The reasons why Bitcoin securities can't be regulated by the SEC

Saturday, 06 October, Year 4 d.Tr. | Author: Mircea Popescu

As stated in various other venues, MPEx does retain ample counsel. We've proactively prepared a defensive litigation plan and written as well as oral arguments in order to be able to defend our position as well as the interests of the larger Bitcoin community in multiple relevant jurisdictions.

After much internal debate, and in the light of recent developments (by which I mean the misguided actions of one patently incompetent and emotionally unstable individual behaving in a manner consistent with mid-age onset schizophrenia) I've decided to prepare and release a limited statement detailing in principle our considered position on some matters of interest.

The reasoning is that while it is both unwise and uncommon for legal arguments to be disclosed before actual litigation due to the obvious advantage this confers on the other party, nevertheless it would seem the community could significantly benefit by some general framework to consider things within. In balancing this latter need with the former imperative I think MPEx is behaving generously to its environment while at the same time not significantly endangering its own position.

What follows is not a legal document per se, because it has been much abridged, it lacks significant devices, references etc and and for this reason it shouldn't be included in litigation as-is. It would be in the best case an amicus brief.

I. The Securities and Exchange Comission is governed principally by the Securities Act of 1933, which gives a definition of a security as follows :

(1) The term ‘‘security’’ means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

The meaning of this definition has been mostly established by the Certiorari to the Circuit Court of Appeals for the Fifth Circuit, generally known as SEC vs W.J. Howey Co. et al.i, which discusses its meaning based on common use in blue-sky states previous to the enactment of the law, and introduces the Howey test. To wit :

Section 2 (1) of the Act defines the term "security" to include the commonly known documents traded for speculation or investment. This definition also includes "securities" of a more variable character, designated by such descriptive terms as "certificate of interest or participation in any profit-sharing agreement," "investment contract" and "in general, any interest or instrument commonly known as a `security.'" The legal issue in this case turns upon a determination of whether, under the circumstances, the land sales contract, the warranty deed and the service contract together constitute an "investment contract" within the meaning of § 2 (1). An affirmative answer brings into operation the registration requirements of § 5 (a), unless the security is granted an exemption under § 3 (b). The lower courts, in reaching a negative answer to this problem, treated the contracts and deeds as separate transactions involving no more than an ordinary real estate sale and an agreement by the seller to manage the property for the buyer.

The term "investment contract" is undefined by the Securities Act or by relevant legislative reports. But the term was common in many state "blue sky" laws in existence prior to the adoption of the federal statute and, although the term was also undefined by the state laws, it had been broadly construed by state courts so as to afford the investing public a full measure of protection. Form was disregarded for substance and emphasis was placed upon economic reality. An investment contract thus came to mean a contract or scheme for "the placing of capital or laying out of money in a way intended to secure income or profit from its employment." State v. Gopher Tire & Rubber Co., 146 Minn. 52, 56, 177 N.W. 937, 938. This definition was uniformly applied by state courts to a variety of situations where individuals were led to invest money in a common enterprise with the expectation that they would earn a profit solely through the efforts of the promoter or of some one other than themselves.

As recently as 2011 this test was being applied (as for instance in USA vs Thomas Anderson Bowdoin, jr) as 1. Investment of Money towards a 2. Common Enterprise which 3. Depends on the Efforts of Others and likely remains in full force as the standard test for the matter pending further Supreme Court rulings.

II. It is our considered opinion that Bitcoin does not constitute either "Money" as discussed in the second reference nor does a purchase of a Bitcoin denominated virtual security such as offered on MPEx constitute "the placing of capital or laying out of money" as discussed in the first reference.

III.1. At some point in 2008 or 2009, an unknown person or group created a new, innovative Massive Multiplayer Online Player Game by means of introducing a cryptographically-secure, peer-to-peer distributed currency. This move was both technically brilliant and direly necessary : all MMORPGs to date have collapsed due to the poor management of their economies, mostly through in-game currency debasement carried on haphazardly by the game developers. The introduction of this new currency, which is undebasable, has given rise to ample development efforts of unrelated third parties to fill in the gaps and release to the public MMORPGs taking advantage of this significant technical advancement.

