In July 2018, Coinbase – one of the largest cryptocurrency platforms — announced that it had won regulatory approval for a trio of acquisitions. This announcement generated a lot of publicity that Coinbase is on its way to creating the first marketplace on which blockchain-based tokens classified as “securities” can be traded. As it turns out, Coinbase never received regulatory approval for the acquisitions. However, the announcement was nevertheless a potentially significant event for the future of crypto trading.
In order to operate an exchange for securities, an entity must register as a national securities exchange or operate under an exemption from registration, such as the exemption provided for alternative trading systems (ATS) under SEC Regulation ATS. An entity that wants to operate an ATS must first register with the SEC as a broker-dealer, become a member of a self-regulating organization, such as FINRA, and file an initial operation report with the SEC on Form ATS.
Because Coinbase is neither registered as a national securities exchange nor operates under an exemption, it cannot operate an exchange-based trading platform for blockchain-based securities. However, the recently announced acquisitions indicate that Coinbase may be headed in that direction. The three companies acquired by Coinbase were:
- Venovate Marketplace, Inc. (registered as a broker-dealer and licensed to operate an ATS)
- Keystone Capital Corp. (registered as a broker-dealer)
- Digital Wealth LLC (registered as an investment advisor)
By acquiring companies with the proper licenses already in place, Coinbase may be able to speed up its plan to create an exchange-based trading platform for blockchain-based securities as a regulated broker-dealer.
What exactly are blockchain-based securities anyway?
They are digital assets, similar to Bitcoin, that grant the holder certain rights and that qualify as “securities” under the Howey test—named after the 1946 case in which the U.S. Supreme Court set the standards used to determine whether something constituted a security for purposes of the Securities Act of 1933. Under Howey, something is a security if there is (1) an investment of money; (2) in a common enterprise; (3) with an expectation of profits; (4) solely from the efforts of the promoter or other third party. Blockchain tokens may or may not constitute securities depending on whether the structure of the token includes each of the four required elements above.
Much uncertainty remains regarding how the courts will apply the Howey test to cryptocurrencies and blockchain-based token offerings, although the SEC has recently issued guidance on this issue. For a more detailed discussion of whether blockchain-based tokens may qualify as securities under federal securities laws, see our prior blog post here.