Crypto Ratings Council nudging regulators to step up

  • Asset Management
  • 10.10.2019 11:39 am

The recent announcement of the formation of a Crypto Rating Council (CRC) has been met with mixed feelings and confusion. Branded as a joint commitment “to responsible growth and maturation of cryptocurrency markets and related financial infrastructure and trading services”, as stipulated on its website, the CRC claims to be providing a system that simplifies US federal securities laws for the benefit of retail investors.

Cryptocurrencies have become ubiquitous in recent years, prompting global authorities and financial institutions to explore regulation with increasing scrutiny. There has been ongoing debate around the world about how blockchain-based digital assets, cryptocurrencies and tokens should be classified. Debatably, the "Howey Test" has served as the closest means of classification for cryptocurrencies in terms of securities in the US, although it serves broadly for determining whether various forms of transactions qualify as investment contracts and doesn’t cater specifically for crypto.

Consisting of eight leading US crypto exchange members, including Coinbase, Bittrex and Kraken, on the surface the establishment of the CRC appears to be a legitimate form of self-regulation; however, some industry and legal experts are advising caution.

Revix co-founders Louis Buys and Sean Sanders say that, “The membership’s goal is an important one in trying to bring legitimacy and regulation for the continued growth of the industry. However, while self-regulation is a welcome step, particularly for an asset class that is suffering from a great deal of legal and legislative ambiguity in the US and UK, it sends mixed messages to many investors.”

“Some fear that, by being run by industry players rather than by an overarching external body, it is unlikely that fair and unbiased ratings of digital assets will be possible,” says Buys. “If this is true, the ratings would favour the best interests of the Council members themselves. We are of the opinion that it is too early to make this sort of judgement.”

The model the CRC employs sees a rating of 1 to 5 applied to any given digital asset. By the Council’s definition, an asset with a “5” rating would be classed as a security, while assets with a value of “1” would be deemed akin to a truly decentralised currency that no single party controls. Seemingly, within the crypto sphere, some investors have battled to distinguish between the bank-free, peer-to-peer transactions of decentralised currencies and the tightly regulated publicly traded securities listed on global stock exchanges.

According to the first crypto ratings by the CRC Bitcoin and Litecoin are rated as 1s - i.e. not securities - while Ethereum, EOS and Stellar are rated between 2 and 3.75,  and well-known Ripple, Maker and Polymath are considered the highest with ratings of 4 to 4.50.

“The CRC may in time gain influence, but it has no legal or legislative power at its disposal,” adds Sanders. “The 1-5 sliding scale may imply, in the CRC’s opinion, that certain assets are more in need of securities compliance than others, but it’s important to keep in mind that these determining characteristics stem from existing federal securities laws. Presently, all we’re seeing is an attempt to decode and simplify the US Securities and Exchange Commission’s (SEC) classification guidelines for the benefit of potential investors.”

The CRC argues that its system will better inform investors about the digital assets they are investing in and with objective clarity. However, decoding and supposedly clarifying existing guidelines is in itself an arguably subjective move.

“This move to declare how crypto assets should be regulated by a group of private companies may play on existing misconceptions towards crypto investment and scepticism of the asset class,” Sanders said.

The US is regarded as the strictest securities regulatory environment in the world, which leaves little room for ambiguity. Yet, considering the painfully slow pace with which crypto regulation is coming into effect in countries such as the US and UK, it was merely a matter of time before exchanges attempted to take matters into their own hands and streamline the syntax of existing governance in order to attract further investment.

Buys continues, “The CRC’s classification system is unlikely to have much influence on institutional investors, who ought to be conducting adequate legal due diligence before acquiring crypto assets, but it may indeed serve to simplify the choices of less experienced investors who have neither the time nor in-depth resources at their disposal to make complicated investment decisions.

“Although less strict than the US when it comes to securities, UK regulation also remains ambiguous in many respects. In time, we may see a similar council established on British soil.”

With the CRC recently publishing its first round of 20 digital asset ratings, including its declaration that the likes of Bitcoin and Litecoin do not fall under the securities classification, there may be greater reassurance among investors. Although the announcement is unlikely to come as much of a surprise, there probably will be a great deal of scrutiny by exchanges to ensure that the SRC is adhering to the SEC's long-standing classification system and merely providing an abridged, simplified version as it claims.

“Ultimately the accuracy and success of the system will be determined by whether the SEC consistently concurs with the SRC's classifications. If, however, the system's accuracy comes into question by inadvertently misleading investors, the greatest risk may be to the credibility of the Council members themselves,” concludes Sanders.

While the market is currently abuzz with all of the recent developments surrounding the CRC, only time will tell whether this independent governance body will be able to make any real impact on this fledgling market sector. For now, most experts agree that the initiative should be commended and viewed as a step in the right direction because it factors in the needs of both regulators and investors.

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