In the 14th century, Dante Alighieri forever shaped our vision of a retributive afterlife with his Divine Comedy. Tellingly, the first “level of hell” introduced therein was populated by those who could not decide (“those who lived without occasion for infamy or praise”); to the celebrated Renaissance poet, those habiting the sidelines of history could hope for limbo, at best, in the final judgment.

The Securities and Exchange Commission (SEC), the multibillion dollar agency that safeguards investors, presently stands on the precipice of the layer Dante reserved for the indecisive. For, nearly a decade after Bitcoin burst onto the scene in 2010, there has been no concrete attempt at delineating purchaser from investor in the cryptocurrency market—indeed, it appears the agency is content to provide guidance regarding fraud and custody rather than defining products and attendant responsibilities for those soliciting funds for digital conversion. And a generation of new investors continues to clamor for alt-currency gains creating legends in the press.

Background: A Noble Reaction

When first launched, Bitcoin—then seminal, but now merely emblematic of crypto—seemed a natural progression from populist anger at the 2008 bailouts. A peer-to-peer payment system eradicated charges by credit card issuers to both buyer and seller. Meanwhile, the augur of “non-fiat currency” raised valid questions about government tender no longer directly backed by gold or scarce commodity.

But the Quixotic alternative to traditional currencies quickly met with two notable problems.

First, the advent of the digital coin occasioned spectacular failures and frauds. In 2014, the Japanese exchange Mt. Gox saw its inventory vanish almost overnight. The disappearance of over $100 million of Bitcoin inspired criminal investigation and bankruptcies that are only now seeing resolution. Separately, the heinous acts attributed to the online black market titled Silk Road led to its founder being imprisoned for life in 2015.

Second, the crypto field has seen its original mission of direct commerce between merchant and consumer overtaken by a galaxy of middlemen. New, online vendors buy and sell previously mined coins; still others promise astronomical returns for those investors committed to secondary trading. Eclipsing them all may be the emergence of the initial coin offering (ICO), a nearly unfathomable market benefiting from its nominal link to the traditional (registered) “IPO.”

The result? Radiating little trust as a means of payment, alt-currencies continue to serve primarily as alt-investments. Unsupervised “crypto exchanges” are a keyboard button away. Contemporaneously, as has been noted, less than 2% of all Bitcoin transactions currently involve any payment to somebody. Olga Kharif, Bitcoin Rally Masks Uncomfortable Fact: Almost Nobody Uses It, Bloomberg News (May 31, 2019).

The sheer pervasiveness of alt-currency as passive money-makers necessitates SEC intervention. To its credit, the SEC has hit entities hard in clear cases of confused investors.

SEC Responses to Date

Utilizing the time-honored “Howey Test” created by the Supreme Court in 1946, the SEC has exercised jurisdiction over transactions and their promoters with little resistance.

Specifically, when a company issuing “shares” proved little more than a Ponzi Scheme, the SEC has sued. See, e.g., SEC v. Shavers (2013).

When a company disguised securities as “tokens” or coins,” the Commission has similarly taken action. See SEC v. Recoin Group (2017).

When two Instagramming celebrities referred to non-registered coin markets as formal “exchanges,” their fines were significant. Those parallel disciplinary decisions simply skipped over the requisite findings of the presence of traded “securities.” Order Instituting Cease-and-Desist Proceedings, SEC v. Floyd Mayweather Jr. (2018).

And when a company promised to pool crypto trading profits to provide “passive income,” the SEC obtained a preliminary injunction. Blockvest, LLC, 2019 WL625163 (2019).

In April, to demonstrate evenhandedness, the SEC issued a No Action Letter, thus permitting a coin offering to go forward without registration. That letter explained that such excepted entities must ensure that, among other things, the resulting revenue is not earmarked for the trading platform, the coin's value is set at a nominal and non-fluctuating value, and speculative investment is not encouraged nor facilitated.

In early July, the SEC and the chief broker-dealer regulator issued guidance to such registered entities on how to treat crypto assets. However, no regulation establishing SEC jurisdiction or defining crypto investments has been promulgated. The result is an informal doctrine establishing simply that cyber entities should never misstate the truth (a universal credo) and/or that such entities should not promote speculation in their digital assets (a specter arguably outside their control).

Aggressive Federalism?

Fragmented and local legal guidelines have therefore become the norm. A proposed uniform virtual currency act has been introduced in less than 10 states. Meanwhile, individual state responses have been varied, to say the least.

