Regulatory Oversight of Token Sales Kicks Into High GearAlthough testimony before Congress by the chairmen of the Commodity Futures Trading Commission (CFTQand the U. S Securities and Exchange Commission (SEC) recently indicated that neither intended to completely shut down the crypto space, both regulatory bodies should be expected to continue the trend of enforcement of existing laws that we saw in 2017. and the market should expect attempts to create new regulations to address regulatory gaps. While the enforcement of regulations may eliminate some strategies currently used by offerors of tokens, the benefits for consumer protection and presumed decrease in reputation-damaging scams should far outweigh the limitation on capital generation.

The SEC in particular is expected to continue enforcement to facilitate its twin aims of protecting investors and facilitating capital formation. Token sales or initial coin offerings (ICOs) will probably be viewed by the SEC as the offering of securities if the issuer or promoter promises profits (no matter the mechanism behind those gains), or if the issuer ma rkets the token with

A promise that it will be listed on a trading exchange. Regulators have made it clear that they view most ICOs as investment opportunities and intend to regulate them that way. This should drive token sellers to seek counsel and offer tokens to the market through regulated or exempted offerings, which will, in many cases, limit the scope of initial token purchasers to accredited investors or non-U. S. purchasers. The market should expect increasing private suits and regulatory enforcement against token issuers who offer tokens as being anything but securities, or offer products without seeking legal advice from qualified counsel.

This, however, does not signal the death of token sales as fundraising vehicles: regulatorily compliant token sales will continue to use legally recognized exemptions from registration under the securities laws and eventually wi indude properly registered tokenized securities. While creative issuers may try novel means to distribute tokens in attempts to avoid being categorized as securities, these strategies are speculative and of unclear effect

Issues regarding secondary trading, fiduciary duties and custody vail continue to challenge market participants and regulators, and mishaps in these areas will bring even more lawsuits.

The Future of Funds and Exchanges

It is unlikely that retail-oriented funds like index or exchange-traded funds (ETFs) for cryptocurrencies will be approved until issues regarding liquidity, valuation, asset custody, asset creation and redemption are addressed.

Previously, the SEC refused to permit the creation of Bitcoin ETFs because the SEC is unable to effectively surveil the crypto trade markets for manipulation and the markets are not regulated: these circumstances have not and will likely not be rectified in the near future.

The CFTC will regulate crypto assets sold on forward contracts and by options and futures, but will not regulate spot trading of crypto. Based on the CFTCs approach and experience with hyper-volatile assets, it should be expected that the crypto-derivatives market will expand faster than retail investment funds.

Exchanges have been a key area of vulnerability in the crypto environment. Expect exchanges to be a continuing area of interest to regulators, who will evaluate the compliance of cryptocurrency exchanges including their data reporting: capital requirements: cyber security standards: measures to prevent fraud and price manipulation: Anti-Money Laundering (AML). Know Your Customer (KYQ and Office of Foreign Assets Control (OFAQ compliance: and trading of restricted shares. Admittedly, exchanges exist in a regulatory netherworld where neither the SEC or CFTC have appropriate power to fully regulate their behavior.

The SEC and CFTC. along with the Department of Justice. Federal Reserve and Consumer Financial Protection Bureau, are expected to cooperate and identify gaps in their respective jurisdictional reach and to seek power from Congress to address those gaps, including delineation of which regulator has jurisdiction over certain activities. New rules or an

Expansion of a regulators existing powers to address exchanges are a likely first place to expect new laws. A total shutdown of domestic exchange activity is unlikely: although new restrictive laws regulating exchanges may cause a temporary plunge in prices and volume, even a total shutdown would not destroy crypto markets, as most domestic trading volume would migrate to international exchanges and to emerging decentralized exchange platforms.

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