On May 1, 2018, the Wall Street Journal reported that the United States Securities and Exchange Commission (hereinafter referred to as SEC) and the United States Commodity Futures Trading Commission (hereinafter referred to as CFTC) will hold a hearing on May 7 to discuss ETH (short for Ethereum token) ) Is it a question of securities? Although on May 7th, the hearing was not held as scheduled, whether ETH was a security caused an uproar in the encrypted digital currency industry, and the prices of most encrypted digital currencies fell across the board that day. In the field of blockchain, new things such as ICO (Initial Coin Offering) and encrypted digital currency transactions are global regulatory problems, which have always been controversial, and the United States is no exception. The United States is extremely influential in global regulatory policies and has become the focus of attention of the world. This article attempts to analyze whether ETH is a security under US law (especially the securities law), and its possible related regulatory policy risks and legal risks.
1. The development and main functions of EthereumEthereum is a concept proposed by Canadian citizen Vitalik Buterin, and the token issued by it (or called an encrypted digital currency) is called ETH. In July 2014, the Ethereum Foundation raised approximately 31,000 bitcoins through an ICO, with a market value of approximately US$18 million at the time. The bitcoins raised are used for the construction of the Ethereum ecosystem. Ethereum is a decentralized application development platform that combines blockchain and smart contracts, which is called blockchain 2.0. According to statistics from CoinMarketCap, as of May 2018, the market value of Ethereum was around US$70 billion; at its highest price, the market value was as high as nearly US$140 billion. In the encrypted digital currency industry, its market value is second only to Bitcoin, and it has long been ranked second and has a huge influence. After 4 years of development of Ethereum, its token ETH has the following functions: first, the fuel required for technological development based on the Ethereum platform; second, the "currency" payment method accepted by merchants; third and second Speculation in the market; fourth, investors buy ETH to participate in the token-raising activities of other ICO projects, and exchange it with other tokens.
On July 25, 2017, the US SEC released an investigation report on The Dao project. At the same time, the report is also to understand whether ICOs based on Ethereum belong to the scope of the securities law. Although the report does not make it clear that all tokens issued by ICOs are securities, ICO projects that declare that they meet the attributes of securities must comply with the provisions of the U.S. Securities Law and require a series of strict regulatory requirements such as registration, registration, and investor certification; non-compliance ICO tokens defined by securities do not need to comply with U.S. securities laws, but they need to comply with other laws. The report does not play a substantive role in judging whether the tokens issued by ICO projects are securities or not. The purpose is more to remind investors of the speculative risks of participating in ICOs, and to provide guidance and reference for future blockchain projects ICOs.
The U.S. Federal Securities Law defines securities very broadly. The definition of securities is mainly based on the U.S. Supreme Court’s interpretation of the Securities Acts of 1933 and 1934. It includes two aspects: First, securities are usually regarded as: stocks, notes, bonds, other typical equity and Debt instruments; second, any form of investment contract. The most common interpretation of the meaning of "investment contract" comes from the Howey test determined by the U.S. Supreme Court in 1946 in the case of SEC v. WJ Howey. Therefore, for judging whether an ICO project is a security, specific analysis and judgment should be made based on the Howe test. In the Howe test, the Supreme Court determined four factors: first, monetary investment; second, investment in a joint enterprise; third, reasonable expected return on benefits; fourth, the benefits are wholly or mainly derived from others Efforts (usually from the management and efforts of the organizer). Only when the above four factors are met at the same time can it be recognized as a security. Whether Ethereum can pass the Howe test is a huge controversy.
(1) Money investmentThe US CFTC believes that Bitcoin and other virtual currencies are commodities under the Commodity Exchange Act (CEA) and have the same characteristics as precious metals; while the SEC describes Bitcoin as a decentralized peer-to-peer virtual currency that can be used like money , Exchanged with other currencies for the purchase of goods and services. The Supreme Court of the United States has stated many times that the flexibility of the Howe test is sufficient to cover the emerging investment environment, where monetary investment only needs to meet the specific and clear consideration of "money" provided by investors in exchange for benefits with substantive securities characteristics. That is, it is not required to be in the form of cash. Private currencies such as Bitcoin have the value of monetary investment, and ETH, as an important member of encrypted digital currencies, is no exception. There is no sufficient reason to prove that ETH does not belong to the category of money. The key to the terms is whether the money here is provided by investment participants, and the bitcoins raised by Ethereum for ICO come from investors, which undoubtedly also meets this requirement.