III.2. The advantage of Bitcoins of being undebasable comes from the particular manner in which new coins are created. The only manner to acquire coins is to run a computer in prescribed fashion for an interval of time. This practice is commonly known under the name "farming" in game communities. The activity of "gathering game resources" is regarded by most players as boring and cumbersome, and since it lends itself in most cases to automation virtually every game that is large enough has one or multiple "bots", ie computer programs created by third parties that automate the gathering of game resources for the player, without requiring his significant intervention. Some games, which are owned and developed by known persons or groups, introduce a license either forbidding outright or else curtailing the practice of using automated means ("bots") to gather game resources, because of a perceived "unfairness" this introduces in the game environment. Bitcoin however lacks any such authority or group that could impose a license on users, and possibly for this reason goes in practice the other way, placing the tools of automation at everyone's disposal yet limiting the creation of game currency by other means (and it is neither the first nor the only to walk down this path).

III.3. While it is true that some people spend money or other capital to acquire such in-game currency, it is not true that :

    a) Any authority exists which could issue Bitcoins, promise to issue Bitcoins, or make any representations as to Bitcoins whatsoever ;
    b) Any state, government or organisation issues Bitcoins or could conceivably issue Bitcoins either as legal tender, for the payment of taxable income, as a currency of account or to be used in local or international trade.

Because of these reasons it can not be said that anyone holds any title in either law or equity to any Bitcoin. Since there is no first owner of the Bitcoin that could then pass title as part of a contract, all purported Bitcoin "purchases" are contracts for no consideration and as such legally without merit.

Furthermore, while it is true that Bitcoin may be regarded as an item of value by one or more people, this also is true of the in-game currency of each and every single one game ever released to this date and to be released for the conceivable future. Ruling that indeed Bitcoin constitutes in itself either money or capital in the sense of the Securities Act of 1933 would both retroactively expose all game developers and game players to extensive and burdensome reporting and compliance requirements as well as burden the SEC with an enormous task. Further, it would severely limit and curtail the ability of future game developers to bring computer games to the general public. In either case such extensive re-writing of existing and well understood law can not be the empire of the court system, and unless or until such a time as Congress introduces legislation specifically rendering online in-game currencies legal tender, or otherwise money, or capital this matter can only be laid to rest.

  1. Case summary : Two connected Florida corporations were offering patrons of a nearby hotel operated in connection with them the opportunity to buy land in a citrus grove, which land was apportioned in long thin strips usually as wide as one tree line, and also offered a contract to farm the land and market the produce. While the Court of Appeals agreed with the first instance in rejecting the claim of the SEC that this constuction amounted to an investment contract, the Supreme Court reversed. []
Category: Bitcoin
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25 Responses

  1. These are interesting arguments, thanks for publishing.

  2. Mircea Popescu`s avatar
    Mircea Popescu 
    Saturday, 6 October 2012


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  6. Bugpowder`s avatar
    Sunday, 18 November 2012

    Some unofficial analysis from a friend who is a patent litigator...

    "I am not familiar with the securities laws, other than what I read in the linked article (which obviously does not include the counter-arguments), so I can't say whether or not the defense would hold up.

    But I find these statements laughable on their face:

    - It is our considered opinion that Bitcoin does not constitute either “Money” as discussed in the second reference...
    - ...all purported Bitcoin “purchases” are contracts for no consideration and as such legally without merit.

    The whole point of Bitcoin is to be a currency. How can you say it is not "money" and that it does not provide "consideration" for purchases? I think people who have purchased goods or services with Bitcoins would be extremely surprised to learn that their transactions were "legally without merit." If true, a seller who accepts Bitcoins would have no obligation to send the buyer the goods and the buyer would have no recourse. Also if true, there would be no consequence for "stealing" Bitcoins. While I understand that the technology makes it difficult to track down and prosecute Bitcoin theft, I'd find it hard to believe that such theft is perfectly legal. But if you accept the author's position that no one ever holds any title in law or equity to Bitcoins, that would be the logical result.

    Now how all this translates to securities law, I can't say. But if it walks like a duck and sounds like a duck, what do you think the Courts are going to call it? Or as the Supreme Court said in the Howey case cited in the article: "Form was disregarded for substance and emphasis was placed upon economic reality." (Note that in Howey, the Court took a broad view and found the land contract, the warranty deed, and the service contract at issue to be an "investment contract" and therefore a "security" under the law.)

