SEC Extends Reach to Digital Currencies

The Securities and Exchange Commission (SEC) released a series of investor bulletins, investigative reports and statements late on July 25, detailing its examination of a recent case of fraud in the ether digital currency.

It found that certain initial coin offerings (ICOs), which act as a form of equity crowdfunding by allowing investors to purchase tokens or coins that entitle them to a share of a company or project, can behave in the same way as traditional investments. As such, the SEC says, they should be registered with the SEC and fall subject to its rules governing such processes.

“The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, co-director of the SEC’s enforcement division, in a statement.

The SEC’s report focused specifically on an event that took place regarding “the DAO”, a digital venture set up to fund proposed companies or projects, where investors would vote on which would receive capital. During 2016, a hacker exploited weaknesses in the code and stole roughly one-third of the funds in the DAO.

The co-founders and other specialists pulled off a daring move to effectively split the blockchain and return the money to investors, but the incident has become legend within the digital-currency community, and to outside observers, a cautionary tale of the many problems that plague this market.

The SEC says that whether or not an ICO or a digital currency constitutes an investment will vary, but typically indications include investing cash or other assets in exchange for returns, dividends or other benefits, which many ICOs do promise.

“There’s a lot of dumb money in this market,” says a senior executive at a UK-based asset manager that has experience in trading digital currencies. “More regulation and a tighter grip on making sure only accredited investors can participate, so ordinary people don’t lose their shirt when these things go belly up, can only be a good thing.”

Another US-based portfolio manager at a hedge fund with exposure to digital currencies said it was “about time” that the SEC acted.

“This is just the SEC saying if it looks like a duck and walks like a duck, then it’s probably a duck,” he says. “The problem is that it hadn’t said that before, so ICOs and some digital assets existed in a grey area. What’ll be interesting now is if we see the momentum behind price start to falter as the number of ICOs drop off.”

An explosion in the amount of ICOs has been cited by some experts as being a driving force behind bitcoin and ether’s rise in value this year, which has seen the former hit an all-time high of over $3,000 in June, while the later has shot up from $10 to over $300.

The volatility of the currency has drawn interest from some institutional players, with systematic commodity funds in particular being attracted to the market, but also more traditional players. Wealth manager Rothschild Investment Corporation, for instance, took a relatively small position in a bitcoin investment vehicle operated by investment manager Grayscale, according to SEC filings from the end of June.

Big asset managers such as Fidelity Investments have also publicly expressed enthusiasm for digital currencies, but the market remains immature from an institutional perspective, with little regulatory oversight and vast potential for fraud. Furthermore, it lacks a developed derivatives market, although firms such as LedgerX, which received approval from the Commodity Futures Trading Commission (CFTC) to operate a clearinghouse and trading venue for bitcoin options on July 24, are aiming to change that.