Futures may be nearing a tipping point
What’s the tipping point for Bitcoin Futures on top derivatives exchanges like the CME, an exchange that has recorded a daily trading volume of over $300M and Open Interest of over $400M, consistently, for the past 3 months.
Well, a small shift in Open Interest or trading volume can have a cascading effect on Bitcoin Futures’ performance in the next 180 days. Such a shift will be influenced by several factors, and it begins at the tipping point. Three factors, to be more specific.
In the current phase of Bitcoin’s market cycle, these factors are more relevant for traders on derivative exchanges. This becomes more evident when the Liquidations chart for BitMEX is observed. Over the past 3 months, sell liquidations have paid for buy liquidations. However, over the last few days, this trend has been reversed, and buy liquidations have covered for sell liquidations on BitMEX.
The point here is to detect the source of the domino effect before the dominoes start falling. In the case of Bitcoin Futures, the tipping point may be closer than anticipated.
One of the top factors influencing the tipping point is the Law of the Few.
The Law of the Few states that “the success of any kind of social epidemic is heavily dependent on the involvement of people with a particular and rare set of social gifts.”
In the case of Bitcoin, institutional investors, derivatives traders, and whales fit the bill. The success of Bitcoin Futures in the global trading community heavily relies on institutional investors trading on CME. In fact, the daily trade volume and Open Interest on CME influence the trading sentiment across spot exchanges as well.
The last time a cascading effect was witnessed was when BTC Futures’ Daily Trading Volume hit $445M on CME and there was a rally all the way up to $614M. At the time of writing, the Daily Trading Volume was up 63.3%, when compared to the figures 6 months ago, and it has the potential to hit $614M with one move in the right direction.
This effect heavily relies on another key factor – The Stickiness Factor.
Back in 2017, when Google search results for “Bitcoin” and “Crypto” broke the record, the trading community witnessed a historic Bitcoin bull run and altcoin rally. Institutional interest and growth of Bitcoin derivative products ensued. A similar event transpired when Bitcoin Futures’ aggregated daily volume hit $184B on 27 July 2020. This event was a unique occurrence, and it made Bitcoin Futures stick in the portfolio of the average institutional investor and the derivatives trader.
The aggregate trade volume hasn’t dropped to pre-July 2020 levels since then. Despite drops in Bitcoin’s price on spot exchanges, Futures contracts continue to trade at a premium and there is more optimism. Volume is not directly impacted by Bitcoin’s price and when the spot market is riddled with bearish sentiment, long contracts continue feeding shorts on BitMEX. This stickiness is a driver of the aforementioned tipping point.
Inching closer to the tipping point, the powerful context is the rise of stablecoins and their instrumental role in lowering the barrier to entry on spot and fiat-crypto exchanges.
Over the past three months, stablecoins like USDT have added $100M in volume every day and their market capitalization and dominance have risen tremendously. In fact, Tether has also crossed a market capitalization of $15B.
This directly influences the tipping point for Bitcoin Futures as it makes Futures trading more accessible to traders. Bitcoin held on exchanges has nearly doubled over the past month, corresponding to an increase in Tether’s market capitalization and circulation. This resonates with derivatives traders who opt for physically-settled Bitcoin Futures contracts on exchanges like Bakkt. In fact, on Bakkt, the daily trade volume was upwards of $80M for the past week, while the Open Interest has been consistently above $10M.
All of these factors are highlighting a shift in derivatives traders’ strategy, while also underlining increased activity on derivatives exchanges. The race to the tipping point has begun – An increase in aggregate trading volume on physically-settled Futures contracts or CME may trigger the much-awaited domino effect.
Tron, Synthetix, VeChain Price Analysis: 19 September
Tron was observed to have hit a strong zone of resistance, before being rejected and pushed to the downside, at the time of writing. In fact, such bearish momentum appeared likely to continue for TRX. At a time when Ethereum was increasingly being criticized for high Gas fees and a congested network, it could have been Tron’s moment to shine, but things didn’t pan out that way at all.
TRX was seeing oversold conditions a few days ago when its RSI hit a low of 23, before ascending just past 50. However, the RSI was unable to remain above 50, and its drop beneath the level highlighted the fact that TRX’s recent 12% surge from $0.263 to $0.296 was merely a bounce.
TRX found a zone of strong resistance at $0.3 and looked likely to drop towards the support at $0.265.
Interestingly, a recent Reddit post has raised questions about JustSwap’s vetting process, claiming that the Tron Foundation has whitelisted a DeFi project that has since pulled a $2 million exit scam. This, despite DappRadar listing the project as “high-risk.”
Synthetix underlined the possibility of dropping lower on the charts. The Directional Movement Index did not yet show a strong trend, but ADX (yellow) was inching towards 20 and could move further north. Also, the rising -DMI (pink) denoted a bearish trend.
Over the past week, every SNX bounce off the level of support has been overwhelmed by selling pressure. This can be expected to continue. With the price registering lower highs, the way down remained the path of least resistance for SNX.
The next level of support after $4.23 lay at $3.36, representing a 20% depreciation.
VeChain showed bullishness in the market after a period of consolidation. The Bollinger Bands expanded to indicate heightened volatility, while the price broke out towards the upper band. At the time of writing, the price was staying above the 20-period moving average, a moving average that could be tested as support as VET steadily climbs toward its resistance around the $0.158 zone.
The breakout was also accompanied by high trading volumes, legitimizing the breakout.
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