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FTC Publishes Cryptocurrency FAQs

FTC Publishes Cryptocurrency FAQs

There are hundreds of cryptocurrencies on the market – not just bitcoin – which are a type of digital currency.

Cryptocurrencies are widely publicized as a fast and inexpensive way to pay online. However, many are marketed as investment opportunities.

The FTC has recently published some guidance that it wants consumers to consider before they decide to purchase cryptocurrency as an investment.

First, cryptocurrencies are not backed by a government or central bank. Unlike most traditional currencies, such as the dollar or yen, the value of a cryptocurrency is not tied to promises by a government or a central bank.

Second, if you store your cryptocurrency online, you do not have the same protections as a bank account. Holdings in online “wallets” are not insured by the government like U.S. bank deposits are.

Third, the FTC reminds consumers that a cryptocurrency’s value can change constantly and dramatically. An investment that may be worth thousands of dollars, one day, could be worth only hundreds, the next. If the value goes down, there is no guarantee that it will rise again.

Fourth, nothing about cryptocurrencies makes them a foolproof investment. Just like with any investment opportunity, there are no guarantees.

Fifth, nobody can guarantee that you will make money off your investment. Anyone who promises you a guaranteed return or profit is likely scamming you, according to the Commission. Just because the cryptocurrency is well-known or has celebrities endorsing it does not necessarily mean it is a good investment.

Lastly, the FTC reminds consumers that not all cryptocurrencies or the companies behind them are the same. Before consumers decide to invest in a cryptocurrency, the FTC recommends that they look into the claims the company is making. For example, conduct an online search with the name of the company and the cryptocurrency with words like review, scam or complaint.

In December 2017, the SEC issues a statement on cryptocurrencies and initial coin offerings, stating that “[t]he world’s social media platforms and financial markets are abuzz about cryptocurrencies and “initial coin offerings.”

According to the SEC, a number of concerns have been raised regarding the cryptocurrency and ICO markets, including that, as they are currently operating, there is substantially less investor protection than in our traditional securities markets, with correspondingly greater opportunities for fraud and manipulation.

Investors should understand that to date no initial coin offerings have been registered with the SEC. The SEC also has not to date approved for listing and trading any exchange-traded products (such as ETFs) holding cryptocurrencies or other assets related to cryptocurrencies.

The SEC has issued investor alerts, bulletins and statements on initial coin offerings and cryptocurrency-related investments, including with respect to the marketing of certain offerings and investments by celebrities and others.

These markets span national borders and that significant trading may occur on systems and platforms outside the United States. Invested funds may quickly travel overseas without a consumer’s knowledge. As a result, risks can be amplified, including the risk that market regulators, such as the SEC, may not be able to effectively pursue bad actors or recover funds.

The SEC has stated that activity that involves an offering of securities must be accompanied by the important disclosures, processes and other investor protections that our securities laws require. A change in the structure of a securities offering does not change the fundamental point that when a security is being offered, our securities laws must be followed. Said another way, according to the SEC, replacing a traditional corporate interest recorded in a central ledger with an enterprise interest recorded through a blockchain entry on a distributed ledger may change the form of the transaction, but it does not change the substance.

Market professionals are urged to read closely the investigative report the SEC released in 2017 (the “21(a) Report”) and review its subsequent enforcement actions. In the 21(a) Report, the Commission applied longstanding securities law principles to demonstrate that a particular token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, the SEC concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

Following the issuance of the 21(a) Report, certain market professionals have attempted to highlight utility characteristics of their proposed initial coin offerings in an effort to claim that their proposed tokens or coins are not securities. Many of these assertions appear to elevate form over substance, says the SEC. Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.

Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law.

The SEC has also cautioned market participants against promoting or touting the offer and sale of coins without first determining whether the securities laws apply to those actions. Selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of “scalping,” “pump and dump” and other manipulations and frauds. Similarly, the SEC also cautions those who operate systems and platforms that effect or facilitate transactions in these products that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934.

On cryptocurrencies, the SEC has emphasized two points.

First, while there are cryptocurrencies that do not appear to be securities, simply calling something a “currency” or a currency-based product does not mean that it is not a security. Before launching a cryptocurrency or a product with its value tied to one or more cryptocurrencies, its promoters must either (i) be able to demonstrate that the currency or product is not a security; or (ii) comply with applicable registration and other requirements under our securities laws.

Second, brokers, dealers and other market participants that allow for payments in cryptocurrencies, allow customers to purchase cryptocurrencies on margin, or otherwise use cryptocurrencies to facilitate securities transactions should exercise particular caution, including ensuring that their cryptocurrency activities are not undermining their anti-money laundering and know-your-customer obligations. Market participants should treat payments and other transactions made in cryptocurrency as if cash were being handed from one party to the other.

The SEC’s Division of Enforcement will continue to police this area vigorously and recommend enforcement actions against those that violate federal securities laws.

If you are interested in learning more about this topic, or if you are the subject of a regulatory investigation or enforcement action you can contact the author directly or follow him on LinkedIn.

Richard B. Newman is a Federal Trade Commission compliance and defense attorney at Hinch Newman LLP focusing on advertising and digital media matters. His practice includes conducting legal compliance reviews of advertising campaigns, representing clients in investigations and enforcement actions brought by the FTC and state Attorneys General, commercial litigation, advising clients on promotional marketing programs, and negotiating and drafting legal agreements.

ADVERTISING MATERIAL. These materials are provided for informational purposes only and are not to be considered legal advice, nor do they create a lawyer-client relationship. No person should act or rely on any information in this article without seeking the advice of an attorney. Information on previous case results does not guarantee a similar future result. Hinch Newman LLP | 40 Wall St., 35thFloor, New York, NY 10005.

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About Carol St. Amand

Carol St. Amand

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