    It is laughably disingenuous to say that Bitcoins are the same as virtual currencies in MMORPGs. Although there are undeniable parallels, there are key differences. In particular, Bitcoins are not limited to or associated with a game. They are used to purchase actual things in the real world (mostly drugs other contraband as I understand). And they are fully transferable and not subject to any game developer's EULA. These are not minor insubstantial differences, and they cause the author's analogy to crumble under scrutiny."

  7. Mircea Popescu`s avatar
    Mircea Popescu 
    Sunday, 18 November 2012

    A ok, thanks for that.

    The whole point of Bitcoin is to be a currency.

    Who established this point, by what authority and on what basis ?

    Aside for that, the point of Monopoly money is just as well to be a currency, for a particular use.

    If true, a seller who accepts Bitcoins would have no obligation to send the buyer the goods and the buyer would have no recourse. Also if true, there would be no consequence for “stealing” Bitcoins.

    This is quite so, in fact. I understand the misgivings the person expresses, but they themselves admit these come from outraged sentiment rather than some sort of reason. In fact, nobody has title to any bitcoin. They have posession, at best, and only in some conditions. That's all.

    Probably a good place to introduce the discussion of GPG contracts. Turns out Bitcoin is more of a revolution that originally thought : pretty much all civil law is rendered obsolete by their workings, from bankruptcy protections to forfeiture or what have you.

    The discussion of the key differences would be of great value, if they exist.

    In particular, Bitcoins are not limited to or associated with a game.

    This is much akin to saying that Game X is not asociated with Game X. Just because Bitcoin is open source and thus usable in any ulterior game doesn't mean much in the context, does it ? Why exactly is the captivity of some specified developer's EULA relevant ?

    They are used to purchase actual things in the real world

    The fact that pretty much any item has been at some point used to inflict grevious bodily harm does not make each and every item a weapon. Sure, people may trade anythign they want for anything else they want, such as for instance stamps for golf balls or round pebbles for Subway Sandwiches. The excentricity of X and Y that trade guns for Monopoly Dollars can not make some kid down the block a criminal for having received a Monopoly game for his birthday.

    It would seem in fact that the proposed differences are exactly unsubstantial, and crumble under scrutiny. But in any case I suspect we'll hear more of this matter in time.

  8. Mircea Popescu`s avatar
    Mircea Popescu 
    Friday, 15 March 2013

    Somewhat related :

    Regulation - which is based on force and fear - undermines the moral base of business dealings. It becomes cheaper to bribe a building inspector than to meet his standards of construction. A fly-by-night securities operator can quickly meet all the S.E.C. requirements, gain the inference of respectability, and proceed to fleece the public. In an unregulated economy, the operator would have had to spend a number of years in reputable dealings before he could earn a position of trust sufficient to induce a number of investors to place funds with him. Protection of the consumer by regulation is thus illusory.
    ~Alan Greenspan

  9. Hi Mircea,

    Just read this. My securities partner happens to agree that bitcoin is not a security (; but it is not our legal opinion or advice, just a blog post -- please don't rely on it!

    Of course, there are other laws that may apply to people transacting in bitcoin, depending on the nature of their businesses.


  10. Mircea Popescu`s avatar
    Mircea Popescu 
    Friday, 15 March 2013

    He may well have a point.

  11. Mircea Popescu`s avatar
    Mircea Popescu 
    Tuesday, 19 March 2013

    Apparently FinCEN agrees with the foregoing :

    A final type of convertible virtual currency activity involves a de-centralized convertible virtual currency (1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort.

    A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.

    A person's acceptance and/or transmission of convertible virtual currency cannot be characterized as providing or selling prepaid access because prepaid access is limited to real currencies.

    A person must exchange the currency of two or more countries to be considered a dealer in foreign exchange. Virtual currency does not meet the criteria to be considered "currency" under the BSA, because it is not legal tender. Therefore, a person who accepts real currency in exchange for virtual currency, or vice versa, is not a dealer in foreign exchange under FinCEN's regulations.