(2) Investment in joint enterprisesIn the investigation report on The Dao project, the SEC believes that investors who bought DAO tokens are investing in a joint enterprise, but the SEC did not give a specific analysis to prove this conclusion. In the SEC v. Howe Company, the Supreme Court also failed to explain the meaning of "joint enterprise". Later, the U.S. district courts repeatedly referred to the concept of "joint enterprise" in numerous judgments, but each had its own merits in judging the "joint enterprise". Some courts adopt the view of horizontal commonality. The main focus is whether to pool the assets of multiple investors and link the destiny of different investors in order to share corporate profits and risks (see case: SEC v. Infinity Group Co. , 212 F.3d 180, 187-88 (3d Cir. 2000)); horizontal commonality emphasizes the sharing or pooling of investors’ funds. Another part of the courts adopted the view of vertical commonality, in which the fate of investors is closely related to the success of the sponsor, rather than to the fate of other investors. This view is divided into a broad sense of vertical commonality and a narrow sense of vertical commonality. The former requires that the fate of all investors depend on the efforts or expertise of the promoters (see case: SEC v. Koscot Interplanetary, Inc., 497 F.2d) 473, 478-79 (5th Cir. 1974)); the latter requires the fate of investors to be intertwined and depend on the efforts and success of third parties (including managers and organizers) (see case: SEC v. Glenn W . Turner Enters., 474 F.2d 476, 482 n.7 (9th Cir. 1973)).
From the perspective of horizontal commonality, investors participating in ETH crowdfunding are indeed brought together. Although these investors are relatively independent and can freely judge whether to participate in ETH crowdfunding, once they are brought together, It has the characteristics of a community of interests. Therefore, from the perspective of horizontal commonality, Ethereum is more likely to meet the characteristics of securities. In the broad perspective of vertical commonality, the fate of investors depends on the efforts or expertise of the initiator. Although each holder of ETH can independently decide whether to participate in the development of applications on Ethereum, holders of ETH You can still benefit from the efforts of the Ethereum Foundation or the development team to encourage the development of such applications. Generally speaking, the more applications based on Ethereum technology, the more profitable ETH holders can sell ETH tokens. The narrow vertical commonality theory requires that both the horizontal commonality and the broad vertical commonality view be satisfied. Under the first two theoretical viewpoints, if there is a common enterprise in Ethereum, there will naturally be a common enterprise under the narrow vertical commonality theory.
Although there are different theoretical viewpoints, we believe that the possibility of Ethereum being identified as a joint enterprise is very high.
(3) Interest returns with reasonable expectationsAccording to incomplete statistics, from the birth of Ethereum to the present, there are thousands of tokens based on Ethereum. There are a large number of investors participating in each ICO project from all over the world. Investors generally need to buy ETH first, and then exchange it into a token issued by another ICO project party, and then look forward to the appreciation of the token and the ability to trade in the secondary market, realizing as soon as possible to obtain high returns. As one of the most important basic tokens for ICO financing, ETH holders expect to have a strong investment purpose by participating in the process of replacing another token by participating in the ICO. Holders who choose to hold ETH tokens have a reasonable expectation that the price of ETH will increase as Ethereum applications increase and the number of merchants willing to accept ETH as a payment method increases. When the value of ETH is expected to increase, investors use ETH as a form of investment.
As the underlying technology of Ethereum, developers can publish the smart contracts they need on the Ethereum platform. In order to prevent the network congestion that may be caused to Ethereum, the designers of Ethereum stipulate that each calculation step of the contract needs to be paid through the Ethereum protocol. This fee is called fuel, and ETH tokens are the form of payment for fuel. . According to a report in the Wall Street Journal, some of the supporters of Ethereum believe that the use of Ethereum is beyond the scope of transactions. ETH is to pay operators who develop decentralized projects based on Ethereum technology. This argument is too reluctant because This purpose is only for a small number of program developers, compared with many investors, this part of the number is almost negligible. Joseph Lubin, the co-founder of Ethereum, believes that ETH is only a fuel used for the operation and construction of the Ethereum platform. So, does ETH here have a channel function for product usage rights? We think it is negative. When Ethereum raised Bitcoin in 2014, Ethereum did not have developed and perfect products and services for buyers to use. For investors who participated in crowdfunding at that time, Ethereum was still in the promise of project development. In the prospect and promotion concept stage, it is difficult to believe that the participants of ETH crowdfunding were paying for the fuel developed based on Ethereum technology at that time.
According to the U.S. Supreme Court’s definition of the expected return on benefits: "Capital appreciation resulting from initial investment development" or the income generated by participating in the use of investor funds. We believe that Ethereum has the obvious characteristics of bringing investors "reasonably expected returns".
