Are bitcoin securities? One would-be closed end fund says yes.

Turning conventional wisdom on its head, the sponsor of a closed-end fund has argued in a letter dated June 14, 2019 to the Securities and Exchange Commission (SEC) that yes, bitcoin are securities.

The regulatory repartee began on May 13, 2019, when Cipher Technologies Bitcoin Fund filed a registration statement on Form N-2 to register shares of a closed-end interval fund that would invest in – you guessed it – bitcoin and related derivatives instruments.

In a letter dated May 14, 2019, the staff of the Division of Investment Management asked Cipher Technologies Management LP, the sponsor of the interval fund (the “Sponsor”), to withdraw the registration statement, because, among other things, “it is unclear whether the proposed fund would meet the definition of an investment company,” and therefore whether the fund can be registered under the Investment Company Act of 1940.  The staff asked the fund to provide an analysis of whether and how it would meet the definition of an investment company. (Click here to read our Shearman FinTech Insights summary of this letter.)

The sponsor, in the June 14 letter, fired back, asserting that bitcoin is a security for purposes of the Securities Act of 1933, the Securities Exchange Act of 1934, and yes, 1940 Act.

In a nuanced analysis, the Sponsor claims that using the traditional Howey definition of a security, bitcoin is and is a security because, for purposes of this fund, it consists of (i) an investment of money (ii) in a common enterprise, (iii) with profits (iv) to come solely from the efforts of others.

The Sponsor rejected that the argument articulated by William Hinman, Director of the SEC’s Division of Corporation Finance, in June 2018 that certain digital asset transactions do not represent securities offerings when “the network on which the token or coin is to function is sufficiently decentralized.... ”   That is, Hinman said, there may be no “investment contract: when “purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts.”

Moreover, the Sponsor asserted, any determination that bitcoin is a commodity is simply irrelevant to determining whether bitcoin is also a security under federal securities laws.

The Sponsor concluded by stating that it respectfully declines the staff’s request that it withdraw its registration statement.

Our Take

The Sponsor’s arguments will certainly raise eyebrows in the digital markets.  If bitcoin and other digital assets are securities, the implications could be significant for market players and regulators alike, who will then face a challenge of rethinking how U.S. securities laws and regulations would apply to a fast growing market with existing products.  Stay tuned . . .