Cryptocurrency: a Brave New World
Bitcoin, dogecoin, ether, litecoin, blockchain, Mt. Gox – just a few of the terms any cryptonerd is expected to ring off without second thought. While some of us may have heard of a few of the terms before, the real question becomes, does anyone really understand this stuff? One would assume that before getting involved in cryptocurrencies investors would do their due diligence. Yet, time and time again we see reports that a recent Initial Coin Offering (ICO) or a new and promising bitcoin competitor was really a wolf in sheep’s clothing. [1] This can, at least in part, be blamed on the complexity that is cryptocurrency. Even honest people get caught up in a misunderstanding of the complex law surrounding securities, more specifically whether their cryptocurrency related activities qualify as a securities issuance. [2] However, blame can also be put on nefarious actors trying to make a quick buck. This post will explore some of the issues that have arisen around cryptocurrencies with particular focus on the recent explosion of fraud and other activity that is closely related.
Cryptocurrencies: the Talk of the Town
There is no question that cryptocurrencies are a hot topic. Many are claiming that the crypto-bubble is about to burst at any minute, while others claim that the bubble is far from bursting because the industry is in its infancy. [3] Regardless, bubbles only arise in the context of paradigmatic shifts in investor expectations. Black’s Law Dictionary defines a bubble as, “[a] temporary market condition of inflated value created especially in a particular segment of the economy by excessive speculation or buying, the result being artificial inflation of values.” [4] Indeed, it appears a bubble is here. For instance, there has been an unusual trend of public companies inserting cryptocurrency “buzzwords” into their name, or alternatively changing the name of the entity all together. [5] These companies have seen surging valuations of their stock, however questions remain as to whether these companies are truly pivoting their business models or rather trying to make a quick buck off of unrealistic investor expectations. [6] While there is little question that these entities intend to become involved in the cryptocurrency game to an extent, whether that be by getting involved in mining, announcing an intent to do an ICO, or some vague reference to the usage of blockchain, the question becomes whether it is a misrepresentation to stock holders that the underlying business model has changed. [7] However, these entities are no where near the worst of the bunch – enter, ICOs.
Crowdfunding…What Exactly? The Rise of ICO’s
To truly understand ICOs you must first understand Initial Public Offerings (IPOs). An IPO is when a company, for the first time, offers their stock for sale to the general public. [8] Companies use IPOs to raise capital for expanding their underlying business and are responsible for reporting how they use this capital to both investors and the SEC. [9] However, unlike IPOs, most ICOs have no underlying successful business, and further unless registering with SEC have little to no oversight by any regulatory agency. [10] ICOs use bitcoin, ether, or some other cryptocurrency which is already in existence as the currency with which investors purchase a stake in the ICO, and in exchange are given a “token” or “coin”. [11] The Economist describes these token or coins as “essentially digital coupons, tokens issued on an indelible distributed ledger, or blockchain, of the kind that underpins bitcoin . . . That means they can easily be traded, although unlike shares they do not confer ownership rights . . . Investors hope that successful projects will cause tokens’ value to rise.” [12]
An important distinction between IPOs and ICOs is that to date, no ICO has been registered under the 1934 Securities Act which requires the issuer to register a prospectus. [13] A prospectus contains information about the company’s financial health in order to allow investors to make an intelligent investment decision. [14] This information is quite detailed including, “information about the issuer’s financial condition, the identity and background of management, and the price and amount of securities to be offered.” [15] The question becomes whether these ICO issuances are actually securities issuances such that section 5 of the Securities Act applies. “Section 5(a) of the Securities Act provides that, unless a registration statement is in effect as to security, it is unlawful for any person, directly or indirectly, to engage in the offer or sale of securities in interstate commerce.” [16] The SEC has recently indicated that at least one such ICO by an entity referred to as The DAO failed to register in spite of the fact that the issuance was clearly a securities issuance. [17] The DAO project has since been shut down after a hacker managed to make off with nearly $50 million in ether. [18] Although running afoul of the law, the DAO had good intentions.
