The Securities and Exchange Commission has been keeping a close eye on blockchain technology.
Such crowd funded blockchains seemingly operated under a so-called “good deal exception,” in which investors, who are satisfied because they are making money, do not complain to authorities.
That didn’t stop the SEC from pondering how securities law might apply.
“We are closely monitoring the proliferation of [blockchain technology] and already addressing it in certain contexts,” Mary Jo White white said in a speech at Stanford last March.
She noted: “One key regulatory issue is whether blockchain applications require registration under existing Commission regulatory regimes, such as those for transfer agents or clearing agencies. We are actively exploring these issues and their implications.”
The SEC’s issued its Advanced Notice of Proposed Rulemaking and Concept Release on transfer agent regulations in December 2015, asking for public comment on the use of blockchain technology.
Originally called Bitcoin 2.0 technology, the public blockchains after Bitcoin propose smart contracts as a way to push the technology forward. The simplest example of a smart contract is a two of three Bitcoin transaction, wherein code ensures two of three wallet password holders cryptographically sign off on a particular transaction for it to proceed. Thus, nobody can run off with the money thanks to a contract determined by code.
Smart contract proponents suggest that an array of sophisticated smart contracts – from smart property to AI – are possible.
In March 2014, a group of developers, led by Vitalik Buterin and blockchain consultants, introduced Ethereum, a public blockchain. As well, the group introduced Ethereum’s native digital currency, ether.
An ether pre-sale, conducted in July 2014, raised nearly $20 million. In 2016, an overlapping group of developers launched a second crowdsale for “the DAO,” a so-called decentralized autonomous organism via smart contracts, which quickly became the largest crowdsale of all time at $120 million. 14% of all ETH were sent in the DAO in exchange for DAO tokens.
An attacker exploited a vulnerability in the code starting June 18, siphoning off DAO ether funds through a bug in the code. The DAO’s design means funds, drained into child DAOs, are stuck in escrow until July 15.
A petition which appeared on petition website Change.org states: “Without action the attacker will eventually secure a very large amount of ETH. This is of concern to the wider Ethereum community, not just those who have investments directly at stake.”
The main concern are Ethereum’s stated plans to transition from the platform’s current Bitcoin inspired proof-of-work platform to a proof-of-stake platform.
Proof-of-stake rewards blockchain participants who run the network. Those who hold the most amount of digital currency units enjoy the most voting power on the network. Satoshi Nakamoto opted instead for proof-of-work whereby energy expenditure results in block rewards for miners when they produce a block, which is a verified package of data.
If Ethereum chooses to remain on proof of work, instead of transition to proof of stake, those who purchased ETH could feel misled – which might have legal implications for developers and others on the Ethereum Foundation. The blockchain crowdsale advertises that token holders are participants in the organization, possibly a way of masking the DAO tokens securities-esque qualities.
The Change.org petition urges a hard fork, a change in the Ethereum protocol, to avert a future situation where the attacker holds $55 million ETH and therefore considerable voting power.
Bitcoin hard forked in August 2010 when a bug that allowed double-spending was discovered. Buterin supports a hard fork.
Either way, confidence in Ethereum and the DAO have been tarnished.
How the SEC and various states regulate public blockchain technology remains to be seen. An SEC official other than White commented June 20 that the $55 million attack against Ethereum underscores concerns over blockchain systems.
Developers argue they provide software, and not an investment or security. They nevertheless term their projects “initial coin offering” or “token sales” and the like.
Some believe the high-falutin verbiage blockchain crowdsales adopt to describe their “decentralized organizations” is obfuscatory.
Jason Seibert, a lawyer on Bitcoin and securities cases, suggests: “Does it look like a duck? Does it walk like a duck? Then, it’s a duck! Right? You can try to call it a pigeon but it’s not…it’s a duck.”
Securities laws, he told Motherboard, are liberally interpreted and adaptable to new ways of raising funds.