(4) Benefits come entirely or mainly from the efforts of others
Although compared with the traditional company structure, Ethereum claims to be a decentralized technology development platform, and its autonomous Ethereum community is to allow ETH holders to directly participate in the operation and management of Ethereum. However, investors are very interested in Ethereum. The impact of decision-making is very limited. Vitalik Buterin, the founder of Ethereum, once stated through a public social platform that the total amount of Ethereum can be limited (the total amount is not currently limited). The founder's influence on the Ethereum project is very large. From the SEC's investigation report on The Dao, Ethereum has the same characteristics as The Dao: the success of the project depends on the efforts of its project founders or organizational managers. After Ethereum raises Bitcoin and uses it for project development, ETH holders can share the potential profits brought about by the development of Ethereum technology. The Ethereum token can be quickly realized in its encrypted digital currency exchange. To a large extent, its price will change with the efforts of the project party.
For Ethereum, we can draw the following conclusion: Among the factors that affect the reasonable and predictable return for investors, the efforts of the Ethereum Foundation and its founding team have an "undeniably important" status. , The efforts of investors are trivial. The expected profit comes from the efforts of the Ethereum Foundation and its founding team, mainly for the following reasons: 1. The Ethereum Foundation and its founding team have produced a white paper on Ethereum investment projects, which is suitable for general investors. 2. The Ethereum Foundation and its founding team use public information to guide investors to believe that they can achieve the success of the project through their efforts. The relevant public remarks of the Ethereum founders will directly or indirectly affect the price of ETH. 3. In the operation of the Ethereum project, the efforts of investors are negligible, mainly relying on the professional technology and development capabilities of the Ethereum Foundation and its founding team. 4. The holders of ETH cannot really control their prospects for gaining income.
Joon Ian Wong mentioned in a post on QUARTZ that Peter Van Valkenburgh of Coin Center believes that even if ETH at the time of ICO is recognized as a security, today's ETH should not be recognized as a security. The reason is: Compared with 2014 Today, the relationship between the Ethereum Foundation and investors has undergone tremendous changes. We believe that the relationship between the Ethereum Foundation and investors has not undergone fundamental changes, and the influence of the Ethereum Foundation and its founders on the Ethereum community has always been a pivotal role. If the fourth factor of Howe's test is to require investors to expect the benefits "totally" come from the efforts of others, then there will be no controversy over security risks in Ethereum. However, the benefits investors can expect include "mainly" from the efforts of others. Although we cannot directly use mathematical statistics to draw conclusions, and the court’s decision and the SEC’s determination are highly subjective, from the perspective of the role of the Ethereum Foundation and its founding team on ETH, we believe that ETH Meets the fourth element of Howe Test. Therefore, ETH is easily judged to have securities attributes according to the current laws and regulations in the United States.
3. ConclusionThrough the Howe test, the SEC believes that the investor's investment in The Dao project is to obtain a return with interest and expectation in the future, and The Dao conforms to the characteristics of the investment contract. However, the SEC only required The Dao's project parties to return the raised encrypted digital currency to investors, and did not impose any penalties on it. At the same time, the report emphasizes that no matter what term is used to describe it, whether it is a security depends on specific facts and circumstances. Investors participate in ICO for different purposes, but usually the funds raised are used to pay developers’ salaries, various operating expenses and project promotion, etc., to allocate the tokens of the replaced new project to a considerable group, and to Encourage early participants, and fundraisers often use discounts in the early stages to attract investors to participate in time (the so-called "early bird discounts"). ETH tokens have mixed properties of certain characteristics of currency and securities. Therefore, according to the existing currency or securities theory, it is impossible to simply and directly make a unified qualitative analysis of the entire encrypted digital currency. It is still necessary to conduct specific analysis for different projects. And judgment.
We believe that Ethereum has a higher risk of being recognized as a security under the US Securities Law. However, there is still a certain degree of uncertainty. ETH holders have not obtained the owner's equity, and will not receive dividends and dividends; technical developers must pay miners' fees to develop applications on the Ethereum platform. This requirement makes ETH a certain degree of practicality. ; ETH holders will not share profits or income; the Ethereum Foundation and its founding team will not benefit from ETH transactions; these factors are positive for Ethereum. The Howe test is not the only standard used by the SEC or courts to assess whether a particular tool is a security. Even if it passes the Howe test, ETH is not treated as a security, but it may still be determined by other judgment standards.
Since September 2017, mainland China has suspended all forms of ICO, which is of positive significance for timely control of related risks. However, due to the point-to-point decentralization of blockchain technology, the issuance of virtual tokens to Chinese citizens still exists in large numbers. How to clarify the legal nature of such behavior? Although the relevant Chinese financial regulatory authorities have accused this kind of behavior as suspected of illegally issuing securities and illegal fund-raising, it is difficult for mainland China to find a directly related legal basis. China's "Securities Law" defines securities too narrowly, and it is difficult to apply to virtual tokens and ICOs. Therefore, the legislation and supervision practices of the United States can provide some reference for China's future securities-related legislation and supervision.
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