Bitcoin Everything You Need to Know About Cryptocurrency Regulation (Right Now) By AtoZcrypto Posted on August 16, 2018 15 min read 0 3 534 Written by Gary Ross This article was originally published on UpCounsel. The meteoric rise of cryptocurrencies has taken the world by storm. Innovators, investors, users, and governments are scrambling to wrap their heads around cryptocurrencies and the blockchain technology that they rely upon. The emergence of a new market and business model has created great opportunities for participants, but it also carries significant risk. Cryptocurrencies present an inherently unique challenge to governments because of their new technology, cross-jurisdictional nature, and frequent lack of transparency. Governments are struggling to develop new ways to regulate cryptocurrencies, adapt existing regulations, and identify fraudulent schemes. Cryptocurrencies and their regulations are evolving before our eyes, and this article will provide a brief background on cryptocurrencies and an overview of where cryptocurrency regulations currently stand. What are cryptocurrencies? Cryptocurrency is, by any other name, a currency—a medium of exchange used to purchase goods and services. Or, as some have suggested, cryptocurrency is a “peer-to-peer version of electronic cash.” However, this currency has two qualities that distinguish it from traditional bills and coins. First, cryptocurrency is a virtual currency that is created through cryptography (i.e. coding) and developed by mathematical formulas through a process called hashing. Second, unlike traditional bills and coins that are printed and minted by governments around the world, cryptocurrency is not tied to any one government, and thus is not secured by any government entity. The fact that cryptocurrencies are not secured by a government authority has led to concerns from critics that this is the second coming of Tulipmania, because we are ascribing value to an otherwise valueless item. However, the potential for cryptocurrencies as a medium of exchange remains enormous. What is blockchain? afrochain.co Blockchain is the technology at the heart of most cryptocurrencies, and explaining the technology in detail would require a blog post of its own. What is important to know is that blockchain is a record of peer-to-peer transactions categorized into blocks on a distributed ledger. Despite the obtuse terminology, blockchain functions similarly to a local bank authorizing and recording a transaction, but instead of only one party holding the entire ledger book, the transactions are recorded communally by member nodes, with each node being a computer in a peer-to-peer distributed network. The blockchain can confirm a transaction within minutes, removing errors that exist when trying to reconcile and audit separate ledgers and transactions. Whenever a transaction takes place, the miners on the blockchain develop a new hash and digital signature to update the ledger and create a new “block.” This block, or recorded transaction, is time-stamped and encrypted and will remain on the blockchain for life. afrochain.co Regulation in the US – Utility Tokens v. Investment Tokens In the United States, there has been no federal regulation of cryptocurrencies. Instead, cryptocurrencies are often grouped into two non-binding categories: (1) investment tokens that fall under the purview of already existing U.S. securities laws like the Securities Act of 1933 and the Securities Exchange Act of 1934, and (2) utility tokens, which remain largely unregulated (for now). Security Tokens Whether the tokens being offered in connection with a particular cryptocurrency are security tokens is decided on a case-by-case basis that even experienced securities lawyers can disagree upon. Tokens are usually analyzed under the four-part Howey Test below to see if the token is in fact a security. Securities must meet the following criteria: An investment of money in a common enterprise with an expectation of profits predominantly from the efforts of others Each characteristic of the token is analyzed against this framework to see if the cryptocurrency is in reality functioning as a new-age security. If it is, then regulators treat it as such, and cryptocurrencies must then be registered and handled with all of the same disclosures and precautions as any other security sold in the United States or to U.S. investors. Utility Tokens Cryptocurrencies can also be categorized as non-security utility tokens. These tokens purport to offer intrinsic utility and value, and are typically instrumental in powering the blockchain technology. These tokens function more like commodities than securities, and while they may act like currency in a fully functional network, they also have other values. However, having a utility token with a properly formed and functioning network does not preclude said token from being labeled a security by the SEC. In In the Matter of Munchee, Inc., a purported utility token with a non-functioning network was labeled a security by the SEC. While labeling a token without a functioning network as a security – as it has no present utility – is not unexpected, the SEC also concluded that: “even if [Munchee] tokens had a practical use at the time of the offering, it would not preclude the token from being a security.” After analyzing the Munchee Tokens under the Howey test, the SEC concluded that they were investment contracts because purchasers of the tokens had an expectation of profits predominantly from the efforts of Munchee and its staff. The SEC further concluded that Munchee had primed such expectations through its marketing efforts. While this new case does not eliminate the distinction between utility and security tokens, it does caution that, when deciding whether a given token is a security, the SEC will look beyond utility at the character of the instrument, and base their conclusion based on the terms of the offer, the plan of distribution, and the economic inducements held out by the token issuer. afrochain.co State Regulation So far only the state of New York has issued any kind of regulation specifically regarding cryptocurrencies: the BitLicense. The BitLicense is New York’s attempt to control cryptocurrencies within its borders by requiring cryptocurrency businesses to register and comply with several different disclosure and financial obligations. The regulation has been divisive, and many businesses have rallied against its high costs. While a few companies have applied for and received the license, most other companies have simply left the state or stopped offering services to its residents. Regulation Abroad – The Ever-Shifting Jurisdictional Question The United States is not the only country grappling with how best to regulate cryptocurrencies. Many cryptocurrency businesses face daunting questions regarding in which jurisdictions to form and to do business in. In the end, the question is quite difficult and fact-specific, requiring communication between legal counsel in different jurisdictions and taking into account nebulous and piecemeal country-by-country regulations. It is impossible to do a detailed analysis without knowing how a country’s existing securities laws, financial regulations, and banking regulations will operate (or will be adapted to operate) with cryptocurrencies. The fact that cryptocurrency-specific regulations are still developing does little to add clarity, and makes the analysis even more challenging. Yet a few global trends are noticeable: Suspending Cryptocurrencies Some notable countries, like China, and South Korea, have suspended cryptocurrencies. These countries have cited the risk of fraud and the lack of adequate oversight in suspending cryptocurrencies and their exchanges, forcing cryptocurrency companies and exchanges to relocate. Regulating Cryptocurrencies Other countries, like Japan and Australia, have adopted disclosure and regulatory measures, or have companies register with the applicable government authority. Several countries have also tried to implement disclosure or registration regulatory regimes when it comes to cryptocurrencies, but such regimes are cumbersome and expensive to fledging companies. Cryptocurrencies as Commodities On the other hand, Switzerland and Singapore, two of the countries at the forefront of the cryptocurrency market, have simply stated that cryptocurrencies are assets not currency, and that they will treat them as such under existing regulations. Conclusion Ultimately, cryptocurrency regulation remains in its infancy. Piecemeal regulation has already begun around the world as governments enact new regulations to control and legitimize cryptocurrencies, fold cryptocurrencies into existing regulations, or ban them outright. These splintered attempts at controlling a global phenomenon will keep the cryptocurrency market volatile, and pose a challenge to innovators, investors, and users. They will continue to work in the cryptocurrency space while pushing for legislation and regulation that will remove ambiguity and legitimize cryptocurrencies. At the same time, they must grapple with the possibility that new regulations may be confusing, detrimental, or have negative inadvertent effects. Featured image from Shutterstock.