New York led the charge for tough oversight. In 2014, its Department of Financial Services opened for public comment regulations obligating all companies offering cryptocurrency to the public to pay a fee for a statewide registration. The resulting regs were implemented in August 2015, requiring of any entity that would exchange virtual currency in New York, among other things, a net capital floor, appointment of a contact person, and recordkeeping.

Conversely, neighboring states such as New Jersey have preferred the carrot to the stick, offering tax incentives to new crypto businesses taking root within its geographical boundaries.

Perhaps most significantly, against the backdrop of well-publicized SEC enforcement action, Iowa grabbed headlines in February by proposing a legislative amendment openly stating that certain of its securities laws do not apply to cryptocurrency. See 2019 IA H.F. 240 (defining “virtual currency” and exempting parties from aspects of the state's “Blue Sky” law, which includes its own Howey Test).

Many states answer the question of what to do with alt-currency providers by adding crypto sellers to the existing list of money transmitters. See Vermont HB 182 (enacted May 4, 2017).

And, in prescient foreseeing of investor confusion, Missouri disciplined a virtual mining corporation in 2014 while advocating a list of mandatory investor disclosures on the dangers of crypto speculation.

The Inevitable SEC Preemption

All of which has led to conflicting voices at the top. In March, SEC Commissioner Hester Pierce advocated flexibility when she encouraged “less caution” in fitting common law to digital entrepreneurship. Separately, SEC dedicated rulemaking on the subject, perhaps inevitable, has remained but a vague rumor.

Nonetheless, there exist four unavoidable arguments for immediate codification of governmental approach:

First, the Treasury, IRS, and CFTC have but issued public statements or disciplinary cases serving as warnings; more often then not, such pronouncements serve very limited ends (e.g., changing large amounts of crypto to cash invokes transmittal rules; crypto investment gains shall be taxed as property).

Second, the technology terrain has been seen before. In 2012, an expedient hodgepodge of state laws and rules legitimized crowdfunding, permitting some form of the cyberspace alternative to capital formation to exist. The SEC adopted Regulation Crowdfunding in 2016. That harmonization assimilated some state concepts (e.g., limiting investor contributions) while resurrecting Commission principles (e.g., the “intrastate exemption” to securities registration requirements). Most notably, the Commission released concrete guidance informing market players on such topics as caps on investor purchases, issuer need to register, and limits on advertising. See Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers.

Third, the industry has no plans to cabin growth. The Facebook notice of its planned, worldwide digital coin (“Libra”) was monumental enough to trigger subpoenas for congressional testimony and evoke foreign government opposition. Separately, JP Morgan and Goldman Sachs have announced plans for “stable coins,” short-term alt-currencies meant to house deposits but nonetheless subject to speculation as well. PriceWaterhouse Coopers has announced “cryptocurrency auditing” as one of its services. And a recently certified class action includes allegations of 200,000 purchasers and 33 million transactions. Perry Cooper, Bitcoin Mining Company Ponzi Scheme Investors Win Class Status (June 24, 2019), further underscoring the leviathan nature of the problem.

Finally, the current state of investor information is alarmingly fragile. A recent study opined that over 80% of all crypto exchanges doctor figures on volume (while another delivered similar stats for the percentage of the world's 200+ crypto exchanges that have avoided registration).

What thus seems ideal is imminent SEC rulemaking demarcating crypto deals which do not trigger coverage by the securities laws. Such compromise was displayed by the SEC in the TurnKey Letter. Expanding upon that guidance, a dedicated SEC Rule could (1) define alt-currencies, (2) clarify that digital coins/currencies are not per se violative, (3) ensure that issuers have the right to create a nonfluctuating “coin” or “token” for use in a restricted environment, and (4) warn issuers against encouraging or facilitating neophyte speculation.

Conclusion

A more robust response to alt-currencies could halt infighting over the tired Howey Test (a common law creation compelling government registration of deals involving, among other things, silver coins and chinchilla breeding farms). Agency legislation could inspire Congress to act, pre-empt Balkanized state efforts, and distinguish cryptocurrency as a means of expertised trading from cryptocurrency as an end of quick financial gain.

Despite the hint of oversight contributed by headlines and attendant fines, SEC disciplinary cases often succeed primarily in forestalling difficult choices. Transparent and enduring rulemaking is what the nearly 90-year old agency does best. Both investors seeking the proverbial “ground floor” and entities seeking to lawfully enter the market crave guidelines. Surely, to pledge allegiance to neither camp invites condemnation by them both—as well as the great Dante himself.

Scott Colesanti, a former regulator, is a professor at the Hofstra University School of Law, where he has taught securities regulation since 2002.