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Bitcoin Regulation: 5 Facts the SEC Wants You to Know

Dan Caplinger, The Motley Fool

Bitcoin has taken the investing universe by storm, making early adopters rich and capturing the imagination of millions of people worldwide. As the number of people interested in bitcoin and other cryptocurrencies has risen, the potential for abuse has gone up with it. That has gotten the interest of the U.S. Securities and Exchange Commission, and the regulatory agency has made its own positions on bitcoin and other crypto-related assets as clear as possible.

SEC Chair Jay Clayton offered some thoughts on cryptocurrencies and initial coin offerings a couple of months ago. Although the regulatory framework for bitcoin and similar crypto assets is continually in flux, Clayton had several key messages for those thinking about investing in the cryptocurrency arena. Here are five of the most important ones you should know about.

Bitcoin symbol in raised mosaic relief in gold, against a background of gray mosaics.

Image source: Getty Images.

1. There are no SEC-registered investments in crypto-related assets.

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 is aware that crypto-related investments have less investor protection than stocks and other traditional securities, with few or no disclosure requirements. That has opened up opportunities for fraud related to these investments as well as potential manipulation of their prices.

Clayton was quick to warn investors that anyone who says their investment is SEC-registered is incorrect. Before investing in crypto-related assets, it's essential to ask questions and get clear answers in order to understand exactly what you're getting into.

2. The SEC's ability to help you is almost nil

These markets span national borders and significant trading may occur on systems and platforms outside the United States. Your invested funds may quickly travel overseas without your 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.

U.S. investors have gotten used to the idea that government entities like the SEC for stocks, the Federal Deposit Insurance Corporation for bank deposits, and the Securities Investor Protection Bureau for brokerage accounts will be able to help them in cases of fraud or misconduct. Yet the intangible technology-based nature of crypto assets makes them difficult to trace to any particular country, and the money that goes toward purchasing these assets can easily move out of reach of U.S. regulators. That's unfamiliar territory for many investors, but it's the state of affairs for cryptocurrency right now.

3. Some initial coin offerings are in fact securities

The Commission applied long-standing securities law principles to demonstrate that a particular token constituted an investment contract and therefore was a security under our federal securities laws.

Some professionals have asserted that initial coin offerings aren't subject to securities laws because cryptocurrency is a commodity rather than a security. The structure of ICOs, however, often closely mimics that of a public offering of stock. In at least one case, the SEC concluded that an offering of a cryptocurrency token was "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." That would require registration for the ICO for sale to the general public, and the fact that enterprises making ICOs aren't registering their offerings is troubling to the SEC.

4. As cryptocurrency use increases, SEC scrutiny will rise

It is clear that just as the SEC has a sharp focus on how U.S. dollar, euro, and Japanese yen transactions affect our securities markets, we have the same interests and responsibilities with respect to cryptocurrencies.

Cash holdings like U.S. dollars aren't securities, and so trading currency isn't subject to securities laws. However, to the extent that brokerage companies and other businesses that are direct participants in securities markets start to allow payments made in cryptocurrencies, the SEC will have an interest in ensuring that there's no illicit trading or financial transactions associated with the purchase and sale of securities. Extension of credit for cryptocurrency holdings is another area that could trigger scrutiny in the future.

5. The SEC isn't anti-bitcoin per se

The technology on which cryptocurrencies and ICOSs are based may prove to be disruptive, transformative and efficiency-enhancing. I am confident that developments in fintech will help facilitate capital formation and provide promising investment opportunities for institutional and Main Street investors alike.

Contrary to popular opinion, the SEC and other regulators aren't entirely opposed to bitcoin and other cryptocurrency investments. They just want market participants to have the knowledge and information they need to evaluate such investments properly. The SEC believes that crypto-based enterprises can work with the regulatory community to give investors this valuable information and avoid potential problems before they happen.

Be careful with bitcoin

Many bitcoin enthusiasts are happy that the cryptocurrency has little regulatory oversight. In the SEC's view, that state of affairs isn't likely to last much longer. Cryptocurrency investors need to watch closely as regulatory guidelines start to form that could transform the way bitcoin and other crypto markets function in the future.

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