Nefarious ICOs
That is not to say that all ICOs are well intentioned. One need look no further than January of this year to find an example indisputably fraudulent activity related to cryptocurrencies and ICOs. [19] AriseCoin claimed to be “a new digital currency that enables the global economic system the world has been waiting for . . . This new economic system combines the best features of capitalism and socialism, while removing their defects. It’s capitalism without the inequality and socialism without the lack of opportunity.” [20] AriseCoin was supposed to be supported by AriseBank, which claimed to have purchased an FDIC-insured bank, “which would allow it to offer banking products not available on other cryptocurrency projects,” however the Securities Exchange Commission (SEC) says this is patently false. [21] Further, the project claimed to have raised $600 million in capital during its ICO, however, media outlets have been unable to corroborate that claim. [22] The SEC has since shut the project down. [23]
One month earlier, the SEC’s cyber fraud unit took the first enforcement action against an ICO when it shut down PlexCoin. [24] The SEC had been tepid regarding whether they would strictly enforce regulations against ICOs because they are an important source of innovation and had previously made clear that another ICO had “run afoul of securities law, but that [they] would decline to prosecute those responsible. The hope was to get the cryptocurrency world to take securities laws more seriously without doing anything drastic.” [25] The SEC however, found PlexCoin to be an egregious set of circumstances due to the fact that proprietor of PlexCoin’s ICO was a “recidivist securities law violator.” [26]
Cryptocurrency Heists
Despite clear evidence that cryptocurrencies, particularly new cryptocurrencies, have some major risk involved there is also an underlying risk of cryptocurrency heists. For instance, in January of this year hackers made off with $400 million in XEM, a lesser known cryptocurrency, stolen from a cryptocurrency exchange known as Coincheck. [27] In response, Coincheck froze all trading. [28] Coincheck has reportedly promised to partially refund the 260,000 investors effected by the hack. [29] Another now defunct cryptocurrency exchange, Mt. Gox, had to close its doors in 2014 after hackers made off with $400 million in bitcoin. [30] Thus, cryptocurrencies are not just risky when an ICO is announced, but even attempting to cash out through an exchange carries risks. No one knows what new issue tomorrow will bring, however, there is little doubt that as these nascent technologies continue to develop, growing pains will abound.
Questions to consider:
(1) Should cryptocurrencies be regulated as securities, or are they more accurately a currency as the name implies? If they are a currency, what type of regulation should apply to prevent fraud?
(2) Should something be done to prevent companies from changing their names to take advantage of the hype surrounding cryptocurrencies? What about a company that truly intends to change their business model? Where do we draw the line?
(3) Does traditional securities regulations seem to fit into the cryptocurrency world, or would a ground up approach be superior? What might this ground up approach look like?
(4) What type of regulations should apply to cryptocurrency exchanges, particularly in light of the continued heists that occur?
(5) Should the schemas devised to regulate cryptocurrencies, ICOs, and exchanges all work together or does independent regulation of each of these areas seem superior?
[1] Timothy B. Lee, Feds shut down alleged $600 million cryptocurrency scam, ArsTechnica (Jan. 30, 2018), https://arstechnica.com/tech-policy/2018/01/feds-shut-down-alleged-600-million-cryptocurrency-scam/.
[2] Timothy B. Lee, Using a blockchain doesn’t exempt you from securities regulations, ArsTechnica (Jan. 30, 2018) https://arstechnica.com/tech-policy/2017/07/using-a-blockchain-doesnt-exempt-you-from-securities-regulations/; Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Sec.gov (July 25, 2017), https://www.sec.gov/litigation/investreport/34-81207.pdf.
[3] Ted Knutson, Cryptocurrency Bubble Burst Unlikely, Says Ex-CFTC Chair, Now Crypto Industry Adviser, Forbes (Mar. 8, 2018), https://www.forbes.com/sites/tedknutson/2018/03/08/cryptocurrency-bubble-burst-unlikely-says-ex-cftc-chair-now-crypto-industry-adviser/#1fbeed4e5797.
[4] Bubble, Black’s Law Dictionary (10th ed. 2014).
