Gary Gensler’s view of bitcoin hinges on a 55-year-old financial rule

Let’s talk about the Howey test.
Let’s talk about the Howey test.
Image: REUTERS/Jose Luis Magana
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Cryptocurrency enthusiasts have been eyeing Joe Biden’s pick to run the US Securities and Exchange Commission for clues about how he might regulate the technology. In his confirmation hearing today, nominee Gary Gensler suggested that more government oversight of cryptocurrencies was in the offing.

He also hinted that the type of oversight will depend on which form of cryptocurrency is under discussion. With crypto prices on a tear in recent months, the frenetic debate about whether the rapidly evolving market constitutes a legitimate new asset class or a bubble ripe for abuse has turned into a regulatory conundrum, as institutional and retail investors race ahead of rules to govern the space.

As head of the SEC, Gensler would be in charge of cryptocurrencies deemed to be securities. During the Senate Banking Committee hearing, Gensler said that while the SEC should promote innovation in blockchain technology, if there are securities involved that trade on exchanges, “we want to ensure that there’s appropriate investor protection.”

This thinking isn’t new. Using the definition of a security to determine how a financial instrument should be regulated, known as the Howey test, dates back to a 1946 Supreme Court ruling, devised to help define which transactions constitute an investment contract. It’s a rule Gensler knows well. He is known in progressive circles as a tough financial sector reformer from his post-financial crisis days as head of the Commodities Futures Trading Commission, but he is also hailed by the crypto crowd for his understanding of blockchain technologies, as an MIT economics professor who teaches about blockchain, digital currencies, and financial innovation.

Gensler’s comments during the hearing echo his teachings on the Howey test. By this logic, cryptocurrencies are generally either defined as utility tokens, which act like a form of tender, or security tokens, which represent equity or share in a company that would be regulated by the SEC. If a coin offering is meant to give investors an ownership stake, then the company’s token should be subject to the regulations of a security, he told an audience at a 2018 MIT blockchain conference, even if it doesn’t offer a dividend, or have the typical attributes of an equity or bond. “The investing public is clearly hoping for possible appreciation,” Gensler said. “When you quack like the duck, when you swim like the duck, when you walk like the duck…I think the bird’s a duck.”

Bitcoin, the most ubiquitous virtual currency, doesn’t qualify as a security, according to Gensler. “Bitcoin came into existence as mining began as an incentive in validating a distributed platform,” he said at the conference. Unlike other cryptocurrencies being offered by companies like Ripple, bitcoin had no initial token offering and no common enterprise. Ripple, on the other hand, “sure seems like a common enterprise,” he concluded.

The SEC has since followed that logic. In December, it sued Ripple for selling a bitcoin-like digital asset called XRP, a high-profile case Gensler will inherit if he’s confirmed as the agency’s new chair. Bitcoin’s value dipped on jitters about Gensler’s comments during the confirmation hearing. But according to the Howey test, those investors should be in the clear.