The impact of regulatory actions on the market is reasonable, but it is difficult to say when a piece of news has been “effectively” priced.
Written by: Lindsay X. Lin, partner and head of legal affairs at Dragonfly Capital, a blockchain investment fund, formerly the legal counsel of the Interstellar & Stellar Development Foundation. Compiled by: Perry Wang
On January 4, 2018, the Texas Securities Commission issued an injunction to suspend BitConnect’s loan and pledge projects, terminate its upcoming initial coin offering (ICO), and stop BitConnect tokens (“BCC”). Regulatory authorities Claims that BitConnect’s products are unlicensed and unregistered securities products.
When I read a tweet about this news, I opened CoinMarketCap. I think BCC should experience a slump in the market. After all, this means that BitConnect is notorious for being classified as a Ponzi scheme. Although in theory, the Texas Securities Commission’s powers are limited to the state, this move will obviously open the floodgates to other regulatory agencies’ review and enforcement.
Although several hours have passed since the news, the price of BCC has fallen by less than 4%.
The price of BCC remained relatively stable for three consecutive days and then began to decline slowly. On January 9, the North Carolina Securities Commission also issued an injunction. At midnight that day, the price of BCC had fallen by 20% compared to January 3, and the gradual downward trend continued. Finally, on January 16, its price plummeted by more than 80%, from $200 to $30. BitConnect subsequently announced that in light of these prohibitions, it would close its business.
If there was an easy way to short the BCC immediately after the injunction was issued by Texas, traders who listened to all directions could have reaped a lot of gains. In a month’s time, BCC fell from about $450 to $7.
What can traders learn from this story? At that time, the crypto market was too simple, and derivatives were still immature, so there was the incredible incident of BitConnect. Nowadays, traders usually have more relevant knowledge and information, and the range of products offered by derivatives exchanges is much wider. According to the news of the law enforcement of securities regulatory agencies, can we still obtain good trading opportunities of positive value?
Although BitConnect terminated operations in accordance with the order of state securities regulators, the U.S. Securities and Exchange Commission (SEC) is undoubtedly the most active and influential securities regulator in the United States, and has a significant impact on crypto projects involved in the U.S. market. This article analyzes whether it is profitable to short crypto assets based on SEC enforcement information.
Answer: Maybe you can make money sometimes. ¹
Fundamentals
Let’s take a look first, if the SEC sues a project for unregistered and unexempted securities issuance, why would the underlying assets of the project experience a price drop?
First, litigation is a costly and time-consuming process. Most projects are overwhelmed by tasks such as delivering code, products, or partnerships quickly enough, and the discovery of evidence, written examination of witnesses, negotiations, court appearances, and all other matters involved in litigation are a black hole of time for the company. In addition, the initial stage of securities litigation may cost hundreds of thousands to millions of dollars, resulting in almost no funds for actual development in the project’s fund library.
Second, SEC lawsuits have caused damage to the reputation of related projects, which is usually at stake. Potential business partners, investors, and employees are reluctant to work with a company that is accused of being very operating and may be closing down soon. Community members may feel that they do not want to accept regulatory risks and turn to other communities.
Third, since most cryptocurrency exchanges are not securities broker-dealers, exchanges are likely to delist relevant tokens to minimize the risk of trading securities. This will damage the liquidity of the token, making it more difficult for people to obtain and use the token.
Fourth, the SEC may require the project to register its token sale as a securities issue. If this is done, only token trading on stock exchanges and alternative trading systems (ATS) are allowed, and securities trading restrictions must be complied with. If the relevant tokens are payment tokens or used for decentralized activities, the friction caused by registration will almost completely kill its utility.
In short, when news of the SEC’s prosecution of a project comes out, the value of its tokens will fall.
It can also be said that if a project reaches a favorable settlement with the SEC, the result will be very different: if the settlement requires a fine, but allows the tokens to be traded as normal as today, it may cause temporary brand damage, but at least The project can continue to develop. It can even be said that the project can promote its development with greater regulatory certainty.
analysis
I personally tracked the SEC announcements for certain projects, as well as the subsequent price movements of the tokens of these projects in the time frame of 1, 7, 30, and 90 days. Since the rise in the market drives all tokens (and vice versa), I also studied the prices of tokens in USD and BTC.
Given that this analysis focuses on vertical market price effects, I exclude tokens that are required to repay investors’ capital contributions, provide refunds to token purchasers, and/or register as securities with the SEC, such as Bitclave CAT, Dropoil DROP, Gladius GLA, Paragon’s PRG and Airfox’s AIR. These tokens are currently not publicly traded, so there is no market price.
