Recently we launched a virtual offering of the profit shares in our project at cryptocurrency crowdfunding platform Cryptostocks.com: https://cryptostocks.com/securities/123. I’m very interested in the cryptocurrency potential in the area of financial project management and public securities, so this is an interesting experiment for us. We analyzed the current state of Bitcoin denominated securities arena, centralized and decentralized platforms for Bitcoin securities trading, and came to some conclusions which I would like to share.
To summarize what follows and give you some incentive to read it I state my conclusions first: Bitcoin securities are, most probably, here to stay. Some larger exchange will surface, which will provide more solid initial screening of companies listed and will be untouched by regulators. Also decentralized exchanges will be fully functioning, some interaction of centralized and decentralized exchanges are also possible. And (at least for me) the most striking conclusion: although Bitcoin securities exchanges are definitely in the “gray zone” of the current securities regulation their existence can be tolerated by current laws, and incorporated in it analogous to private securities and pink sheets.
To validate my point of view let’s take a look at the history of Bitcoin securities exchanges first. I should note that only exchanges where projects can list their shares are considered here, I don’t mention in this post legality of Bitcoin to fiat exchanges or Bitcoin derivative contracts (futures options etc.) exchanges. Here I discuss only stocks (shares in company profits) denominated in Bitcoin. In my opinion the main reason for the demise of the most Bitcoin securities exchanges was not the illegality of their operation but shady issuers and fraud.
The first Bitcoin securities exchange in history was called GLBSE, it was launched in summer 2011. The history of its rise and demise is crucial for understanding of the whole Bitcoin securities arena. As many early Bitcoin projects it was started as a hobby by a Englishman named James McCarthy . Its launch accidentally coincided with the first wave of interest to Bitcoin, so the project became successful very quickly. It should be noted that the first successfully listed project ran away with the collected funds in several months after the IPO. GLBSE has been plagued by scammy projects ever since.
The project which killed GLBSE was named Bitcoin Savings and Trust (BTCST). It was started by a Texas man called Trendon Shavers, and accumulated more than 7 million US dollars at its peak. It was an obvious Ponzi scheme, promising 1% daily return. Due to the scale of the operation it attracted attention of the US Securities and Exchange Commission, which charged Shavers with running a Ponzi. Very important here is the fact that it was SEC that stepped in, that is they considered the offering of Bitcoin Savings and Trust as securities in the accepted legal meaning of the term. Shavers tried to dismiss the accusations, countering that this investment cannot be considered to be a securities offering, since Bitcoin is not money.
In turn SEC denied this by applying so-called Howey test, which defines whether a certain business offer can be viewed as an offer of “securities”. According to the test, a financial instrument is a security offering if: It is an investment of money, in a common enterprise, with the goal of obtaining purely passive income. Shavers claimed that Bitcoin was NOT money, but the court concluded that Bitcoin can be USED as money, so, according to the Howey test, offering of BTCST is a security offering. A very important legal precedent has been made, Bitcoin was found to be money, and investment contracts in Bitcoin to be in purview of the existing securities laws.
After that the operator of GLBSE allegedly sought legal advice to check whether his hobby project was compliant with law. He was told that it actually was not, which let to the closure of GLBSE for good. It should be noted that the project was not closed due to any orders from SEC or any other agency, it was closed due to fraudulent activity of the listed companies and obvious reluctance of the project founder to be involved in this.
After the closure of GLBSE new exchanges called Bitfunder and BTC-TC followed in its footsteps. Their path was similar, both of them were closed by the founders citing legal concerns. It should be noted that with these new exchanges no real take-down orders were issued, they closed absolutely deliberately. Another exchange should be mentioned here, Romanian-based MPEX, the exchange which listed Satoshidice securities. In its case we do have a letter from SEC to its owner Mr.Popescu about the Satoshidice IPO. But as far as we know nothing followed this letter and no investigation was initiated. MPEX still functions.
