Long awaited guidance from the US Securities and Exchange Commission (SEC) on application of the Howey test to digital assets came on April 3 in the form of a Framework for “Investment Contract” Analysis of Digital Assets (“Framework”) and a No-Action Letter regarding TurnKey Jet, Inc. (the “TurnKey No-Action Letter”). These two documents are best understood as part of a trilogy with the June 2018 Hinman speech.
The Framework offers the clearest indication yet of the SEC staff’s thinking on the Howey test, with the TurnKey No-Action Letter and the Hinman speech providing examples of where a digital asset fails to meet a necessary element of the test. For purposes of clarity, it helps to think of the Howey test as having four elements: (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) derived from the efforts of others.
The first two prongs are essentially throwaways inasmuch as the Framework devotes only three sentences to them in total. SEC staff note that these prongs are “typically satisfied” in evaluating digital assets. On the other hand, the Framework pays significant attention to the third and fourth elements.
Starting with the “efforts of others” element, the Framework introduces the concept of an “Active Participant” (AP) as a promoter, sponsor, or other third-party (or affiliated group of third-parties) that provides essential managerial efforts that affect the success of the enterprise. The Framework then gives examples of when the actions of the AP are likely to indicate that a purchaser of a digital asset is relying on the efforts of others. In prior cases, the SEC has focused on whether a network is fully functional or still in development, and whether it has achieved the requisite level of decentralization. On this latter point, the Framework confirms that decentralization is to be viewed from a governance and managerial standpoint. The staff is interested in whether the AP has a “central role” in the maintenance and ongoing development of the network. It also may be worth noting that the Framework characterizes this element as “reliance on the efforts of others” in contrast to the DAO report and the Hinman speech, which use the phrase “derived from the managerial efforts of others.” There is no explanation given for this shift in phrasing.
The Framework’s analysis of the “reasonable expectation of profits” element further introduces many new characteristics that may not have historically been viewed as evidence that a purchaser has a reasonable expectation of profits. These include whether the digital asset is transferrable or likely to be so in the future; whether there is correlation between the purchase price of the digital asset and the value of goods or services for which it can be exchanged; or whether the AP is able to benefit as a result of holding the digital asset.
However, the clearest understanding of the staff’s thinking on this element comes from the TurnKey No-Action Letter in which the SEC Division of Corporation Finance staff found a purchaser of tokens sold by TurnKey Jet, Inc. (TKJ and TKJ Tokens) would not have a reasonable expectation of profits. In this case, the token is essentially a dollar-denominated stablecoin that can be used solely to purchase air travel priced in USD, and where any redemptions by the issuer would be at a discount (i.e., less than one USD). The TKJ Token is a means for users and providers of air travel services to avoid various transaction costs and delays associated with credit cards and wire transfers. TKJ Tokens are not likely to appeal to many entrepreneurs who seek the benefits of open-source software development and community networking, such as speed to execution, diverse development activities, sharing of expenditures among multiple network participants, fostering alternative network uses and commercial providers, and diversity of viewpoints in network governance. (See additional insight from Steptoe on the TurnKey No-Action Letter here.)
Fortunately, an investment contract must meet all four elements of the Howey test, and thus most entrepreneurs will focus on whether the purchaser of a token is relying on “the efforts of others.” It was this element upon which Director William Hinman in his June 2018 speech concluded that Ether was not a security. Many of the factors cited in his speech have been incorporated into the Framework, but they are now better understood because they are placed directly in the context of each element of the Howey test, and because there is a greater understanding of what is meant by when a “network on which [a token] is to function is sufficiently decentralized.” These factors include:
- Whether or not the efforts of an AP, including any successor AP, continue to be important to the value of an investment in the digital asset;
- Whether the network on which the digital asset is to function operates in such a manner that purchasers would no longer reasonably expect an AP to carry out essential managerial or entrepreneurial efforts; and
- Whether the efforts of an AP are no longer affecting the enterprise’s success.
While expectations were flying high that the Framework and TurnKey No-Action Letter would answer all outstanding questions concerning token issuances, we believe the Framework and TurnKey No-Action Letter – read together with the Hinman speech – are a positive step forward to providing a clearer flightpath to compliance.
