United States Securities and Exchange Commission (SEC) recently released “charges against Zachary Coburn, the founder of EtherDelta, a digital ‘token’ trading platform. This is the SEC’s first enforcement action based on findings that such a platform operated as an unregistered national securities exchange.” It is a for sure first, but it will not be the last, and crypto legal experts have weighed-in.
EtherDelta Owner First Unregistered Exchange Charged by Feds
Coburn agreed to shell out a disgorgement of $300,000, along with $13,000 in interest and a $75,000 fine. He neither admitted guilt nor denied the regulator’s accusations. “The Commission’s order recognizes Coburn’s cooperation, which the Commission considered in determining not to impose a greater penalty,” the SEC noted.
SEC Enforcement Division Director Stephanie Avakian explained, “EtherDelta had both the user interface and underlying functionality of an online national securities exchange and was required to register with the SEC or qualify for an exemption.”
It’s the first exchange operation to be charged in this manner, though previously the US regulator has “brought enforcement actions relating to unregistered broker-dealers and unregistered ICOs, including some of the tokens traded on EtherDelta.”
2017 DAO Report
From Washington D.C. on Nov. 8, 2018 a financial regulator in the most economically and militarily powerful country in the world announced a settlement with EtherDelta. The exchange is described in the SEC press release as “an online platform for secondary market trading of ERC20 tokens, a type of blockchain-based token commonly issued in Initial Coin Offerings (ICOs).”
The company was a “marketplace for bringing together buyers and sellers for digital asset securities through the combined use of an order book, a website that displayed orders, and a ‘smart contract,’” the SEC continued. And its platform “was coded to validate the order messages, confirm the terms and conditions of orders, execute paired orders, and direct the distributed ledger to be updated to reflect a trade.”
Its crime? Founder Zachary Coburn hadn’t registered as a national securities exchange. For about a year and half, the company processed close to 4 million orders, which included “tokens that are securities under the federal securities laws. Almost all of the orders placed through EtherDelta’s platform were traded after the Commission issued its 2017 DAO Report,” the SEC noted.
High Risk Situation
That report proved to be prescient in concluding “certain digital assets, such as DAO tokens, were securities and that platforms that offered trading of these digital asset securities would be subject to the SEC’s requirement that exchanges register or operate pursuant to an exemption,” the SEC explained. And the logic simply follows from there. The company “offered trading of various digital asset securities and failed to register.”
The regulator described their investigation as “continuing.” Indeed, crypto legal analyst Marco Santori immediately took to Twitter, insisting the SEC’s settlement was “important for what it says but, maybe more so for what it doesn’t say.” Santori was quick to also remind Coburn sold the exchange “to non-US purchasers. EtherDelta seems to be up and running, humming along just fine.” He also puzzles at how the order states “92% of the trades took place subsequent to the DAO report. That’s a lot of trades. Presumably one of them was a security, but we don’t see any cited.”
Santori also notes, “EtherDelta had an ‘open listing’ system, which is to say that anyone could trade any token. That’s a high risk situation. Big picture? It supports common wisdom among attorneys today: [decentralized exchange or DEX] is not a good way to escape securities laws. They are very, very broad. Much broader than the money services laws in the US. Your DEX might not be money transmission if it is [decentralized] enough. But, as I type here today, I can’t think of a commercial DEX that falls outside of the broker dealer/securities exchange rules. It’s not clear at all whether a token that comes out of an ICO is itself a security. Sure, prevailing wisdom is that the contract between a seller and buyer of a pre-functional token is usually a security. But what about the token itself?”
The Big Chill
Larry Cermak of The Block pointed out wording from the actual order, where enforcement authorities noticed the platform “was available to anyone, including U.S. persons, and had no specified hours of operation.’ Good luck out there shitcoin exchanges,” he teased.
“The purchasers of such digital tokens invested money with a reasonable expectation of profits, including through the increased value of their investments in secondary trading, based on the managerial efforts of others.”
He also keys-in on citizenship, explaining “Zachary Coburn, the founder of EtherDelta is a US citizen. And so is Erik Voorhees who was pressured to start doing KYC on Shapeshift. It will be much harder to charge non-US citizens running unregistered securities exchanges,” which could put a chill on future decentralized exchanges popping up or continuing in the United States.
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