  12. Krishna`s avatar
    Friday, 10 April 2015

    Ideally the concept is to rmveoe the mess that has been created with factional reserve banking. Right now so much power is in the hands of the central banks. This power gives them the ability to control the amount of currency that is in circulation. In essence money is created out of thin air with no weight to it like the gold standard created. Money is built on trust in the value of that currency, which is very scary. You can even see in recent times how this type of system has created massive problems and will only get worse as time goes on. The only way I personally feel that currency can be fixed since we left the gold standard is to create a new currency with a relative value unit assigned to it. The relative value can be tied to something tangible. To supply a certain good or service it requires certain resources. Those resources being natural, human and others. For example it takes a specific amount of resources to produce a car. Machines, equipment, people working on it, natural resources like metal, plastics and time. These factors can be used to produce a RV for that car. Unfortunately I think there is so much money in circulation, that it would be near impossible to go back to the gold standard as there may not be enough gold available in circulation to match out the currency to. Why not create a balance of the commons of ALL available tangible resources and not just gold?The concepts I like of BitCoin are the fact that there is no central authority for currency. What you produce is what you own. You actually own that currency that you have produced using your resources and it has value based on the fact that others had to go through the same create that currency as you did. The idea of using CPU cycles is very geeky and not sustainable. The idea though that you have this resource and by using that resource you are producing something that holds value amongst those doing the same type of work place the value and trust in that currency. So when you go to work based on your education, work experience, skills, time spend doing your job, the actual work being done and even the value your employer feels you are worth to them can all be used as factors. That value of currency that you produce has no value that is set by factional reserve banking and the amount of currency in circulation. It is based on a true tangible asset like the gold standard used to be.Just my two cents.

  13. Mircea Popescu`s avatar
    Mircea Popescu 
    Friday, 10 April 2015

    You'd probably benefit from a lot more reading. Typing can be a secondary preoccupation for a while.

  1. 14
    Adnotated words of wisdom on the topic of online fraud pe Trilema - Un blog de Mircea Popescu. (via Pingback)
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    [...] limited by the quality of his control. Sounds familiar ? Why yes, it’s the exact problem with ownership of Bitcoin. The subtle difference being that the “owner” of stolen goods has goods with no title [...]

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    Bitcoin Transactions as an Exercise in Free Speech - CoinChomp (via Pingback)
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    [...] notice of the preparation of a defensive litigation plan should Bitcoin regulation be enacted. Read more about it here. Leave your two satoshis-worth in the comments below. Stay in touch with @CoinChomp on [...]

  3. [...] hopes of creating fiat-businesses out of exploiting Bitcoins are pretty much quashed by even a cursory examination of some aspects of the legality of the matter. Sure, they had hoped to one day be listed on NYSE on [...]

  4. [...] limited by the quality of his control. Sounds familiar ? Why yes, it's the exact problem with ownership of Bitcoin. The subtle difference being that the "owner" of stolen goods has goods with no title because he's [...]

  5. [...] Legally MPEx will continue to promote the correct view of BTC, as a game currency not in any significant way different from any other game [...]

  6. [...] old cryptography mail list where Satoshi originally specifiedi his idea for a next generation game currency contains some invaluable nuggets. Not penned by Satoshi himself, but by James A. Donald. To quote : [...]

  7. [...] as well as the interests of the larger Bitcoin community in multiple relevant jurisdictions. ~ The reasons why Bitcoin securities can’t be regulated by the SEC, 6 October 2012ii “We have more lawyers than engineers,” said Singer, who stressed that the new [...]

  8. [...] as discussed here two years ago, nobody holds any title to any Bitcoin. This means that nobody can claim superiority of title, and [...]

  9. [...] side : while you're derping about how you've "lobbyied" for Bitcoin, think of simple things : MP said Bitcoin is not a currency in 2012. Notwithstanding all your derpage, in 2014 this was confirmed by the supposed authorities you were [...]

  10. [...] kids" hoola-hoop and so forth. Quite impressive for something over which no court and no government has any jurisdiction, wouldn't you say ? [...]

  11. [...] press, which never apologized or, for that matter, admitted. October 6th, 2012 : Published the binding ruling on the subject of "regulation" of Bitcoin by impudent agents without a Serenissima commission. This [...]

  12. [...] why bitcoin securities can't be regulated by the sec with a concrete -if abridged- framework from MPEx's own legal arguments on the [...]

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