 In the Framework, the SEC describes the Howey test as having three elements, treating the “reasonable expectation of profits derived from efforts of others” prongs as a single element, but then identifying separate characteristics for determining whether there is (i) reliance on the efforts of others; and (ii) a reasonable expectation of profits.
 The “efforts of others” element is clearly satisfied because TKJ is retaining total control over all aspects of the network.
Bullish? On-Exchange Bitcoin Declines While Whales Accumulate (Report)
A recent report suggests that the amount of Bitcoin stored on exchanges is declining while BTC whales increase their holdings and that’s bullish for Bitcoin’s price.
The paper also highlighted that investors have a much larger time horizon for their holdings now compared to previous years.
Bitcoin Stored On Exchanges Drop
In its latest report shared with CryptoPotato on Bitcoin investors’ behavior, the popular research company Digital Delphi explored the number of bitcoins stored on cryptocurrency exchanges. The document indicated that if the BTC stock on platforms increases, it could put sell pressure.
However, this isn’t necessarily the case during bull runs, as retail investors often “leave BTC on exchanges and traders use BTC as margin collateral.” Alternatively, in case the asset price rises while the stock on exchange decreases, this typically implies an accumulation trend.
The report indicated that Bitcoin stored on exchanges marked an all-time high of 2.96 million in mid-February. Since then, the trend has reversed, and the number has dropped to below 2.6 million.
Digital Delphi argued that the reason behind this decrease of BTC on exchanges is because investors are most likely preparing for a longer-term holding period. More importantly, though, the paper highlighted a substantial decline in speculative trading interest in Bitcoin, while the HODLing mentality has increased.
“Unlike the 2019 price uptrend, which coincided with BTC stock increasing, this current trend has seen a divergence between BTC stock and price. This suggests a more sustainable move upwards for BTC, in comparison to that of 2019, as data indicates a holder base with longer time horizons.”
Bitcoin Whales Haven’t Slowed Down Accumulating
Digital Delphi’s data reaffirmed previous reports that Bitcoin whales, meaning addresses containing between 1,000 and 10,000 BTC, continue to accumulate large portions. The company outlined that whales have been on a shopping spree since the start of 2020, as their holdings have increased by 9% YTD.
Moreover, the US Federal Reserve’s actions to print extensive amounts of dollars since the start of the COVID-19 pandemic have accelerated whales’ accumulations.
“Since the USD M2 supply expansion in March, there has been a 7% increase in whale holdings.”
According to the document, this only emphasizes the narrative that Bitcoin serves as a hedge against dollar inflation, and “the smart money is clearly betting on this.” It’s worth noting that prominent US investor Paul Tudor Jones III purchased BTC earlier this year to protect himself against precisely the rising inflation.
US Crypto Tax Avoiders Beware: The IRS Updates 1040 Tax Form
The Internal Revenue Service (IRS) seems to have found a way to block crypto tax evasion, following an update of its tax form.
IRS: No Excuses for Crypto Traders
According to the Wall Street Journal on Friday (September 25, 2020), the IRS is planning to alter its 1040 tax form. The revised tax form will see cryptocurrency holders give a straight answer about their crypto activities.
The IRS has been relentlessly pursuing crypto investors to disclose transactions, as it suspects that many taxpayers were guilty of tax evasion. However, the tax administrator looks like it has found a way to make all Bitcoin holders accountable.
Presently, the tax form will mandate crypto traders to answer a” yes or no” to the following question:
“At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?”
What makes the update interesting is the placement of the above question. Prior to the revised tax form, the question appeared in a section where taxpayers were not mandated to fill the answer. However, the question’s position in the altered tax form just below the taxpayer’s name and address leaves no room for excuses or oversight on the part of the crypto trader.
Reacting to the altered form of 1040 was Ed Zollars:
“This placement is unprecedented and will make it easier for the IRS to win cases against taxpayers who check ‘No’ when they should check ‘Yes”
There have been complaints in the past about the lack of a robust regulatory framework for crypto tax filings. In October 2019, the IRS published new tax guidelines that would supposedly make it easier for crypto investors to file taxes. The U.S. tax agency also sent reminder letters to crypto holders. Earlier in September, the IRS announced a payment of $625,000 to anyone who could crack Monero and Bitcoin’s lightning network.
