SEC Chair Clayton: Safeguards Don’t Exist in Digital Currency Markets

SEC Chairman Jay Clayton relayed a mixed message to the crypto community during a conversation with Glenn Hutchins, founder of private equity firm Silver Lake Partners at the Coindesk Consensus Invest conference yesterday.

Speaking in a personal capacity, Clayton praised blockchain – bitcoin’s underlying technology – and said that the technology had “incredible promise” for infrastructure in financial markets, beyond securities. But he also expressed concern about the absence of safeguards currently at cryptocurrency exchanges.

“When you see an asset trade on Nasdaq or NYSE, there’s a great deal of surveillance preventing you and I from teaming up and pretending we’re decentralized. Those sorts of safeguards don’t exist in a lot of markets where digital currencies trade,” he said. His statement was a reiteration of problems that the SEC had listed earlier this year to explain its decision to reject Bitcoin ETFs.

Clayton also said that entrepreneurs should consider their initial coin offering (ICO) token a security at the start. “If you are funding a venture by selling tokens, you should start with the assumption that you are selling a security,” he told Hutchins.

The regulatory status of tokens has been a gray area in the cryptocurrency ecosystem. To escape the SEC’s scrutiny and cut back on costs while raising funds, most entrepreneurs sell their tokens as utility tokens – which can be used for various purposes within an application, including commerce. Security tokens, which are used to fund and scale entrepreneurial ventures, require significantly more disclosure and costs. The SEC has refused to provide clear-cut guidance on the matter but has increasingly cracked down on cases where security tokens were masqueraded as utility tokens by entrepreneurs.

In recent times, Chairman Clayton has cleared bitcoin and ethereum of being securities because they are decentralized. But he did not provide clarity on the status of Ripple’s XRP yesterday. “Some of these decisions require a lot of information in order to make a definitive statement,” he said. “Others are obvious.”

XRP is the world’s second-most valuable cryptocurrency. Approximately 60% of its supply is controlled by Ripple Labs and the cryptocurrency has 16 market makers who stand to profit from a surge in its price. According to the Howey Test, a token is deemed a security if it is a common enterprise, has profit written into the undertaking, and a third party promotes the enterprise for profits. In the case of Ripple’s XRP, Ripple Labs, which promotes the cryptocurrency through its enterprise solutions for banks, and its market makers are on the hook as parties who profit from its gains.

SEC Chair Clayton kept the door open for his agency to work with entrepreneurs, albeit with certain caveats. “We are happy to engage with people in this space,” he told Hutchins. But he also warned them from pulling wool over the agency’s eyes. “If there’s a gap between what you’re telling [the SEC] and what you’re telling people investing in your venture, that’s not a good place to start,” he said.

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