Mining for Federal Regulation: What Does SEC v. Shavers Mean for the Future of Bitcoin?

October 15, 2013

Tuesday, October 15, 2013, by Will Blackton
Last week, the FBI seized about $80 million worth of Bitcoin from Ross Ulbricht, the mastermind behind Silk Road, the anonymous online marketplace for guns and drugs. This most recent chapter of the ongoing saga of Bitcoin in the courts heightens the concern of Bitcoin users of increasing governmental scrutiny.
In April of 2013, during the Cypriot financial crisis, a Bitcoin ATM was set up on the island nation as an alternative means of accessing money. Bank withdrawals were suspended in the island nation for a brief period, and many speculate that the widespread anxiety over the stability of the European banking sector may have been the force rocketing Bitcoin to an all-time high of $266 in early April. With the meteoric rise in value, also came increasing scrutiny from federal regulators. By mid-April, FinCEN published the Remarks of Jennifer Shasky Calvery at the National Cyber Forensics Training Alliance CyFin 2013 Conference, clarifying the regulatory responsibilities for users of emerging payment methods.
Bitcoin is an online digital currency that relies on peer-to-peer technology for transaction, management, and distribution. The closest the currency comes to the physical realm is in the transmission of electrons across the wires that make up our telecommunication infrastructure. Bitcoins are not backed by government fiat or commodity; there is no regulatory body that issues them into being, nor anything but the pure free market to give Bitcoin value. The only thing backing up the security and confidence in Bitcoin transactions is the community of dedicated hobbyist programmers and those willing to trade goods and services for BTC. The most troubling aspect of Bitcoin, from a regulatory point of view, is the lack of a centralized administrative body. Other digital means of transaction, like frequent flier miles, corporate rewards points, and money acquired in video games, have some centralized administrative structure to issue and regulate the currencies.
In August, the SEC brought an enforcement action alleging fraud in connection with a Bitcoin Ponzi scheme against Trendon Shavers. According to the SEC complaint, Shavers offered and sold Bitcoin Savings and Trust (“BTCST”) investments over the Internet, raising more than 700,000 BTC in principal investments from BTCST investors, or more than $4.5 million based on the daily average price of BTC when the BTCST investors purchased their BTCST investments.
The Court in Shavers used the three part Howey test to determine that the investment scheme that Shavers set up qualified as an investment contract for the purpose of securities regulation. Judicial interpretation of securities regulation is largely guided by the phrase “investment contract.” In SEC v. W.J. Howey Co., the Supreme Court set forth a three factor test to determine, for purposes of the Securities Act, that an investment contract is “any contract, transaction, or scheme involving (1) an investment of money, (2) a common enterprise, (3) with the expectation that profits will be derived from the efforts of the promoter of a third party.”
The Shavers court found that BCTST investments satisfied the first factor of the Howey test, an investment of money, because Bitcoin could be, “used to purchase goods and services in a limited capacity, but it could also be exchanged for conventional currencies.”

The entire Bitcoin economy might not be disqualified from wholesale securities regulation because every participant is an investment promoter.

Traditionally a single person or corporation has been responsible for the promotion of investment in a product, but the decentralized nature of the Bitcoin peer-to-peer transaction system does not prohibit every participant from characterization as a third party promoting the value of Bitcoin as an investment vehicle. The expansion for the potential to spend and use Bitcoins has been responsible for the appreciation in value of the currency since 2009; it is the only valuable characteristic of the currency – people’s confidence and willingness to use it as a means of exchange. The entire Bitcoin economy might not be disqualified from wholesale securities regulation because every participant is an investment promoter. While the Court in Shavers is still applying the traditional definition of common enterprise by pointing to a particular individual, the unprecedented attributes of Bitcoin, namely decentralization, will engender a much broader and more forceful approach by regulators.
A Bitcoin miner may invest minimal effort in establishing his virtual mining operation, setting up the appropriate computer hardware and software, and watch their potential gains. There is significant reliance on the established but de-centralized Bitcoin protocol, strewn across the internet, to enable this generation of wealth. The volatile price swings of BTC have drawn many speculative investors, who need to exert only minimal effort by investing their initial cash purchase of Bitcoins. But each of these miners and speculators in turn “promotes” the value of the entire Bitcoin enterprise with mere participation.
Upon further examination of the nature of Bitcoin transactions, federal regulatory bodies may determine that Bitcoin as an alternative means of exchange is untenable under current securities law.