[5] Factbox: Companies change names, businesses to ride the crypto wave, Reuters (Dec. 22, 2017), https://www.reuters.com/article/us-cryptocurrency-companies-factbox/factbox-companies-change-names-businesses-to-ride-the-crypto-wave-idUSKBN1EG1UE.
[6] Id.
[7] Id.
[8] Adam Hayes, IPO Basics: What is an IPO?, Investopedia https://www.investopedia.com/university/ipo/ipo.asp (Last visited March 3, 2018).
[9] Id.
[10] Alex Wilhelm, WTF is an ICO?, TechCrunch (May 23, 2017), https://techcrunch.com/2017/05/23/wtf-is-an-ico/.
[11] Id.
[12] The market in Initial Coin Offerings risks becoming a bubble, The Economist (Apr. 27. 2017), https://www.economist.com/news/finance-and-economics/21721425-it-may-also-spawn-valuable-innovations-market-initial-coin-offerings.
[13] Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, supra note 2 at 10.
[14] Id.
[15] Id. (quoting SEC v. Cavanagh, 1 F. Supp. 2d 337, 360 (S.D.N.Y. 1998)).
[16] Id.
[17] Id.
[18] Dan Goodin, Bitcoin rival Ethereum fights for its survival after $50 million heist, ArsTechnica (June 21, 2018), https://arstechnica.com/information-technology/2016/06/bitcoin-rival-ethereum-fights-for-its-survival-after-50-million-heist/;
[19] Lee, supra note 1.
[20] Id. (quoting the AriseCoin developers white paper on the cryptocurrency).
[21] Id.
[22] Id.
[23] Id.
[24] Timothy B. Lee, Feds shut down allegedly fraudulent cryptocurrency offering, ArsTechnica (Dec. 4, 2017), https://arstechnica.com/tech-policy/2017/12/feds-shut-down-allegedly-fraudulent-cryptocurrency-offering/.
[25] Id; Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, supra note 2.
[26] Lee, supra note 24.
[27] Sean Gallagher, Two new cryptocurrency heists make off with over $400M worth of blockchange ArsTechnica (Jan. 26, 2018), https://arstechnica.com/information-technology/2018/01/two-new-cryptocurrency-heists-make-off-with-over-400m-worth-of-blockchange/.
[28] Id.
[29] Daniel Shane, $530 million cryptocurrency heist may be biggest ever, CNN (Jan. 29, 2018) http://money.cnn.com/2018/01/29/technology/coincheck-cryptocurrency-exchange-hack-japan/index.html.
[30] Jose Pagliery, How Mt.Gox went down, CNN (Feb. 26, 2014) http://money.cnn.com/2014/02/25/technology/security/bitcoin-mtgox/index.html?iid=EL.
Criminal Law in the Virtual Context 
If cryptocurrencies can be used as regular currency, then they likely should be regulated as securities, if for no other reason than to protect people who don’t quite understand how they work. The discussion in this post about AriseCoin’s patently false statements is indicative of why the public needs to be protected. It would be very easy for individuals to accept exactly what AriseCoin said about their ties to a “FDIC-insured bank.” Should individuals buying into such currency do their due diligence in researching these statements? Probably, but that’s probably unrealistic, particularly if the cryptocurrency is masquerading as a legitimate enterprise with buzzwords that most Americans would recognize and trust. Furthermore, if a cryptocurrency can be traded similarly to how securities are traded in the stock market, then they should be regulated as such. If an ICO operates similarly to an IPO, then investors should be protected as they are when IPOs are offered.