Currently we have two operating centralized projects, cryptostocks.com and Havelockinvestments.com. Cryptostocks poses as a crowdfunding platform, the listed project are rather limited in trading volume and attracted funds. Havelockinvestments is a larger platform, which was initially started as a Canadian company but then transformed into Panama-registered investment fund. It does provide as such a certain legal framework for the listed securities, basically they are considered to be sub-funds in the feeder fund. Havelockinvestments allegedly buys shares in all listed companies, and resells it for Bitcoins as stocks corresponding to its sub-funds. Havelockinvestment has also been involved in a recent debacle with NEO and BEE, Cyprus company which claimed to have started a Bitcoin banking in Cyprus, but the founder has split with the collected funds.
Besides we definitely should mention purely blockchain-based systems. Blockchain technology seems to be really appropriate for completely decentralized stock exchanges, there are technical hurdles there but they can be overcome, no doubt about it. Currently Counterparty (Bitcoin blockchain based system) supports fully operational stock exchange, also Mastercoin is about to launch one, and cryptocurrency community has really high hopes for upcoming Etherium project, which is supposed to be a universal solution for all blockchain based financial applications.
So what do we have? We have several projects that closed down due to fraud and concerns of its owners about the legality, and a couple of active projects. Also emerging decentralized exchanges are picking up steam. What we don’t have is the real legal action against the project owners, all of them were quite public, we’re not talking here silkroad-like projects. So why is that? SEC is usually even pro-active in clamping down on illegal securities activity.
Three main lines of reasoning can be thought of here.
1. Recent developments in Bitcoin regulation contradict Shavers’ case and definition of Bitcoin as “money”. IRS regulations concerning Bitcoin taxation perceive Bitcoin not as money, but as commodity. From this point of view Bitcoin securities are closer to some kind of barter contracts than to financial instruments. This is quite odd actually. The IRS ruling as a whole seems to be a little inconsistent, most probably it was caused by a recent spike in Bitcoin price. It’s hard to call a unit of value which costs around $1,000 a “currency”. It seems closer to commodity. But this is an aberration of perception, of course. Bitcoin is nothing more than decentralized accounting system, which is by its construction is much closer to currency than to commodity.Another precedent is FinCEN guidelines for handling virtual currencies, which puts them is a separate category, not lumping them together with traditional currencies. Only companies which convert to or from real currency to virtual currency are subject to FinCEN regulations and need to apply for money transmitter license. Operations which stay within virtual currencies are not regulated by FinCEN.Anglo-Saxon law is case law, so precedent is very important. But along with Shavers case IRS and FInCen treatment of Bitcoin also consitues a precedent, and will effect the official stance on Bitcoin.
2. The costs of regulation and law enforcement could be prohibitively high. The emergence of decentralized marketplaces which are effectively impossible to take down should make governments worldwide to re-think their stance on regulation, and understand that some things cannot be regulated, and have to be simply dealt with. Blockchain based systems are closer to nature events which cannot be canceled by the will of the government than to some website whose servers can be shut down and confiscated.
3. Current nature of Bitcoin securities are closer to private offerings which are exempt from most securities laws worldwide. They are offered to limited community of cryptocurrency enthusiasts, businesses in question usually are Bitcoin businesses, so it all stays within a limited community. It resembles hedge funds who deal with accredited investors only, and pink sheets stocks, which are regulated much more lightly. Bitcoin community can be considered a community of accredited investors after all
Considering the points above I believe that Bitcoin stocks are here to stay. The key to success here would be the issuers screening and preemptive measures against fraudulent players. Serious and responsible project can be successful here, and most probably relatively unperturbed by regulators. Centralized exchanges should have a crucial role, since decentralized ones cannot probably achieve high level of protection against fraud.
- Why cryptocurrency world needs more services like ours.
- Bitcoin stocks follow-up: decentralized exchanges experiment.