At Thursday's Yahoo Finance summit on cryptocurrency, the director of the SEC's Division of Corporation Finance, William Hinman, delivered remarks entitled "Digital Asset Transactions: When Howey Met Gary (Plastic)." Today, some publications latched onto Hinman's statements regarding Ether, the second largest cryptocurrency by market capitalization (behind bitcoin).
"Putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions," he said. "And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value."
The director's stance may generally signal how the nation's stock market regulator decides to approach oversight and enforcement issues related to Ether, the native tokens of the Ethereum network. Unfortunately, his commentary on Ether was limited to a single paragraph, and he didn't explain why he arrived at these conclusions. So, as observers, we're left with a bevy of questions.
For instance, what does the director perceive as the Ethereum Foundation's ongoing role in the development of the Ethereum network? Does his attitude toward Ethereum also apply to Ethereum Classic?
Furthermore, does the planned shift from PoW to PoS change anything in his analysis? Has he considered the Foundation's own Ether holdings (or those of the most prominent Ethereum developers)?
All told, it's unclear how the commission might measure "decentralization."
Is it based on the number of developers with commit access? The number of nodes? The validation schema?
Even though Hinman said that other decentralized networks could arise (and not be subject to securities regulation), cryptocurrency enthusiasts might be wondering how that could happen legally. Quite simply, it seems like everything that's "decentralized" begins with some degree of coordinated management. These broad strokes make it difficult to fathom a world with competing networks and, as such, early movers might retain an important regulatory advantage. Depending on how things shake out, developers could even demonstrate a preference for airdrops over initial coin offerings (ICOs), though even those could pose legal challenges.
While Hinman left his listeners wanting, it's worth noting that his views closely paralleled those expressed in April by former Commodity Futures Trading Commission (CFTC) chair Gary Gensler. At the time, Gensler emphasized that there seems to be a "strong case" that Ripple (XRP) is a noncompliant security. But, Ethereum, as usual, was more complicated.
Shortly after Hinman finished his speech, an email from CoinCenter landed in the ETHNews inbox. Like some of the media, the cryptocurrency advocates somewhat jumped the gun, characterizing the director's statements as representative of the commission's own views:
"We are glad the SEC agrees with our long-held analysis of how securities law applies to decentralized cryptocurrency networks like Bitcoin and Ethereum," they wrote. "We are thrilled to see it take strong pro-innovation approach to this nascent technology. With this guidance, the SEC is showing that taking a pro-innovation approach does not have to come at the expense of protecting investors."
Unfortunately, as should be made clear to investors and observers, Hinman's statements embody only his personal views. While the director did shed some light on the agency's considerations, let's not make a mountain out of a molehill.
Today, Hinman answered the question, "Can a digital asset that was originally offered in a securities offering ever be later sold in a manner that does not constitute an offering of a security?" with a "qualified 'yes.'" Let's not forget the director's caveats or the many complexities that remain.
"The digital asset itself is simply code. But the way it is sold – as part of an investment; to non-users; by promoters to develop the enterprise – can be, and, in that context, most often is, a security – because it evidences an investment contract. And regulating these transactions as securities transactions makes sense."
"If the network on which the token or coin is to function is sufficiently decentralized – where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts – the assets may not represent an investment contract."
Finally, I'd like to share the two sets of questions that Hinman included for his audience. While "not exhaustive," these likely provide the greatest insight into the commission's regulatory approach to digital assets.