I do not possess too much knowledge about this topic, and quite frankly, even after doing all the readings assigned for this topic, I still feel like I do not understand how this works very well (I feel it is all too fictitious, bogus and subjective) . Nonetheless, I do think some sort of regulation should apply, just because we are seeing how, according to the arts technics article, most users are motivated to enter this market because of the anonymity that it offers–that being said, the motivation seems to be the fact that you can move currency to do things that would otherwise be prohibited by law in most countries. Right now it seems like those who are investing in bit coins know they are taking risks and they are, or should be, aware of the volatility in value (after all it is an investment). Yet, there is something fundamentally unfair when you do pay actual dollar value for something that then suddenly disappears because it turns out the place that was supposed to store that valuable for you was a scam or a fraud. But still, what worries me the most is that here in the United States we have regulations–specially sanctions to other countries and individuals imposed by the Office of Foreign Assets Control — that could be easily avoided altogether by trading in these crypto currencies. I think that undermines national security and that would be my number one justification as to why the government should step in and regulate not just to make sure that investors get what they pay for but also to know details about the transactions that take place there. Otherwise I agree with cmgc18’s comment above that these transactions look and feel like securities and I see no reason why the securities regulation should not apply to them–at least for now while we wait and see how it all evolves.
1) I think the term “cryptocurrency” is itself an overbroad categorization meant to encompass a diversity of new products that developed suddenly and for the most part are still foreign to the average user/consumer. I think as people become more familiar with these products, more specific categorizations will emerge that will lend themselves better to regulation. To use a concrete example, I think Bitcoin could be classified as a currency, whereas Filecoin and Siacoin [1] could be regulated more similarly to securities given that there is a specific service being offered (decentralized storage). I think the fact that there are design features distinguishing these different cryptocurrency options is an important difference between cryptocurrency and traditional currency. What makes cryptocurrencies similar to securities trading is that you are betting on the success of an individualized product. This distinction should be studied and quantified, with regulation graduated depending on how “product-like” an individual currency is.
2) The line should be drawn at false advertising. If a company wants to build hype by using crypto-currency terminology, I see it as a no different than a company selling snake oil that uses pseudo-science in its infomercials. The average consumer may not have a full understanding of medical terminology, but we still lean toward caveat emptor until actual false statements are made, in which case a cause of action is created.
3) Hard question. Clearly there are similarities, but how do you regulate anonymous purveyors of a decentralized currency? I feel like part of the value of something like Bitcoin is that it isn’t state-sponsored and that there is no “plug” for a government to pull.
4) I think instituting regulations for false claims (though statutes allowing for a cause of action for false advertising may already cover this?) and requiring the registration of a prospectus for currencies that are sufficiently “product-like” would be appropriate. Like my response to #3, however, I think there may be some enforcement issues with these kinds of regulations.
5) There could be an omnibus bill that encompasses all of these areas, but I think that it would still require some individual attention given to each type of product given the diverse services being offered and conceivable abuses at each step in the currency-trading process.
One question I still have after the readings: Is stealing cryptocurrency actually “stealing?”
The “gentle primer” on Ars Technica describes block-chain technology as a decentralized ledger and asymmetric encryption as the means by which individuals “sign” their transactions. [2]. If Alice writes “I, Alice, transfer my coin to Bob,” and encrypts the message with her private key, it is evident to anyone who uses Alice’s public key to decrypt the message that Alice was the one who wrote it. It’s the aggregate of all such “proven” transactions that constitute the ledger that is stored in the block-chain, thereby allowing for this intangible currency to exist and ownership to be asserted.
If copies of the ledger exist on a network of computers all over the globe (rather than being in my exclusive possession), and the ledger is the only means by which ownership is asserted (i.e. there are no physical bitcoins in my pocket that an individual is taking from my possession), then what “property” is being stolen from me when a hacker steals my bitcoins?
If someone who isn’t Alice acquires Alice’s private key and adds a transaction to the ledger stating “I, Alice, transfer all of my coins to Hacker X”, is Alice’s property being stolen? Should the hacker, if located, be charged with stealing? Or is it forgery? What if instead of hacking, the private key is acquired by Alice’s inadvertent sharing? If I inadvertently publish the code to my hotel safe and someone comes and takes all of my money out of it, that’s stealing because my property is being taken. But by what basis do I have a property interest in a line on a decentrally stored ledger?
I’m not the principle blogger, so I don’t think that anyone has to actually answer these questions. Still – these are some of the thoughts that I had while reading on this topic.
