Are ICO Tokens and Cryptocurrencies Actually 'Securities'?

You might have heard the term 'securities' floating around. Recently, the U.S. Securities and Exchange Commission, or SEC for short, has been digging deep into everything related to cryptocurrencies. Earlier this month, SEC chairman Jay Clayton expressed his views in comments a U.S. Senate hearing, focusing on ICOs. To be specific, he mentioned that, in his opinion, 'every ICO I’ve seen is a security.'

The term 'security' carries significant weight because it brings a heap of complex laws and regulations. Should cryptocurrencies be officially labeled as securities, it would mean that in the U.S., these digital assets would have to adhere to all SEC regulations and legal requirements.

What is a security?

A security , broadly speaking, involve financial instruments rooted in debt or equity.

Debt securities are things like bonds or CDs. Owning one means someone owes you money. For example, if you own a city bond, that city has to pay you back according to the bond's schedule. The other category is equity securities. Equity means owning a piece of a business, like owning stock shares in a company such as Microsoft.

Website of the U.S. Securities & Exchange Commission

The landscape gets muddier when we wade into cryptocurrencies.

Take bitcoin, for example. With bitcoin, you’re not holding onto any specific promise of debt or repayment. There’s no set issuer bound to repay you at some point. Therefore, bitcoin doesn't fit the mold of a debt security. Similarly, holding bitcoin isn't akin to owning a stake in a company; it’s not a share of ownership. Its value comes from the intrinsic value of bitcoin itself, much like gold or diamonds, making it more of an asset than a security.

Are ICO Cryptocurrencies Considered Securities?

As we delve further into the diverse range of cryptocurrencies and ERC-20 tokens offered in ICO’s it becomes clear why defining them is tricky. ICOs typically come from a business or individual. Even if not officially a company, the offerings are from individuals who benefit from sales.

With Jay Clayton from the SEC believing most ICOs are securities, the implications for American citizens could be vast. Outside the U.S., many countries – whether directly or indirectly linked with U.S. laws – might feel the ripple effects. During a hearing, Clayton suggested to Sen. Elizabeth Warren that ICOs, as they currently stand, violate laws.

SEC Chairman Jay Clayton, Image from Omaha.com

Are ICO’s illegal? At this point, not quite To deem an ICO illegal in the U.S., labeling it as a security is the first step. If that happens, selling it without following SEC protocols might be illegal. However, the current situation is very ambiguous and not clear-cut. While SEC Chairman Clayton feels that ICOs are securities, U.S. law has not fully embraced this perspective.

US-Based ICO’s walk on eggshells

Due to thorough scrutiny, many U.S.-based ICOs have played it safe with their terminology, avoiding the term “ICO” outright. Instead, they lean towards terms like “crowd sale” or “token generating event.” They've also shifted away from calling their tokens currency, opting for alternate expressions.

Salt Lending , a company from Denver with a past ICO, now refers to their ERC-20 tokens as “memberships.” They strictly prohibit chat about exchange prices or speculation in their group. official Telegram chat Users who breach this rule face quick bans. When questioned, moderators swiftly point to the SEC and potential legal repercussions with pre-crafted messages.

For some time, Americans have faced barriers or outright bans from numerous promising ICOs. If not outright banned, often only “accredited investors” are allowed to join—this term mostly refers to the wealthy. Those without this label are called retail investors. This all traces back to SEC guidelines that, theoretically, wish to shield retail investors from potentially huge losses due to risky ventures.

Do We Really Need SEC Regulations for ICOs?

Imagine a hypothetical situation: say a consumer orders a pasta maker online. Upon arrival, they discover it’s faulty, or it quickly breaks. In such cases, how much should the government intervene? To safeguard consumers, should a Pasta Maker Quality Commission or PQC come into play? Would companies then need extensive registration processes, involving costly legal fees and many lawyers?

Now suppose companies quickly dodge PQC regulations by simply dubbing their creations “Italian-style noodle makers.” In response, legal terms would need adjusting to define pasta makers precisely, forcing companies to stay ahead of changing descriptions.

But is any of this necessary? Wouldn’t it make more sense for consumers to rely on their own judgment, peer reviews, or brand reputation rather than a heavy-handed government body 'guarding' them? To ring the alarm bells, what if only the affluent could purchase the best, budget-friendly pasta makers unregistered by the PQC, leaving ordinary folk with costly, outdated, subpar models approved by them?

This case may sound ridiculous, yet it’s a close parallel to the SEC’s relationship with ICO opportunities for retail investors.

A new financial paradigm

Historically, only the rich had chances to leverage the best, most thrilling, and profitable investments. Things changed when Ether came along for under a buck, suddenly democratizing investment opportunities in what could be one of the most significant financial events of the century.

While the SEC regulations may theoretically serve a valid purpose, they might soon become redundant and unwarranted. The SEC states their mission is to guard retail investors from scams and cons.

If that’s true, why does law permit the affluent to participate in such investments?

Today’s retail investor is better informed than ever, thanks to the internet and countless tools. Maybe the SEC needs to re-evaluate ICOs, placing trust in the knowledge and prudence retail investors can wield. While some ICOs may be scams exclude retail investors, doing so only ensures that the wealthy elite get the top-notch investment prospects.