eBusiness Weekly
Cryptocurrency regulation: Sec Zim appropriate authority to drive change.
Prosper Mwedzi
There has been a lot of debate about the regulation of cryptocurrencies which to this day are still unregulated instruments in most jurisdictions unless packaged as a financial instrument such as derivatives like contracts of difference (CFDs).
One of the countries which is leading the charge on the regulation front is Thailand, which boasts of a raft of laws covering offering of cryptocurrencies and investment vehicles such as Initial Coin Offerings (ICOs).
Malta is another jurisdiction which is emerging as a powerhouse in Europe with the prime minister openly declaring blockchain as the future of technology.
Japan has taken a different and more interesting approach when it comes to this area as it is the only country so far which has gone for the option of self regulation for the industry through a public statement made by the Financial Services Authority which is the regulator of financial services.
Although there have been developments towards regulation in other jurisdictions, regulation in the US has always been seen as a significant development and there appears to have been a chaotic approach in the US in the past year.
The whole world was also grappling with how to deal with the disruptive technology, dubbed web 2.0.
However, November has seen a significant development in the virtual currencies space in the US.
The United States Securities and Exchanges Commission (SEC) which regulates securities settled with two issuers of cryptocurrencies — CarrierEQ Inc. (Airfox) and Paragon Coin Inc — who had conducted ICOs in 2017 after the Commission had warned that ICOs can be security offerings. In US law, anyone who fund raises by taking funds from the public has to register the offering as this is required to ensure that there are protections to investors. The US applies the Hoey Test which was established in the ancient case of SEC v. W. J. Howey Co.(1946), which was an interpretation of the US Securities Act of 1933.
Howey Test and cryptocurrencies
The Howey Test determines that a transaction represents an investment contract if “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”. ICOs, had been seen as a way of crowd funding and there had been consensus within the tokens space that this method circumvents securities laws.
This was mainly done through ensuring that the token has utility and anyone buying it does so for the purpose of accessing services to be provided on a platform to be launched in the future.
Until recently the SEC and the Futures and Commodities Trading Commission (CFTC) had only gone as far as expressing opinions and issuing public warnings about risks involved in investing in tokens. Although there have been a few pronouncements by US Federal Courts interpreting the laws in favour of SEC and CFTC, these cases were not of wider application, they acted as specimen litigation.
The settlement with Airfox and Paragon marks a departure in the regulation of cryptocurrencies by the US and sets a new benchmark for the industry. It shows a clear resolve by SEC to apply the dusty Howey Test on cryptocurrencies. The SEC is known for its approach of “regulation through enforcement” which is seen as effective for tactical reasons.
It enables the regulator to set a standard which can then be used as a regulatory template-the recent orders against the aforementioned companies has just done that now for SEC and could trigger a lot of SEC action in the coming days and months.
The Airfox and Paragon settlement decisions were followed up with a statement which now sets out in clearer terms the loose framework under which SEC will operate and there is no reprieve for crypto assets.
Implications of S E C enforcement
SEC enforcement heralds the arrival of a “new sheriff in town”, the warning shots have already been fired and the cryptocurrency space has taken heed through a flash market crash which saw bitcoin plummet by 30 percent in a space of 24 hours. Although there are other factors for the crash such as the Bitcoin Cash hard fork, there can be no doubt that the ramping up of the regulatory rhetoric in the US has also played a contributory part in the flash market crash.
The implications of the US position are far reaching and the orders issued against Airfox and Paragon should send shivers to all token projects which pursued the ICO funding route especially if based in the US. This is because apart from the fines issued, the projects have been ordered to refund all ICO contributors.
All small projects are likely to be bankrupted by such a measure and the next few months are going to be defining for crypto space. The long arm of US law knows no boundaries and it could even have its reach on projects which are located outside the US where there are extradition arrangements in place. The clear message seems to be that the days of ICOs are over.
There is far more risk in doing an ICO, most new projects are likely to default back to Initial Public Offerings (IPOs). Recent SEC action could also result in a “tsunami” of litigation against lawyers who advised ICOs and investors who have not realised any returns. This is especially relevant in current market conditions where most ICO tokens have lost over 80 percent of ICO value.
US SEC’s taking the lead in this space in the US implies that Zimbabwe’s Securities and Exchanges Commission might be the appropriate authority to quickly respond and regulate cryptocurrencies in Zimbabwe while this area awaits legislative attention. It does not appear to be an area within the competence of the Reserve Bank of Zimbabwe.
Views expressed in this article do not constitute legal advice and are opinions and observations.
Prosper Mwedzi is a Zimbabwean Solicitor and blockchain enthusiast based in the United Kingdom.
