New “coins” or tokens and their platforms are all the rage. Bitcoin, Bitcoin Cash, Ethereum, Litecoin, Zcash, Dash, Ripple, Monero, the list goes on and on and new ones keep popping up. The new coins are either entirely their own platform or they are derivations, i.e. spin-offs of one of the existing virtual currency platforms.
The IRS took the position in 2014 that Bitcoin and coins like it were property, and not currency. Interestingly, it did this as it referred to Bitcoin and other coins as “virtual currency.” The classification of Bitcoin as property has certain effects on its treatment with respect to tax issues. The IRS has a decent FAQ on this here.
Also note that the US Commodity and Futures Trading Commission took action against an unregistered Bitcoin option trading platform in 2015, which would imply that Bitcoin may fall within the scope of a commodity subject to the Commodity Exchange Act (although this is unclear as to its scope – but if Bitcoin is a commodity it would follow that it should not be treated as a security).
It was only a matter of time until the SEC weighed in. Especially because the promoters of these new coins started calling the birth of new coin platforms as ICO’s (“Initial Coin Offerings”), and heavily advertising them to the public, such as Floyd Mayweather’s promotion of the Stox ICO on social media platforms, from which ICO he said he was going to make a “sh*t ton of money”. That’s the type of situation and language that gets the SEC up in the morning.
Now under the federal securities laws (which I have described with respect to virtual world items in the past), an offering of “securities” must be done only after registration of such securities or pursuant to an exemption from registration. The main issue present with these ICOs is whether the virtual currency is a “security” or not. This would bring up the “Howey Test”, from SEC v. Howey Co., 328 U.S. 293 (1946), which can be summarized as whether the individual investing the funds into a common enterprise expects profits to come solely from the efforts of others (there are some other factors used in the test as well, but that’s it in a nutshell).
Profit is defined in United Hous. Found. v Forman, 421 U.S. 837 (1975) as as “either capital appreciation resulting from the development of the initial investment” or “a participation in earnings resulting from the use of investors’ funds”.
Usually the people pumping money into these ICOs are not the ones working on the platform (usually blockchain type information exchange platforms), and without that involvement it may come down to the investor’s expectation – are they expecting the money they invest to go towards the growth of the platform which would increase the popularity and hence value of the platform’s coin? If so that may be an issue. What a coin (or sometimes called a “token”) is still has not been fully defined, and the characteristics of each coin or token vary by platform and change over time.
The SEC issued an Investor Bulletin that said that some ICOs depending on the circumstances “may” involve sale of securities. It should be taken as a warning. While the application of the securities laws to coins and ICOs is a gray area, there is a line somewhere and the first very public ICO to cross it without registration or use of an exemption (which is doubtful if public advertising is used and investment is taken from anyone, regardless of circumstances), the SEC may come after. Watch out Floyd, you may not be too worried about Conor McGregor but you should be of the SEC.