[1] https://arstechnica.com/information-technology/2017/08/investors-poured-millions-into-a-storage-network-that-doesnt-exist/
[2] https://arstechnica.com/tech-policy/2017/12/how-bitcoin-works/
With all the problems that are presented by cryptocurrency there should be heavy regulations on the exchange of the currency and the ICO’s. I agree with the earlier comment that if the ICO’s are operating the same as IPO’s there should be a regulating agency like the SEC to protect those who wish to invest. The risk involved because of the unknown of the new world of cryptocurrency would warrant even stronger regulations than those on normal securities. The cryptocurrency heists seem entirely different to me, and my very very limited knowledge of the topic than the securities problems associated with the ICO’s. The situation with AriseCoin seem similar to stock exchange and fraud, the heists seem like modern day bank robberies. The first is defrauding an investor with a phony business model and the other is literally hacking into a system and stealing someone’s money. To me these are two separate problems and should be regulated separately.
(1) They should be regulated as securities. Cryptocurrency is traded, sold, or exchanged for financial gain by people who are betting on their value going up to make money. Treating cryptocurrency as securities would also require them to be registered with the SEC to make the market safer and make sure that investors are not throwing their money away. Treating them as securities would also force their creators to offer information on the financial health of the coin and the underlying technology.
(2) I believe that there should be a limit on companies changing their name to take advantage of the cryptocurrency hype. However, companies that are engaging in the use of the new technology that is being used should be allowed to do so. The investors in Filecoin are a prime example, they have invested in the technology rather than the actual value. They believe that the growth will pay off eventually but their initial though is to have the technology grow. The limit I would draw would be that the company make a showing that they are integrating cryptocurrency technology into their business model beyond the name.
(3) A traditional securities approach to cryptocurrency would be difficult to enforce since individuals can hide who they are when using cryptocurrency. A ground up approach would be better in that it could be created with the collaboration of the individuals who create a coin, though they may not be centrally in charge of it the information they could provide on the technology underlying the coin could make it valuable to use.
(4) The cryptocurrency exchanges should be required to be FDIC-insured as soon as they get online. The exchanges are collecting transaction fees as well which could be used to fund their own insurance companies to better protect their customers. The federal exchanges will eventually be required to work with the government to declare when people are moving large quantities of cryptocurrency, much like banks have to with large amounts of money. The individuals who make gains should be taxed and if the exchanges work with the federal government, the exchanges can offer more security for the customers while also providing a new source of income for the government.
(5) I believe they should all work together because they are all parts of the machine built around cryptocurrency. The heists carried out when exchanges are hacked could be identified if there was communication, when the coins are stolen they must go somewhere and if there is communication between exchanges they could be identified. Granted part of the reward of cryptocurrency is the anonymity, but there must be some communication for cryptocurrency to become more legitimate.
Should something be done to prevent companies from changing their names to take advantage of the hype surrounding cryptocurrencies? What about a company that truly intends to change their business model? Where do we draw the line?
I do believe that there should be restrictions on changing a company’s name to take advantage of the cryptocurrency buzz words. Such name change is clearly done to persuade uninformed investors to invest without certification that the name change must do with a changed business model and the inclusion of cryptocurrency in their business operations. I believe a company should have to file a name change request and prove that the name change is for real business reasons and not to take advantage of the benefits of being associated with a cryptocurrency-like name.
Does traditional securities regulations seem to fit into the cryptocurrency world, or would a ground-up approach be superior?
I believe that a ground-up approach would be superior. Since this is such a new technology, I believe the best way to build proper regulations would be to include those that know cryptocurrency the best, the founders of the currencies and those that worked to build the currency up to what it is today. Only these people truly understand the ins and outs of the currency and what the best and fairest way to regulate them would be.
Should the schemas devised to regulate cryptocurrencies, ICOs, and exchanges all work together or does independent regulation of each of these areas seem superior?
The cryptocurrency world seems to be all interconnected with each other, thus I believe that the schemas should all work together to regulate the currency most efficiently. With different systems, regulations, and rules for each part of the cryptocurrency world, there would be loopholes for people to avoid regulations, which could possibly harm many cryptocurrency investors and create a lack of trust in the entire system.
