As Bitcoin adoption increases – and other cryptocurrencies emerge – the need for industry regulation is becoming increasingly clear. In particular, the growth of stablecoin epitomizes the growing appeal of digital currencies. Stablecoins, issued by stablecoin issuers, are a type of cryptocurrency that is typically pegged to a government-backed currency, such as the U.S. dollar.[1] As a result, unlike Bitcoin – which has had a wildly fluctuating price over the past few years – stablecoins retain the same value over time. This stability has attracted many users. In the past year and a half, the stablecoin market has grown from a size of $20 billion to more than $120 billion.[2] Simultaneously, the amount of fraud occurring in both the Bitcoin and stablecoin industries is increasing too.
Governments know that regulation is needed. The harder question is what this regulation should look like. Are Bitcoins commodities or securities? And should stablecoins be regulated in the same way? The answer to these questions could determine legal jurisdiction, and because the CFTC and SEC have mutually exclusive bounty programs, it could also determine which of the federal bounty programs are available to a potential whistleblower.
Commodities:
One popular answer is to regulate Bitcoin as a commodity. In a 2015 enforcement order, the Commodity Futures Trading Commission (CFTC) stated that “Bitcoin and other virtual currencies are encompassed in the definition [of a commodity] and properly defined as commodities.”[3] Their jurisdiction was affirmed in the 2018 case CFTC v. McDonnell. In its ruling, the Court held that the “CFTC may exercise its enforcement power over fraud related to virtual currencies sold in interstate commerce.”[4]
The argument that Bitcoin is a commodity rests on some shared characteristics between the two goods. Commodities – such as oil and gold – are interchangeable goods, are stores of value, and are typically exchanged in either cash markets or future contracts.[5] Bitcoin is similar: it is interchangeable – regardless of who “mined” the Bitcoin – is a store of value, and is commonly sold in futures contracts on cryptocurrency exchanges.[6]
Securities:
Others have argued that Bitcoin is more like a security. Securities must satisfy the requirements of the “Howey Test,” a set of criteria developed in the 1946 U.S. Supreme Court case SEC v. W.J. Howey Co.[7] The Howey Test states that “an “investment contract” exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”[8] (Emphasis added). While there is agreement about Bitcoin as an investment, and even perhaps as a common enterprise, questions remain about the third prong of the test.[9] Bitcoin is a decentralized currency; no singular entity controls it. Consequently, it is difficult to say that purchasers of Bitcoin expect some defined, third party to create profits for them. If that is true, Bitcoin does not meet the criteria of the Howey Test, and is not a security.
Stablecoins:
Stablecoins do not fit into this binary framework neatly. Unlike Bitcoin and commodities, stablecoins are more like a digital currency, and are often used as a medium of exchange.[10] Considering the role that issuers play, stablecoins may pass the third prong of the Howey Test, and be classified as securities. Nevertheless, there is no definitive consensus on whether stablecoins meet the Howey requirements.[11]
Moreover, considering the large role of stablecoin issuers, others seek to classify issuers as money market funds, or even banks. Yet, while stablecoin companies do resemble money market funds in some ways, they should not be regulated as such. There are many gaps in market fund regulation – gaps that arguably exacerbated the 2008 financial crisis, and that resurfaced at the beginning of the COVID-19 pandemic.[12] If the goal of regulation is to stabilize the financial system, the best option is to treat stablecoin issuers as banks. Unlike Bitcoin miners, stablecoin issuers perform many of the functions that physical banks do.[13] Moreover, banks must comply with stringent regulations, and thus, are typically more stable members of the financial system. As per the National Bank Act of 1984, banks are regulated by the Office of the Comptroller of the Currency (OCC).[14] While the OCC does not have its own whistleblower program, it can bring enforcement actions as related actions to a parallel SEC whistleblower claim. Moreover, considering the resources that the OCC has its disposal, the organization can play a large role in holding cryptocurrency issuers accountable.
Enforcement:
These classifications matter because they determine who will enforce regulations and how they will do so. As highlighted above, both the CFTC and the SEC see a role for themselves in cryptocurrency regulation.[15] Leaders of both agencies have recently advocated for their jurisdiction.[16] It seems that there is no perfect solution to regulating cryptocurrencies. To some extent, any attempt to classify them into an existing legal framework will always be like fitting a square peg into a round hole. Nevertheless, at this preliminary point, the form of the regulation matters less than its existence. This is especially true from the whistleblower’s perspective: The CFTC and SEC whistleblower programs are nearly identical and provide whistleblowers with the exact same opportunities to collect an award after settlement of a successful enforcement action.
In the longer term though, it is important for industry insiders to work with the government to build a new framework for Bitcoin and stablecoin, and for other forms of cryptocurrency that will surely emerge in the next few years. As we are seeing, cryptocurrency growth goes hand in hand with the rise of industry fraud levels. Thankfully, federal law provides avenues for whistleblowers to play a critical role in in enforcing fraud statutes and be fairly compensated for their efforts. Sanford Heisler Sharp is experienced representing whistleblowers in the technology industry and traditional finance and is well-positioned to meet clients’ needs even as the line between the two industries continues to blur.
Footnotes
[1] https://www.investopedia.com/terms/s/stablecoin.asp[2] https://www.brookings.edu/research/regulating-stablecoins-isnt-just-about-avoiding-systemic-risk/[3] https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder09172015.pdf[4] 287 F. Supp. 3d 213 (E.D.N.Y. 2018)[5] https://www.reuters.com/article/us-crypto-currencies/is-it-a-currency-a-commodity-bitcoin-has-an-identity-crisis-idUSKBN20Q0LK[6] Ibid.[7] https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets#_edn5[8] Ibid.[9] Ibid.[10] https://www.cnn.com/2021/10/27/success/what-is-stablecoin-feseries/index.html[11] https://www.cliffordchance.com/content/dam/cliffordchance/briefings/2019/09/stablecoins-a-global-overview-of-regulatory-requirements-in-asia-pacific-europe-the-uae-and-the-us.pdf[12] https://www.nytimes.com/2021/04/23/business/economy/money-market-funds-reform.html[13] https://hbr.org/2021/08/stablecoins-and-the-future-of-money[14] https://www.occ.treas.gov/about/who-we-are/history/founding-occ-national-bank-system/index-founding-occ-national-banking-system.html[15] https://www.bloomberg.com/news/articles/2021-10-25/sec-gets-path-to-rein-in-stablecoins-as-u-s-weighs-new-rules[16] https://www.wsj.com/articles/cftc-chief-says-recent-crypto-cases-are-tip-of-the-iceberg-11635370374