Hi, it's Colton again. I cofounded Hedgehog, the crypto roboadviser that makes it easy to diversify and balance your portfolio of digital assets. My many hats still make it difficult to encapsulate what I do without a proper heraldic intro or indefensible acronym, despite our readers' best efforts. (Context: previous discussion of this matter.) Nonetheless, valiantly we forge onward!
Launching right in…
Lawyers stay winning
A heaping handful of cheery headlines from this week:
- "SEC sees decentralized crypto platforms as exchanges, seeks public input"
- "SEC sues yet another crypto company — this time it's Bittrex — in latest challenge for industry"
- "Coinbase CEO says the crypto exchange is preparing to go to court with the U.S. SEC"
- "Coinbase CEO Won’t Rule Out Relocating Company Away From US"
- "Gensler grilled by Republicans over SEC's approach to cryptocurrencies" — in particular, whether the agency considers ETH to be a security
- "Gensler says securities law is time-tested, crypto just needs to fall in line"
Do you catch the vibe? One gets the sense that the Securities and Exchange Commission is none too happy with the crypto industry. In return, the crypto industry is equally frustrated with the SEC. This state of affairs isn't new, but we've entered another dueling-court-filings phase of the fight. It ain't the first bout, and probably won't be the last.
The SEC is keen on scrutinizing — and squashing — what it sees as brazen scofflaws, whereas the crypto community insists that the SEC will stifle innovation to the detriment of the American economy. At the heart of this discord lies a debate about how exactly to categorize digital assets. Should they be treated as traditional securities, commodities, or an entirely new asset class?
I can't fully answer that question here, because frankly it isn't up to me. I can, however, partially answer it. You've probably heard of the Howey test, named after the 1946 Supreme Court case that established the criteria for what counts as a security: "a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of [...] a third party." All four prongs have to be true to consider a contract or transaction a security.
The Howey test has long been the standard for determining whether any given asset is a security. Thus, it is also used to judge whether any given digital asset falls within the purview of the SEC. At least in theory — the SEC is selective with its smackdowns, which some crypto entrepreneurs see as capricious inconsistency.
All the while the Howey test has been criticized as rigid and outdated. This clash of regulatory paradigms produced an uncertain environment for crypto companies, driving some to relocate to more friendly jurisdictions or even dissolve entirely. We've even had potential investors tell us that they would only fund us if we shut down US operations and moved to Europe.
How we handle it
As it happens, Hedgehog's subsidiary, Hedgehog Advisers, is an SEC-registered institution. First, it's important to remember that registration does not imply endorsement or any particular level of skill. See, you can tell I'm the compliance guy!
Disclaimer aside, in order for us to build a product that delivers investment advice, I became Hedgehog's Registered Investment Adviser Representative. That means I am responsible for ensuring compliance with SEC regulations, overseeing investment strategies, and providing appropriate and transparent advice to our clients. The agency checks in with us periodically to make sure we're meeting the necessary standards, and gives us frightening deficiency letters that threaten fines and lawsuits — or in some cases imprisonment — if we're not on our A-game.
You might wonder how Hedgehog was able to get a pass from the SEC while longer-established organizations like Coinbase are mentioning lawsuits and relocation. Well, we're currently talking to the SEC and awaiting their feedback on our advisory program in the lead-up to our upcoming launch, so let's not count the chickens before they hatch.
However, we believe that Hedgehog is doing everything by the book to keep your digital assets unsecuritized in separately-managed accounts where funds are never commingled. We use the discretion you grant us to help facilitate digital asset transfers at a qualified custodian and registered money-transmitter, and we believe we abide by all the requirements of the Investment Advisers Act and Investment Company Act of 1940.
These fine distinctions are achieved through our partnership with Gemini, a crypto exchange that touts itself as so regulation-friendly it ran an ad campaign endorsing government oversight. Gemini is primarily supervised by the New York Department of Financial Services and the 37 other state regulators that oversee money services businesses.
When that ad campaign debuted, CEO Tyler Winklevoss wrote, "The crypto revolution has the potential to solve meaningful, real-world problems that no other technology can — but only a thoughtful, rule-based approach will get us there. Revolutions that build sets of rules to ensure a better future, are the ones that last."
I can't tell you the SEC agrees with Winklevoss, but it's about the closest you're gonna get when it comes to crypto CEOs.
Question of the week: Do you think all the different kinds of crypto are commodities, securities, or some secret third thing? (Your answer is not legally binding. Feel free to make something up.)
You know the deal. Respond with your answer for the chance to win a bundle of Hedgehog swag.