US crypto regulation could be restricting blockchain development

Author: Olly Jackson | Published: 9 May 2018
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A decision from the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) that ethereum – the second most valuable cryptocurrency – is a security, not a commodity could potentially have wide ranging effects on exchanges and investors. It could also further bolster regulation in a sector that had remained relatively untouched until recently.

EthereumThe blockchain ethereum is the most popular choice for investors because of the ease with which it is can produce smart contracts, code capable of monitoring, and executing and enforcing agreements. While the technology is almost universally lauded as having a potentially revolutionary impact over a whole raft of sectors, fiercer regulation could restrict its development and see businesses and customers lose out on the benefits it can provide.

The blockchain ledger can process transactions more quickly, securely and efficiently than standard databases used currently. For example, using blockchain, a contract could be shared with multiple parties and edited once at a time, rather than passing around a paper document to the contracting parties. What is particularly advantageous about the ethereum blockchain are that its nodes – or users – store the most up-to-date state of each smart contract.

In March 2018, SEC chairman Jay Clayton came out in support of blockchain technology. Last week, JP Morgan filed a patent for a blockchain-based peer-to-peer payments services between banks. This is only part of a fast-increasing desire from established banks to invest in the space.

"The results of the SEC and CFTC's meeting could be a watershed moment for the blockchain industry"

But securities regulation could put a halt to this progress, particularly when considering that issuers are often small start-up companies or even individuals who would struggle to comply with the more onerous rules. 

Kevin Grimm, chief executive of the Daily Bit, said that shoehorning blockchain into existing frameworks that do not account for decentralised models is not the right approach to take.

"Too many restrictions will drive entrepreneurs and capital to foreign markets," he said. "The results of the SEC and CFTC's meeting could be a watershed moment for the blockchain industry, as the identification of ether as a security would cripple short-term industry growth."

With technology moving so quickly, any step backwards could be pivotal and hugely detrimental to a technology said to be potentially revolutionary.

Ethereum’s fate strangely lies with a 1946 case about citrus groves. In the case that led to the famed Howey test, a transaction is deemed to be an investment contract and subject to securities laws if: it is an investment of money; there is an expectation of profits from the investment; the investment of money is in a common enterprise, and; any profit comes from the efforts of a promoter or third party. Opinion is mixed as to whether ethereum meets these criteria. Ethereum co-founder Joseph Lubin said it fails the Howey test and does not believe the meeting will result in the cryptocurrency being classed as a security. But if it is decided that it does, the technology underpinning the cryptocurrency could suffer.


  • The SEC and CFTC are said to be determining whether ethereum should be a security. If it is decided that it is, then this could have a big impact on ethereum blockchain;
  •   While financial heads are split on cryptocurrencies, the vast majority are in favour of blockchain, including SEC chairman Jay Clayton;
  • Regulators must be careful that regulation does not curtail blockchain’s development, while also providing protection for investors in cryptocurrencies.

If a cryptocurrency is deemed to be a security and under the SEC’s purview then issuers would need to, potentially, exclude non-accredited investors under regulation D of the 1933 Securities Act – which would allow issuers not to register formally with the SEC. This would have a significant impact on who can invest and, therefore, on the digital currency’s overall value.

As well as regulation S of the Securities Act, the amended regulation A provides an exemption for issuers which raise less than $50 million from standard securities compliance. This could be particularly appealing for initial coin offering (ICO) issuers, given that they would still be able to offer to non-accredited investors and the average ICO last year raised well below the $50 million figure necessary to meet the exemption requirement ($12.7 million). 

"The challenge for the blockchain platforms is that many tokens cannot achieve their intended purpose and function on a blockchain as a security," said Lilya Tessler, partner and co-head of the fintech and blockchain group at McDermott, Will & Emery LLP.

In a recent interview, CFTC chairman Christopher Giancarlo said one of the major problems is that laws dating in the early 1900s are being used for a very new and unique technology. This makes it difficult for regulators to look at how it falls into this existing regulation. The danger is that this rather restrictive regulation curtails the progress of something considered transformative.

But as cryptocurrencies become more regulated, financial institutions seem to be getting more interested. In the last month, Goldman Sachs hired its first ever head of digital asset markets, Justin Schmidt, a move which is expected to kickstart their crypto trading. JP Morgan applied for a blockchain payment patent and the parent company of the New York Stock Exchange – Intercontinental Exchange – has started working on the launch of a bitcoin trading desk. The added legitimacy regulation provides is clearly enticing financial institutions and the inevitable increase in regulatory oversight could see this accelerate.    

An unnamed blockchain advisor said that, rather than harming blockchain, securities laws could be beneficial.

"The securities regulation is the best thing that can happen to the field," they said. "I hope to see these implemented sooner rather than later to open it up to serious investors and institutions to embrace blockchain as the technology of the future."

Opinions on cryptocurrency vary widely, but there is a basic consensus across the financial sector that blockchain is hugely advantageous. Regulators should tread carefully.

See also  

PRIMER: US cryptocurrency ICO regulation

Inclusion of crypto in 5AMLD first step to sector regulation

Ofac’s crypto blacklist could drive investors to riskier exchanges