The US Securities and Exchange Commission (SEC) has vigorously asserted in two recent lawsuits that many crypto tokens other than Bitcoin and Ethereum are unregistered securities under existing US securities law and that crypto exchanges targeting US investors are unregistered securities exchanges. Assuming for the moment that the SEC is correct in those assertions (which many advisors disagree with), what, if anything, should US investors be doing now?
If the SEC is successful in either or both of those assertions, the result would be that many crypto tokens would have to be delisted immediately by the crypto exchanges. Most if not all non-US-based crypto exchanges will no longer knowingly take on US customers, particularly in light of the SEC actions with respect to the Bittrex crypto exchange. As a result, US investors holding tokens other than Bitcoin and Ethereum will likely be faced with a significant liquidity crunch and possibly a complete loss of their investment as they will no longer be able to trade their tokens on an exchange. With the tokens no longer tradable on a US crypto exchange, and limited if no access to foreign crypto exchanges, US investors will have few options other than sales to foreign over-the-counter (OTC) desks or foreign crypto funds. Such buyers may be likely to take advantage of this situation to buy the tokens at significant discounts to the prices on the crypto exchanges, resulting in significant losses to US investors.
For most individual crypto investors, the losses from sales of the tokens would be capital losses which can largely only be used to offset capital gains. Note that currently, such losses cannot be carried back for federal income tax purposes, so some investors may have had significant capital gains in 2022 and capital losses in 2023 that they cannot use.
Some crypto investors may be able to qualify as traders/dealers, in which case they may generate ordinary rather than capital losses.
So, for individual crypto investors with significant holdings of crypto tokens, one choice now would be to sell those tokens on an exchange over the next few months and purchase Bitcoin and/or Ethereum; this could have the effect of significantly increasing the prices of those tokens. Another choice would be to sell the tokens and convert the proceeds into fiat currency. A third choice would be to sell the tokens in a private sale to a venture capital crypto fund or OTC desk.
For US crypto funds, an alternative would be to set up a subsidiary fund outside of the US, for example in Hong Kong or Singapore, and move the investments from the US fund to the new fund in hopes that the crypto tokens could then be moved and traded on a non-US crypto exchange. Such a move raises a host of questions, including US tax and other issues that will arise, know-your-client and anti-money laundering (KYC/AML) requirements for the ultimate beneficiary ownerships (UBOs) of the existing US crypto funds by the new fund, investment advisor and other registration requirements for the new asset manager and fund.
This continued attack on crypto tokens by the SEC without the SEC outlining a plan for crypto token issuers and crypto exchanges to become compliant increases the uncertainty faced by both individual crypto investors and US VC crypto funds. Now is not the time to be an ostrich and bury your head in the sands hoping the regulatory issues will be resolved soon.
