Could Crypto Rally Incite a Wave of SEC Enforcement and a Crypto Market Pullback?

December 20, 2018 / by Zachary Mashiach

The crypto space is in rallying mode as Bitcoin has risen from $3,100 to $4,000, even though the market bounced off of 2018 lows only two or three days ago. The sentiment on Crypto Twitter is not much different than during the historic rally of 2017, with people saying this will be a major rally and egging each other on to buy crypto.

Perhaps this is similar to someone who is dehydrating in the desert and then finally takes a sip of cold water. Right now, this rally seems like a welcome relief, but it could end up in disaster if it incites the Securities and Exchange Commission (SEC) to rapidly take widespread action against unregistered cryptocurrency securities.

The total market cap of all the cryptocurrencies excluding Bitcoin has risen from $45 billion to $59 billion, indicating rapid re-investment into tokens that were issued via ICOs, on the order of 30 percent on average within only a few days. Many blockchain platforms that received their funding via ICOs have either failed or have been forced to take on extreme austerity measures due to the falling market, but now they may be rejoicing. This has the potential to force the hand of the SEC since many of the projects the SEC is targeting are seeing significantly increased market capitalizations.

The SEC has taken numerous enforcement actions against unregistered securities issued via ICOs during 2018. Any cryptocurrency deemed to be a security should expect to see enforcement actions taken against it, no matter when it launched. If a cryptocurrency is a security then the company issuing and selling it must be registered with the SEC. The hard fact is almost no cryptocurrencies are registered as securities with the SEC.

The SEC enforcement actions against unregistered crypto securities became much more serious when civil penalties were levied on Paragon (PRG) and Airfox (AIR). Perhaps the fact that PRG was an unregistered security and simultaneously promoting marijuana gave it priority with the SEC.

PRG and AIR must return all investments to investors, if investors request that, and then they must register as securities. Since PRG and AIR have both lost money since the ICO, it’s possible that both of these companies will eventually go bankrupt after a period of legal battles.

The SEC touted the civil penalties against PRG and AIR as a guideline for enforcing the rest of the unregistered cryptocurrency securities. These actions against PRG and AIR occurred a month ago, and the action on these two cryptocurrencies alone certainly had a severe negative impact on the crypto market. Perhaps the SEC has simply been waiting for the market to stop falling before doing anything else since the SEC can periodically target a different ICO cryptocurrency and keep the ICO market in a state of long-term collapse.

An important point is that the SEC is going after ICOs because of the perceived economic damage that they have caused. Investors have collectively lost billions of dollars on ICOs. The ICO market started as a novel way to raise funding in a decentralized way, and turned into a scammer free for all. Even projects that were not outright scams often ended up spending money too quickly during the rally of 2017, since they did not think the market would crash, and ultimately these projects are viewed as scams since they spent all of their money before achieving their goals.

The SEC’s mission is to protect investors, and they are rightfully angry at the mistreatment of investors in the ICO market. The SEC likely wants to make its enforcement measures against ICOs as persuasive as possible to put an end to these practices. It seems unlikely that the SEC will sit idly by and watch as unregistered cryptocurrency securities launched via ICOs, gain tens of billions of dollars in value, only to potentially repeat the cycle of massive losses for investors.

Therefore, it seems quite possible that the SEC will launch civil penalties against numerous ICOs sometime in the near future. Probably every major unregistered cryptocurrency security has a big case file at the SEC, and the SEC is waiting for the right time to act.

The SEC may have witnessed how some negative market sentiment from Bitcoin Cash’s fork ended up being a ripe time to announce action against PRG and AIR. By issuing those penalties two days after the Bitcoin Cash fork the penalties ended up impacting the entire cryptocurrency market.

Unfortunately, if the SEC wanted to keep a damper on the ICO market, they may have a really good opportunity when the Ethereum Constantinople hard fork happens in less than a month during mid-January 2019. Even without any SEC action, the fork will probably cause a war between miners and investors in the Ethereum community and a potential blockchain split. The Ethereum community will at least be tense when the fork happens or, at worst, totally divided. This would be the optimal time for the SEC to aggravate the situation with broad enforcement on unregistered cryptocurrency securities since most ICOs occurred on the Ethereum blockchain.

Imagine if instead of two ICOs being targeted, it’s 20, or even all of them, right as Ethereum is at its weakest point. It could lead to the ICO apocalypse that so many experts have been anticipating. The SEC would be enforcing the ICOs out of business while the underlying market destroys itself via panic selling and peer to peer lawsuits.

Thus, this brief burst of cryptocurrency euphoria may incite the SEC. If the SEC takes widespread enforcement actions against ICOs, it would almost certainly lead to a devastating market downturn.

All that said, there is a silver lining to everything. If the ICO market ultimately does collapse, it can be compared to a forest fire. Forest fires seem apocalyptic at the time, but they clear the way for new growth, which keeps the forest healthy long term. Essentially the SEC could be lighting the forest fire that burns away scam ICOs, paving the way for a new wave of stronger and more legitimate blockchain companies long term.