Howard Marks

@howardmarks

The SEC Strikes BitFunder

Wow. The SEC has spent the last 8 months warning the crypto community, and they are now taking action. On February 21, the SEC arrested Jon Montroll, the founder and operator of BitFunder, a defunct Bitcoin stock exchange.

The SEC alleges that BitFunder and its founder unlawfully ran a securities exchange and defrauded customers through the misappropriation of their bitcoin. This misappropriation refers to a cyberattack on BitFunder in 2013, in which more than 6,000 bitcoins were stolen by hackers. At the current market price of Bitcoin, that’s more than $64 million.

The context is that Montroll ran two companies: WeExchange, a bitcoin depository and exchange, as well as BitFunder, the platform through which users could buy and sell virtual shares in exchange for bitcoin. These two companies acted similarly to a wallet (WeExchange) and a secondary trading platform for tokens (BitFunder).

In the case of the cyberattack, BitFunder fell victim to hackers, and as a result, the hackers were able to remove more than 6,000 bitcoin from its sister company WeExchange. Due to the missing bitcoin, Montroll’s two companies lacked the capital needed to pay what Montroll owed investors. However, Montroll claimed the attack was unsuccessful to the SEC, who conducted an investigation in the wake of the cyberattack.

In a statement to Reuters, Manhattan U.S. Attorney Geoffrey Berman said, “as alleged, the defendant repeatedly lied during sworn testimony and misled SEC staff to avoid taking personal responsibility for the loss of thousands of his customers’ bitcoins.”

Montroll was charged with perjury and obstruction of justice as a result, but it’s the charges against BitFunder that are far more interesting. Marc Berger, Director of the SEC’s New York Regional Office, stated in the SEC’s press release:

“We allege that BitFunder operated unlawfully as an unregistered securities exchange. Platforms that engage in the activity of national securities exchange, regardless of whether that activity involves digital assets, tokens, or coins, must register with the SEC or operate pursuant to an exemption.”

It is clear by now that tokens being traded as utilities are actually securities, and now the SEC have taken actions against the first exchange. This is really big news. If exchanges want to allow investors to trade the majority of ICO tokens, they have to be registered with the SEC because those tokens are securities! Otherwise, they will be shut down by the SEC and subject to injunctions, disgorgements, penalties and jail.

It’s worth noting that BitFunder has not been in operation since 2013, and it’s likely that the exchange was first targeted by the SEC due to Montroll’s additional allegations. However, you can trust that this won’t be the last exchange to be shut down by the SEC. Berger continues in the SEC’s press release, “we will continue to focus on these types of platforms to protect investors and ensure compliance with securities laws.”

So what are exchanges supposed to do? Well the good news is the SEC has provided two options. The first is to register as an exchange, which is a special designation and only around 20 exchanges exist. It can take many years to get it approved. One example of this is Eric Reis of Lean Startup fame, who wants to create a securities exchange for companies who want long-term shareholders. He has been working on it for years, and who knows if it will ever be approved.

The other and more realistic option is to register as a broker-dealer and create an alternative trading system, also known as an ATS. The main difference is that an ATS trades over the counter securities and does not regulate its members. They follow the SEC and FINRA rules for trading and settling securities.

The SEC is clearly going after the exchanges who are trading securities without a registration. BitFunder is the first of many dominoes to fall. The tokenized economy better be ready.

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