QZ&A

When a crypto token turns out to be a security, the legal complications are dizzying

Obsession
Future of Finance
Obsession
Future of Finance

One of the big questions since initial coin offerings took off—raising billions of dollars in the past year while spawning concerns about scams—is how watchdogs will clean up the ICO market. Last week William Hinman, a top US Securities and Exchange official, provided some guidance on how the agency views digital assets and ICOs, which resemble crowdfunding that’s been supercharged by crypto speculation.

Quartz spoke with Chris Concannon, president of Cboe Global Markets, about Hinman’s speech and what’s in store for crypto-trading platforms and investors, as well as the projects that issue digital assets to raise money. When it comes to ICOs, Concannon thinks the legal entanglements could get much more complicated for all parties—the token may become a kind of legal hot potato that’s difficult for an investor to hold, let alone trade. Setting up in Malta or some other non-US jurisdiction may not be enough to put an enterprise fully outside of the SEC’s rules.

Concannon’s career in electronic markets includes work as an SEC attorney in addition to executive roles at major exchanges and trading firm Virtu Financial. Last year he joined Cboe as part of Bats Global Markets’ merger with the Chicago-based exchange, which launched bitcoin futures in December and is considering an ether derivative. Concannon declined to comment on specific digital assets like XRP. The conversation has been edited and condensed for clarity.

Quartz: What jumped out at you during last week’s speech?

Concannon: The SEC doesn’t think ether is a security at this point in time. Now, what was interesting is Mr. Hinman did talk about how they also recognize that some coins that were originally securities can transform to non-securities at a later date. I think that was the more important macro statement within the speech.

We have been very supportive of the SEC’s efforts with regard to initial coin offerings. Coming from a registered exchange perspective, it’s not fair to see people raising money through these unregistered offerings and just using coins as a reason they don’t have to register. The SEC has been quite clear that you can call it a coin or you can call it a certificate, but either way it needs to register.

If I’m running a crypto exchange for something that turns out to be a security, do I have a lot of work to do?

The SEC has been quite clear that many of these ICOs are unregistered securities offerings. It presents a real problem for anyone involved in the trading of an unregistered securities offering, even if it’s a coin. There are real legal liabilities that can develop for anyone—not only are you an unregistered broker dealer but you can also be deemed an unregistered underwriter. And that can create quite sizable liabilities if you’re not careful about how you go about things. If you’re broadcasting on your platform an unregistered security that is part of an offering, one could argue that you’re an unregistered underwriter and you could be liable for any part of that offering.

It creates a very large legal liability before you even get to the steps that regulators could take against you. Registering as a broker dealer or ATS [Alternative Trading System]—that solves your go-forward liability from a regulatory perspective, but it doesn’t solve your look-back liability from a legal perspective.

What happens if a person who has issued coins in some fashion comes to the realization that they have been involved in a securities offering. What should they do?

You have some serious complications. If your coins are securities, you have to determine who the holders of those coins are, and whether or not you have triggered some of the rules in the US.

Even if you have a perfectly executed offshore offering but over time you develop shareholders in the US, you trigger reporting obligations in the US and it’s just something people have to be aware of. Coins present a unique complexity to all of that, which is how do you even know who your shareholders are? You can’t track them because the coins can be transmitted anonymously. Those are some unique issues that these coin offerings present even to someone who issues offshore.

What else has jumped out at you as the SEC’s stance on crypto unfolds?

The SEC’s overriding effort to regulate the ICO market, which has been an enormous job. I don’t think people appreciate how complex the world gets when you deem a coin an unregistered security. It becomes complex for everybody in the chain of that offering, from the original issuer of that coin, to everyone who participated and really to the end user, whether it’s a retail user or some other holder.

What can they possibly do with that coin? Where can they hold it? Firms can’t take the coin because of fear of being deemed to be holding an unregistered security or being in the securities business as an unregistered broker dealer. The complexity that unfolds when you deem a coin an unregistered security hits everyone in the chain of the offering, from the issuer all the way down to the holder of that coin and where they can hold that coin. It’s really a difficult issue.

Do you think the SEC is progressing slowly so that these questions can be answered and people involved can find some method of recourse?

No, I think the SEC is moving aggressively against these initial coin offerings. It is very hard to track down all the participants in those offerings, but they see real US investors being harmed by these unregistered offerings. You can see it in the chairman’s speeches. He is certainly pushing the resources of the SEC to crack down on these unregistered offerings.

What’s your plan for ether futures?

Ether is one of the more highly liquid cryptocurrencies out there. Along with bitcoin, the demand is much higher in ether than any other cryptocurrency on the market. We’ll look at launching futures in the near term, but there’s a process we have to go through before even announcing such a launch. That process is something we’ve talked to the CFTC [US Commodity Futures Trading Commission] about at length and certainly want to take steps along that process and make sure everybody is comfortable with the next product we announce.

Would ether futures be any different than bitcoin futures?

We have learned a lot about the global demand for the bitcoin future and certainly that demand is similarly high for ether futures as well.

Our plan when we originally launched bitcoin futures was to take the product design and structure and use that structure for other cryptocurrencies as we identify specific currencies we want to launch. Any future cryptocurrency that we launch derivatives on, we’d use a similar structure.

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