As other commentators have said, cryptocurrency is in dire need of some sort of regulation. Though there is a select group of “cryptonerds”, it is becoming increasingly common for the average citizen to try their hand at cryptocurrency in order to make some “easy” money. However, cryptocurrencies are extremely technical and confusing (seriously, I read all the articles and the post and I still feel very lost), and the average person isn’t going to do a ton of research into different cryptocurrencies, the issues surrounding it, and what legal protections they may have if they get involved. I believe that the average citizen investor does bear some of the burden of doing their homework and making a wise investment, however there should be some protections surrounding cryptocurrency.
It is tough to determine whether cryptocurrency should be regulated as securities or currency, because cryptocurrency seems to be a hybrid of sort. However, it appears that cryptocurrency leans more closely to the securities side, and therefore should be regulated in this way.
(1) Should cryptocurrencies be regulated as securities, or are they more accurately a currency as the name implies? If they are a currency, what type of regulation should apply to prevent fraud?
The structure of the crypto currencies seems to resemble securities more than actual currency. Therefore, it should be regulated as such. While it is a currency, as its name suggests, it does not really have a physical form or use outside of the internet, as does dollars and other forms of actual currency. With Bitcoins, you can store millions of dollars’ worth of bitcoins on a thumb drive or even a piece of paper. However, this is not the case with other forms of currency. You cannot store dollars on a flash drive for later use; this is what banks are for.
Another major difference as to why cryptocurrencies should be regulated as securities and not as currency is that they are not backed by FDIC insurance. So, if something goes wrong with an exchange, it is difficult for the cryptocurrency to regulate or rectify the exchange. On the other hand, with currency, when people invest it with a bank or something similar, there is insurance available for the exchanges.
Furthermore, cryptocurrencies are encrypted, so they cannot be seized by the government. If they cannot be seized by the government, then it will be difficult to be controlled by the government as regular currency is.
I’m not sure what any of this has to do with crime, and I’m wholly unfamiliar with what securities are or how they’re regulated.
I do think that cryptocurrencies should have more regulation of some kind, because the inherent irreversibility of Bitcoin transactions seems like a feature ripe for abuse by defrauders, but I think that is an issue for the vendors, and more likely to be mere compliance violations than misdemeanors.
I suppose the nature of cryptocurrencies lends themselves to resisting attempts at regulation, because the blockchain is handled P2P like the cloud, and no cognizable group is responsible for monitoring it. This problem of “the commons” is certainly a unique one, even for the internet, and it would be extraordinarily difficult for law enforcement to monitor even ordinary-level crimes like theft when no cognizable group can be pinpointed as most likely to have all the information.
All the replies are interesting because it does really show that the average person doesn’t fully “get” what the cryptocurrency issues are. At the moment we do have some regulation of these currencies, although not in any coherent way. FinCEN treats them as digital currency and for some of the people involved in the process, they must follow anti-money laundering compliance rules. The person who mines the bitcoin doesn’t need to follow them but the person who gets the coin from the miner to the third party in the transaction does. This raises all kinds of questions about how anonymous the system can remain and still meet the requirements of the law. The SEC looks at cryptocurrencies as commodities and the IRS treats them as property! Oh my gosh…what a mess.
But there is some truth to Dan’s comment above that there are different functions in the cryptocurrency field. Bitcoin is created and used as currency, people use it to buy and sell products, just as you or might use dollars, so perhaps it is right to regulate it as such. ICO’s on the other hand “feel” more like securities. For securities, we don’t have a caveat emptor reaction. There are rules and regulations, although if the entity offering the coin can meet all of the rules (with truthful and transparent filings) then we can feel better about some one who later looses money, because that’s just the nature of investing. And just for the record, even snake oil, can’t violate FDA and FTC regulations. It may still be snake oil but if it violates the rules and regulations, the person selling it can be prosecuted and/or fined.
There is no doubt that some regulation of the currencies themselves, as well as the ICO’s will come. The only question for me is, how many millions will be lost through fraud before coherent regulation comes. I don’t think restricting name changes is viable. How would that work? And companies change names all the time, are we just going to prohibit some companies from changing their names? I just don’t see how that would work.