The Commission’s enforcement action against ShapeShift is the latest installment in the serial drama of the Commission’s poorly conceived crypto policy.[1] The current episode recounts the tale of an early innovator in the market for crypto assets.  In August 2014, ShapeShift AG started an online platform that facilitated trading in crypto assets.  ShapeShift sold from its own inventory, thus acting as a counterparty to both the buyer and seller, and generated revenue on the spread—the difference between its cost to acquire the crypto asset and the price at which it sold the acquired asset.  ShapeShift operated this way for more than six years before announcing in January 2021 that it would be changing its business model.  Customers would no longer be able to exchange crypto assets directly through the platform and ShapeShift would no longer act as the counterparty to any customer transactions.  Before this change, the platform, trading in at least 79 crypto assets, facilitated as many as 20,000 daily transactions.

The Commission’s Order Instituting Proceedings finds that ShapeShift violated Section 15(a) of the Securities Exchange Act of 1934 because it should have registered as a securities dealer.  The Securities Exchange Act defines a dealer as “any person engaged in the business of buying and selling securities . . . for such person’s own account through a broker or otherwise.”[2]  ShapeShift meets this definition, according to the Commission, because “[t]he crypto assets offered by ShapeShift included those that were offered and sold as investment contracts and, therefore, securities, under SEC v. W.J. Howey Co., 328 U.S. 293 (1946).”  The Commission’s Order, however, fails to identify which crypto assets were investment contracts and provides no explanation for its conclusion.  In sum, ShapeShift is in trouble because the Commission, nearly ten years after ShapeShift’s platform started trading and more than three years after it changed its business model, now contends that some unidentified number of the 79 crypto assets it traded between 2014 and 2021 were investment contracts without explaining why.  Notably, the Commission does not allege any harm—ShapeShift and its customers voluntarily transacted and the Order nowhere alleges that ShapeShift defrauded its customers.      

This enforcement action underscores the adverse consequences of the Commission’s approach to regulation in the crypto space and adds to the ambiguity that hangs over the crypto world.  It is entirely unclear how ShapeShift was to discern that the Commission would consider crypto assets generally—and any crypto asset in particular—a security in the form of an investment contract.  Even now, ten years on, it is hardly more discernable.  But perhaps that ambiguity is exactly the result the Commission wants.  Now the next person who comes up with an idea for building something to help other people buy or sell crypto will think twice.  Why spend time and effort creating something only to face an enforcement action ten years later?  The Commission’s mantra in such situations—“Just come in and register”—is manifestly unsatisfying. One can imagine the dialogue for that scene in a future episode: 

Future ShapeShift (“FSS”): Hello, I would like to register as a dealer. 

SEC:  Why? 

FSS:  Because I think some of the assets that I plan to deal might be deemed at some point by the SEC to be securities. 

SEC:  Which ones? 

FSS:   I’m not sure because I can’t really understand what criteria you use to decide whether a token offering is a securities transaction and, if it is, whether the token that was the subject of the investment contract remains a security in secondary market transactions. 

SEC:  Well, if you don’t know whether you’re dealing in securities, you can’t register.  And by the way, if some of the assets you’re dealing in are not securities, you also can’t register. 

FSS:  So can you help us think through which assets are securities? 

SEC:  No.  We suggest that you read the 2017 DAO report,[3] and it will all be clear to you.  You can also look at our enforcement actions if you want.

FSS:  I read it, and I’ve read about your enforcement actions.  I still have questions. 

SEC: Hire a lawyer. 

FSS:  I did, and the lawyer has even more questions. 

SEC: Sorry, we cannot help any more than we already have. We don’t give legal advice. 

END SCENE

This scene is by no means hypothetical.  Industry participants have consistently expressed concern that they need clarity on which crypto assets are securities. The calls for clarity will only increase in response to last month’s expansion of the definition of dealer to reach active liquidity providers.[4]  In adopting the rule, the Commission acknowledged that the new category of dealers might include certain crypto market participants.[5]  People are right now trying to figure out whether they have to register as dealers and, if so, which assets they can handle in the registered entity.  To do so, they need to understand whether the assets for which they provide liquidity are securities.  The fiction that this has been done is undermined by the Commission’s failure to state which specific assets in the case before us are securities.  The standards are so opaque and arbitrary that the Commission itself is unwilling to stand by its own analysis.  If case-by-case determination is possible, we respectfully request that the Commission show its work.

The environment we have created for the crypto asset markets, especially as it relates to secondary trading, is untenable.  It exposes well-meaning entrepreneurs to a regulatory sword of Damocles.  Cases like this do not protect investors; they intimidate innovators and entrepreneurs.  We respectfully dissent.