The Securities and Exchange Commission (“SEC”) recently announced a $388,000 settlement with the founder of EtherDelta, a digital “token” trading platform, for operating an unregistered cryptocurrency exchange. This is the first enforcement action of its kind. EtherDelta is an online platform for secondary market trading of Ether and ERC20 tokens, a type of digital asset on the Ethereum blockchain often used in Initial Coin Offerings (ICOs). According to the SEC’s Order, EtherDelta violated Section 5 of the Securities Exchange Act of 1934 because it was not registered as an online national securities exchange and did not operate pursuant to any exemption from registration.
With this settlement, the SEC resolved that a decentralized cryptocurrency platform is not exempt from exchange regulations. SEC regulations provide that an exchange subject to registration requirements exists if it (1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established, non-discretionary methods under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade. The SEC concluded that EtherDelta satisfied these criteria. The SEC also stated without much fanfare that at least some of the ERC20 tokens traded on EtherDelta were securities under the federal securities laws, as the buyers of such digital assets invested money with an expectation of profits, including through secondary trading based on the managerial efforts of others. The users of EtherDelta executed more than 3.6 million orders for tokens over a period of 18 months, 92% of which were traded after the 2017 DAO Report established that some digital assets are securities and are therefore subject to the SEC’s registration requirements (unless they qualify for an exemption).
This settlement serves as a reminder that the cryptocurrency market faces increased scrutiny from regulators, and it is likely that there will be more actions of this type in the near future. So far, the SEC has investigated and brought actions against unregistered broker-dealers, unregistered investment companies, and unregistered crypto token issuers. It is evident that the SEC is targeting both entities and individuals. Anyone engaged in the business of buying or selling digital assets or operating a platform for such transactions should be sure to assess their compliance obligations under the securities laws.