Coinbase, Kraken, and other major exchanges have created the Crypto Ratings Council in order to determine which coins will be subject to securities regulations. A group of the largest companies in Bitcoin has teamed up to create a system to measure a coin’s chances of being caught up in U.S. securities regulations.
CRC
The Crypto Ratings Council (CRC) was established by Coinbase, Kraken and Grayscale Investments. It also includes Bittrex, Poloniex parent Company Circle and Anchorage custody service. This council will rate specific cryptocurrency on a scale from 1 to 5, based on their likelihood of qualifying as securities (1 being least likely, 5 being most likely).
Blockchain.info lawyer Marco Santori pointed out on Twitter that this rating system is basically “a Hot or Not for the Howey Test” which is the standard for classifying assets as securities based on the Securities Act of 1933.
Security Status
The Importance.The Howey Test is the only industry standard for evaluating a token or cryptocurrency’s legal status as security. The U.S. Securities and Exchange Commission has been clear since the DAO hack in 2016. They have sued several token issuers, including Kik, for violating securities laws with unregistered token sales.
However, some people believe that the Howey Test is outdated and not adequate to deal with a new complex beast like cryptocurrency. For example, the CRC’s legal counsel believes it isn’t sufficient.
“The SEC has provided guidance for participants in the digital asset sector to evaluate the status of digital assets according to U.S. federal security laws, but evaluating these assets remains an important challenge to the industry,” Eric Sibbit of O’Melveny & Myers’ finance technology practice told Bitcoin Magazine. (O’Melveny works with CRC to create the ratings). “The council members have worked together to improve the efficiency of applying applicable case law and SEC guidance, and to draw on the collective knowledge of all members.
Coinbase and co.
They have begun to develop their own guidelines in the absence of any existing cryptocurrency regulation. These ratings are not endorsed by the SEC. Sibbit said that among other regulators, it is unlikely that they will adopt a rating system solely based on industry participants. Sibbit expressed the hope that the rating system would encourage further dialogue between the SEC and the industry participants.
These ratings are not intended to be used as a guideline for cryptocurrency exchanges and companies when deciding which cryptocurrencies to support.
The criteria for rating are based on a variety of yes/no questions. The Coinbase post claims that these questions were created with the assistance of O’Melveny & Myers.
These are the first ratings:
- Bitcoin (1)
- Monero (1)
- Dai (1)
- Litecoin (1)
- Ethereum (2)
- Zcash (2)
- Agoraland (2)
- Chainlink (2)
- Numeraire (2)
- Stellar(3)
- Tezos (3.5)
- Hedera Hashgraph (3.5)
- Loom Network (3.5).
- FOAM (3.5).
- XRP (3.5).
- Decentraland (3.5).
- EOS (3.5)
- Augur (3.5).
- Polymath (4.5)
- Maker (4.5).
Sibbit wrote about the methodology in correspondence to Bitcoin Magazine: “Considerations related to ‘decentralization” are important to answer the question of whether there are any expectations of profits from the efforts of a founding team or others. Other important factors in evaluating a digital asset’s status include how a token has been sold and marketed, its utility and ongoing role by the project team behind it, whether token holders receive some kind of return or payment by holding it, and a variety of other factors.”
The council will continue to review more assets in the future and may expand its reach to other jurisdictions. Projects that have been rated may also provide feedback, but this will not affect the ratings.
What’s the point?
The news has evoked mixed reactions from the community, both from lay observers and lawyers.
Marco Santori, for instance, lamented the lack of a clear framework for industry players. It’s just a collection of legal conclusions without any reasoning. He wrote in a Twitter thread, “A scattershot blast of facts aimed randomly out of Howie’s four short barrels.”
Because enforcement is not providing clear guidance, cryptocurrency teams must invest significant time and capital in determining whether supporting an asset could result in a lawsuit. Santori says that there is no clear and focused legislation from Congress and no regulations from the SEC. This rating system is “basically” the best we have. He concludes that the industry’s largest players worked together to find a solution to a persistent problem. This should be commended.
Robert Cornish Jr. is a partner at Anderson Kill with experience in securities law. He views the news less favorably. What Santori views as an imperfect-but-necessary solution, Cornish views as crypto’s most powerful companies overplaying their hands.
Cornish shared his concerns with Bitcoin Magazine via email. “A ‘council’ of financial service industry participants making affirmative decisions on how and when federal, state securities and commodities laws will apply to products in which it is transacting business are troubling on many levels.” “The SEC’s and CFTC rules regarding the approval and formation of self-regulatory organisations (FINRA, etc.) are troubling. “The rules of the SEC and CFTC on the formation and approval of self-regulatory organizations (FINRA, etc.) are written so that applicants inform regulatory bodies of the steps they are taking in order to ensure that putative members operate within the legal limits. This appears to be more like an ad-hoc declaration judgment forum of cartel members without any regulatory or judicial oversight. To take the model to its extreme, such a “council” could act as a cartel to ignore rulings by courts and arbitration panels in order to encourage anti-competitive behavior. Industry participants need to think about this more carefully.
Conclusion
Whether you believe the council will ignore court action, the underlying concern with the largest names in cryptocurrency trying regulate regulation is that these companies don’t have the legitimacy that gives real self-regulatory organisations (SROs), like the Financial Industry Regulatory Authority, clout in making decisions and legal actions.
The law firm that is advising the initiative views it as a positive step towards improving the existing inadequate framework.
According to a press release by the firm, Eric Sibbitt, O’Melveny partner, stated that legacy financial regulation was not designed to reflect technological advances. This has caused industry participants to have difficulty applying existing laws to digital assets. The CRC aims to improve this process by creating an standardized framework that takes into consideration all available facts and relevant U.S.