This week on Understanding Crypto with Paul Abercrombie and James Burtt they discuss the Securities and Exchange Commission (SEC) allegations of insider trading in the world of crypto and its subsequent reclassification of nine cryptocurrencies as securities. Though the Howey test has traditionally measured investment viability, Paul believes that the FCA task force laid the groundwork for future SEC regulation of digital assets. He predicts additional sanctions from the organization.

SEC Announcement

The Securities and Exchange Commission (SEC) announced nine cryptocurrency securities in response to insider trading charges. Paul explains that in order for a cryptocurrency to fall within the category of a security it has to be a financial asset with monetary value. He claims that it is now common for developers to sell tokens—which are intended to be a digital representation of shares—without really delivering the promised rewards. Although the SEC often disapproves of this approach, it frequently goes unnoticed because cryptocurrency currently operates outside the regulatory framework. 

The Howey test was developed to ensure investment viability by ensuring that assets fit into the following criteria:

1. Is there an Investment of money?
2. Is there a common enterprise?
3. Are you investing with an expectation of profit? 
4. Are efforts derived from others?

“This whole regulation, the SEC, the Howey test, almost sets the trends in crypto over the last couple of years,” Paul remarks.  Interestingly, crypto creators have developed procedures to protect them from the bureaucracy associated with this class of investments in order to lower the likelihood that their digital assets would be classified as securities. However, the ongoing court dispute has shed light on these evasive tactics. [Listen from 1:35]

Commonalities 

Insider trading is now illegal in the cryptocurrency industry as a result of the SEC’s retroactive classification of nine cryptocurrencies as securities. Paul explains, “The person who’s told his mate or his brother that this token is going to be launched, get involved because it's a good project, is actually insider trading because it's a security.” However, he believes the SEC's odds of winning this legal battle against the defendant is low, given that the investment was not a security at the time the offense was committed. 

A detailed examination of the websites of the re-classified crypto projects revealed commonalities, including the frequent use of terms such as community, DeFi institutions and escrow. “So a lot of what's come out of crypto is a circumvention of the Howey test through language. They're not calling profit profit, they're calling profit rewards,” observes Paul. As the SEC looks into other semantic loopholes that many Web3 creators have used to circumvent the stringent rules and processes, he predicts additional sanctions. Paul believes that the Financial Conduct Authority (FCA) task force, which began before Boris Johnson's retirement, laid the groundwork for future SEC regulation of digital assets. He continues, “What will come out of this is a change to the SEC's approach of how they view certain assets because [crypto] is here to stay now.” James' major concern is this: “If the S.E.C. can pin this onto nine cryptocurrencies, then how many of those projects that are existing out there right now sit in that gray area?” [Listen from 12:44]

Key Takeaways

• Insider trading is now illegal in the cryptocurrency industry as a result of the SEC's retroactive classification of nine cryptocurrencies as securities.