Governments Keen on Crypto Taxation
While the IRS seems to have devised a means to trap crypto holders, more countries are introducing crypto tax laws and clamping down on offenders.
As reported by CryptoPotato in April, Spain’s tax administrator sent out notices to 66,000 crypto investors, as against the 14,000 notices sent in 2019. South Korea, on the other hand, has been unsteady about taxing cryptocurrency.
Earlier in 2020, South Korea’s Ministry of Finance and Strategy revealed that there were no intentions to tax crypto profits. However, reports emerged that the Ministry was considering imposing a 20% tax on profits from crypto trading. In June, the country’s Finance Minister called for the imposition of tax on cryptocurrency trading gains.
Australia’s tax agency, the Australian Taxation Office (ATO), sent out reminders to 350,000 crypto traders in March about their tax obligations. According to the ATO, crypto investors were to keep a comprehensive record of their trading activities for ease of tax payment.
Chinese State Media Report: Cryptocurrencies Are The Best-Performing Assets Of 2020
Although China still categorizes Bitcoin and other cryptocurrencies as illegal, several state-owned media outlets purportedly ran reports describing them as the best-performing assets since the start of the year.
Bitcoin And Crypto Run On Chinese Media
A popular state-owned media under the name Xinhua News Agency set the tone yesterday by citing a Bloomberg report titled “crypto is beating gold as 2020’s top asset so far.” Apart from summarizing Bloomberg’s narrative, Xinhua added that cryptocurrencies are “decentralized financial instruments” and concluded that they have become “the best performing asset class this year.”
Another digital asset coverage followed today on China Central Television (CCTV) – among the most popular broadcasting services in the nation. In a three-minute-long video clip, CCTV spoke about cryptocurrencies and emphasized on their year-to-date performance. More specifically, the clip focused on their 70% price increase this year.
According to a popular cryptocurrency commentator Dovey Wan, this “interesting propaganda” spread out among other outlets, being featured on all “avenues, newspapers, online media, and TV.” The advertised narrative was the same – that digital assets have been outperforming all other investment instruments.
Binance CEO Changpeng Zhao commented that people might not understand the significance behind this coverage, but “it is big.”
However, Wan raised a compelling question – what’s the real intention behind this move? After all, cryptocurrencies remain banned for official usage within the world’s most populated nation. She speculated that this coverage might have something to do with the Chinese central bank digital currency that’s reportedly being tested.
China Behind The Price Pump?
As CryptoPotato reported earlier today, green dominated the cryptocurrency field with the total market cap increasing by about $20 billion since yesterday.
Historically, news and announcements from China have undoubtedly impacted prices. As such, it wouldn’t be a surprise that the two-day media coverage promoting cryptocurrencies as the best-performing assets in 2020 has affected the market to some extent.
In late 2019, President Xi Jinping urged the country to accelerate its blockchain adoption. In the next few hours, the cryptocurrency field experienced some of its most impressive price pumps in history. Bitcoin alone skyrocketed by 42% in hours.
Less than a month later, country officials clarified that being pro-blockchain didn’t mean a positive attitude on cryptocurrencies. After reaffirming that digital assets are still illegal, their value plummeted in response.
Blockchain1 month ago
Market Wrap: Bitcoin’s Powell-Induced Price Swing; Ethereum Still High on Gas
Blockchain1 month ago
The US Post Office Files a Patent for a Blockchain-Based Voting System
Blockchain4 months ago
How to Identify the ‘Third Wave’ of Cannabis Investments
Blockchain3 weeks ago
Blockchain Bites: Is DeFi an Inside Deal?
Blockchain2 months ago
Wealthfront Lures Millenials With Crypto Memes and Tactics
Blockchain2 months ago
Top Five Most Advanced Cryptocurrencies
Blockchain4 months ago
5 Tips to Interest the Press in Your Cannabis Business
Blockchain3 months ago
Top 5 Most Effective Cannabis Marketing Strategies