In light of the upcoming SEC regulation of cryptocurrencies, NEO came up on our radar as a problem. We swept through our portfolio to see if there was anything at risk of falling under the SEC definition of security. We wanted to reduce our portfolio risk by removing coins we believe will be a problem and limiting our exposure to others. This process included removing NEO, one of our favorites, due to the fact that it held a meaningful allocation in our portfolio and is likely to be deemed a security by the SEC when they do announce regulations. It was a difficult decision to make, but this isn’t about making friends, this is about wealth preservation. So, what’s the problem with NEO?
We know that regulators have been attracted to crypto because of the dramatic amount of money flowing into the space in recent years. Once the market got into hundreds of billions of dollars, it was just a matter of time before the regulators would step in. We’ve noticed through comments made by SEC officials recently that they have been homing in on ICO’s as the biggest problem area. We don’t think NEO has any ICO issues. But we shouldn’t expect the SEC to limit their attention only to that aspect of cryptoassets. With the SEC’s focus on ICO’s, it is almost universally overlooked that the term security doesn’t just apply to the ICO. It matters what the coin does.
Coins or tokens can do a lot of different things. They can be used as a form of currency, store of value, give membership access to a particular platform, provide discounts, etc. There are a few things that coins could do that are also characteristic of securities. For example, bestow ownership rights. It’s one of the exciting features of blockchain technology that it could rewrite the mechanisms and processes of ownership. But cryptos haven’t really gone there yet. They will soon enough.
But things like profit sharing and payouts are often a feature of securities that some cryptoassets have adopted, like Iconomi (ICN) and TenX (PAY). When coupled with the idea that cryptocurrencies are investments, it starts to become problematic for regulators.
So where does NEO come in?
There are two features of NEO that are typically characteristic of securities – governance and dividends. For each share of NEO a holder has one vote in the governance of NEO. (Unlike most cryptos, NEO does refer to single units as a share, remember that NEO was originally called Antshares.) Governance by itself probably isn’t enough to make a cryptocurrency a security. It would be hard to call something like Decred (DCR) a security just based on the governance model. And the SEC recognizes that the world is trending toward decentralized forms of governance – decentralization is a key feature the SEC is looking at to determine that something is not a security. But NEO has GAS, the utility token of the NEO network. And GAS has value. It, too, is traded on exchanges. And this is a problem.
It’s a problem because you receive distributions of GAS for each share of NEO you hold. GAS distribution is one of the features of NEO that make it attractive as an investment. Oops. Notice the word I just used there – investment. Because for the vast majority of us, that’s what NEO is. When was the last time you used your NEO vote? You’re most likely not holding NEO in order to participate in this grand crypto experiment that NEO is building. You bought your NEO because it was a good investment.
And the SEC is aware that, by itself, even this fact doesn’t necessarily make NEO a security. But distribution of value might. A pre-determined distribution of value in the form of GAS tokens looks an awful lot like a dividend. Imagine you owned stock in ABC Decentralized Corporation and that gave you the right to receive a dividend paid in XYZ Utilities. Doesn’t that make ABC stock more valuable to you as an investor? You know what else distributes value through a predetermined schedule? Bonds. And they’re securities, too. So, this GAS distribution looks like a characteristic of a security. And it looks closely tied to the value of the investment.
We can’t expect that the SEC will miss the opportunity here. They want to get it right the first time, and they must recognize the innovation and creativity of blockchain developers, and the incredible flexibility of blockchain technology. And since they intend not to “do any violence to the traditional definition of a security that has worked for a long time,” as SEC Chairman Jay Clayton says, we must expect that the SEC will address this side of the coin (see what I did there?).
We hope we’re wrong about this or that the SEC comes up with a specific exemption that addresses their concerns but doesn’t restrict too harshly coins like NEO that are actively developing apps and ecosystems with great potential. It would be great if the SEC were generous but when was the last time you remember regulators to be generous? In any case, this needs to be done. Until we have clear guidance from the SEC, there will be increasing uncertainty in the market. A portfolio is a bad place to keep your uncertainties. We hope we can bring NEO back in the fold when this is over.