Are Cryptocurrencies Securities?

Are cryptocurrencies securities? If a business accepts an investment via cryptocurrency, rather than by cheque or otherwise, is it still considered to be soliciting an investment? What about cryptocurrency investment offerings, like Initial Coin Offerings (ICOs) and Initial Token Offerings (ITOs)? Do these constitute purchases and sales of securities?

In many cases, it appears that cryptocurrencies are indeed securities. Positions taken by government regulators in the USA and Canada midway through 2017 indicate that if a person’s participation in a cryptocurrency is tied to future profit, they have likely traded in securities.

What is a security?

A security is a contract that evidences an investment. Despite the name “security,” it doesn’t relate to safety or risk. Examples of securities are:

  • Stocks and shares
  • Bonds
  • Loan Agreements
  • Promissory Notes
  • Warrants
  • Profit Sharing Agreements

Most countries take the position that any purchase with the goal earning of a future return, except when made directly into real estate, constitutes a purchase of a security. Consider the USA’s broad definition, for example:

Any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

Why it matters if cryptocurrencies are securities

The investment world is highly regulated. Each country has its own laws that must be followed by people and companies who wish to purchase or sell securities. In most cases, there are onerous licensing, registration and disclosure requirements, such as filing a prospectus, producing an offering memorandum or relying on an exemption. In short, if you want to create an investment opportunity, there are specific rules that must be abided by.

If cryptocurrencies are securities, then their investment offerings must comply with the laws of each jurisdiction in which they operate and have investors. For example, if an entrepreneur launches an ICO from America, then that offering must be legal not only in the USA, but in each country that it raises money from. That poses significant and expensive legal obstacles for the cryptocurrency world. It can no longer function as a free-for-all.

Are cryptocurrencies securities?

Regulators have taken the stance that a cryptocurrency may be a security if it is being used for investment purposes. For example, if I invested in your business by using Bitcoins, or if I invested in your ICO with Bitcoins, then we both traded in securities. However, if I purchased a product, like an iPhone, from you and paid with Bitcoin, then we did not trade in securities.

Here’s what regulators have indicated thus far:

USA

In July of 2017, following an investigation of a company raising capital through a virtual coin called The DAO, the US Securities and Exchange Commission (SEC) noted that:

Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.

That means a company can’t bypass the law by accepting a cryptocurrency instead of cash. If it is offering an ownership or creditor position in a business venture in exchange for payment, it is soliciting securities. It must follow the same rules as all other issuers. 

Canada

The next month, the Canadian Securities Administrators published a notice (called CSA Staff Notice 46-307) to address cryptocurrency offerings. In stated that Canadian regulators would view cryptocurrency ventures as securities if the purpose for participation is to profit. It gave this example:

If an individual purchases coins/tokens that allow him/her to play video games on a platform, it is possible that securities may not be involved. However, if an individual purchases coins/tokens whose value is tied to the future profits or success of a business, these will likely be considered securities.

The CSA offered a four-point test to help operators determine whether they are trading in securities:

(1) An investment of money (2) In a common enterprise (3) With the expectation of profit (4) To come significantly from the efforts of others.

More about CSA Staff Notice 46-307 here.

International

Cryptocurrencies have not yet received a lot of attention from securities regulators in other countries. I know of few formal rulings or notices that specifically declare them as securities. However, the SEC/CSA’s positions make sense and will likely be replicated across capital markets. The authorities would not allow businesses to circumvent rules that are designed to protect investors simply because they are using a different method of payment.

So what does this all mean?

Deeming cryptocurrencies as securities has serious implications for businesses and investors alike. Among the most rattling is that many (if not all) cryptocurrency investment opportunities, including ICOs and ITOs, are currently illegal. In September 2017, various government administrations in China explicitly banned ICOs outright.

In fact, the borderless and anonymous nature of cryptocurrency transactions may render it impossible for offerings to comply with the law. Regulations mandate disclosure and transparency, which is the antithesis of the cryptocurrency mantra. If a company wants to raise capital en masse, it not only has to disclose sensitive business and financial information, but it may also have to know who its investors are. It can’t simply accept money from any person, at any time, from any place in the world. 

Cryptocurrency investors and entrepreneurs should know that they are playing with fire. As the industry grows, so will the authorities’ attempts to regulate it.

Notwithstanding the law, there are no signs to indicate that the cryptocurrency world is slowing. It is likely that investment offerings will continue and prosecutions will begin. However, few regulators are equipped to handle the complex technological task of tracing buyers and sellers of virtual coins. In the short term, it probably means that most people will get away with it.

About The Author

Alexis Assadi

Alexis Assadi is an investor, entrepreneur and writer, who advocates for making high-performing income investments and the lifelong pursuit of financial intelligence. He is a shareholder and director in three companies that provide funding to small businesses, entrepreneurs and real estate projects. His most recent venture is a firm called Pacific Income LP.

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