Bitcoin has largely escaped
government oversight, but regulators are examining whether other widely traded cryptocurrencies
should be regulated as securities, according to people familiar with the
matter.
The inquiry includes a focus
on ether, representing a significant threat to virtual currencies, which so far
haven’t been drawn into a regulatory crackdown on potential fraud in the market
for the assets. Until now, regulators hadn’t questioned whether rules designed
for stocks should apply to virtual currencies such as ether, the world’s second
most valuable cryptocurrency after bitcoin with a market value of $67 billion.
The analysis, by federal
securities and commodities regulators, turns on whether the creators of virtual
currencies other than bitcoin exert significant influence over their value, in
the same way a company’s stock price depends on its managers and their
strategy, performance and investments, the people said. The Commodity Futures
Trading Commission has deemed bitcoin to be a commodity, meaning it isn’t
subject to investor-protection laws enforced by the Securities and Exchange
Commission.
Some regulators think ether
is in a “gray zone,” but believe its creation in 2014 was probably an illegal
securities sale, the people said. Silicon Valley backers such as
venture-capital firm Andreessen Horowitz disagree, saying no particular person
or entity stands behind ether or is responsible for driving its value.
Under U.S. law, companies
that issue stocks or bonds must either register the deal with the SEC—and give
investors extensive disclosures—or limit the sale to sophisticated institutions
and the rich. Ether’s founders didn’t register the 2014 sale and sold the coins
to anyone willing to buy.
Any determination from
regulators that ether is a security could spark a wave of selling and rattle
major trading venues such as Coinbase that allow investors to buy and sell
it. Coinbase
has discussed applying for an SEC license to operate as a brokerage
firm, a process that could bring the fight over ether to the surface because
brokers can’t deal in unregistered securities.
Gary Gensler, a former CFTC
chairman, said in a speech last week that “there is a strong case that one or
both of ETH and [Ripple’s] XRP are noncompliant securities,” using the
shorthand for the virtual currencies.
Ether’s backers say it
serves a purpose beyond trading. The virtual currency is paid to people who run
the Ethereum program on their computer—a necessary function for a decentralized
project.
Supporters of ether,
including Andreessen Horowitz, also note that ether is mined—or created—by that
broad community of users, not any single person or entity.
Ether “has become so
decentralized it should not be deemed a security,” a group of venture capitalists
including Andreessen and Union Square Ventures wrote in a proposal seeking
a broad regulatory exemption, which was submitted to the SEC in late March.
Coinbase declined to comment
on regulators’ questions about ether.
Cryptocurrency developers
and some of the lawyers representing the industry are frustrated that the SEC
continues to apply an arcane legal test to determine whether a new generation
of assets, such as ether, fall into the basket of assets that it regulates.
The “Howey Test,” named for
a 1946 Supreme Court case involving interests in an orange grove, requires
regulators to assert whether the investment was made in a “common enterprise”
and whether anticipated profits depend on the efforts of others.
Regulators have studied the
role of central actors, such as Ethereum Foundation, which developed ether and
oversees improvements to its software network, in driving the asset’s value.
The foundation, for instance, pays “bug bounties,” which reward programmers who
fix vulnerabilities in ether’s code, showing the nonprofit influences
improvements that can boost the virtual currency’s value, one of the people
familiar with the matter said.
Regulators are studying what
other factors account for fluctuations in ether’s price, some of which temper
the case for calling it a security. For instance, the government is looking at
how much of its demand stems from people who use ether to run applications on
the software platform.
“Applying those factors,
it’s still sort of gray,” said one person familiar with the inquiry.
A working group of
regulators including senior SEC and CFTC officials are scheduled to discuss the
matter on May 7, one of the people said.
The foundation says it
doesn’t control the supply or demand of ether and owns less than 1% of the
amount in circulation.
The foundation raised over
31,000 bitcoin, or about $18.3 million, in July 2014 when it sold about 60
million ether. Because the foundation raised the money to build the Ethereum
platform, and investors probably bought ether speculating the launch would make
the asset rise in value, the deal resembled a securities sale, the people said.
That doesn’t mean it has to
remain a security, some backers of cryptocurrencies say. Instead, virtual
currencies such as ether can become consumer products as the company’s
blockchain project becomes functional, meaning programmers around the world
perform the computations that use or create it, not the foundation or its
officers.
“There’s no legal precedent
for it,” Mr. Gensler said.
Peter Van Valkenburgh,
director of research at Coin Center, said declaring ether a security “would
make a shambles of U.S. innovation policy. It’s going to throw up a lot of
barriers that aren’t necessarily sensible.”
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