I divided the remaining tokens into two categories: news of a “good” solution (for example, no refunds to purchasers, or the need to register tokens as securities, settlements or final judgments), and SEC News of the lawsuit. I included Kik’s KIN in these two categories because Kik had already made progress in the litigation before making the final judgment.
Favorable solution:
- EOS (“SEC and Block.one reached a settlement”)
- SALT (“Salt Blockchain Inc. f/k/a Salt Lending Holdings, Inc.” survived SEC review to some extent)
- KIN (SEC made a final judgment on unregistered Kik Interactive”)
The SEC filed a lawsuit:
- LBC (“SEC sued LBRY, Inc.”)
- XRP (“SEC sued Ripple Labs et al)
- KIN (SEC sued Kik Interactive Inc)
Currency price trend
I tracked the prices of T-1, T, T + 1, T + 7, T + 30, and T + 90 for each token at the end of the day, where T is the announcement date. After that, I calculated the percentage change between the price at the end of the T-1 day and the price of each other date to track the trend over time. For example, a 0.00% change at T + 7 means that the token price has changed compared to T-1.
Favorable solution
SEC files a lawsuit²
Find
For projects with favorable solutions, the price of their tokens denominated in BTC at T + 90 will eventually maintain or exceed the previous price. They may even see price increases on the day the favorable solution is announced, because the favorable solution may be seen as a “victory” and remove the regulatory uncertainty surrounding tokens. ³
On the other hand, projects that are facing SEC lawsuits often experience a sharp drop in currency prices on the day of announcement. The price of their tokens denominated in BTC at T + 90 will fall, although due to the overall market forces, their prices in US dollars are still It may rise. The downward trend in the relative price of BTC indicates that these projects may be losing market share, and their ecosystem strength is also damaged.
It should be noted that there have not been enough cases to form a strict conclusion so far. The analysis has not isolated other shocks that may occur, such as the release of a new version or the departure of key executives. At different stages of market conditions, the SEC’s desire for solutions to favorable projects varies. In other words, it seems that no fixed characteristics have actually appeared.
The purpose of this article is to provide a phenomenon-level analysis. For those who want to perform a more rigorous analysis, I suggest analyzing the trend of the BTC price of a basket of 10 or 20 top tokens during the SEC supervision phase, and considering the average volatility of each token by examining the significant difference . ⁴
in conclusion
Perhaps due to the increasing popularity of global crypto derivatives exchanges in the past two years and the rise of institutional traders and professional market makers in the crypto field, the market’s efficiency in integrating regulatory news has been greatly improved compared to the BitConnect era. ⁵In 2019 and after, it seems that after news of regulatory actions was exposed, the currency price of large-scale projects developed in a reasonable direction. Note, however, that it is difficult to quantify the actual price impact of any such announcement, so it is difficult to say when a piece of news has been “effectively” priced.
Market composition is also very important. Most cryptocurrencies are traded globally, and different regulatory agencies have different definitions of what constitutes securities. ⁶If global traders live in countries and regions where securities laws are relatively loose on cryptocurrencies, they may not care much about the SEC’s rulings. Therefore, if the main trading group of a certain token is non-US users, compared with the tokens mainly traded by US users, the price of the token will not react so obviously to the SEC news.
As institutional holders, professional market makers, professional traders, and more conservative investors (such as pension funds and endowment funds) enter the crypto industry, they have seized greater market dominance compared to retail investors. The SEC’s litigation may become more influential. Few parties that need to comply with reporting and/or licensing requirements are willing to take the risk of potentially engaging in unlicensed, unregistered securities activities illegally.
All in all, the SEC’s announcement does seem to be of great significance to the market, and the direction is more rational. As the SEC enters a new stage of enforcement and Gary Gensler becomes the new head of the SEC, it is interesting to observe whether these trends will continue.
Special thanks to Celia Wan and Haseeb Qureshi for their feedback on this article.
1 Nothing in this article should or should be construed as legal, investment or financial advice. Dragonfly Capital does not hold any positions in any of the cryptocurrencies discussed.
2 Since the SEC has only recently taken action against LBC and 90 days have not passed, there is no data point of T + 90.
3 There must be a lot of people congratulating Block.one because it is reported that its $4 billion ICO has settled with the SEC in a $24 million fine.
4 If you are interested in writing academic articles that analyze these effects, please contact me and I will help you.
5 To be fair, state securities regulators can say that they do not have the direct jurisdiction of the SEC.
6 For example, the Financial Conduct Authority (FCA) in the United Kingdom has a narrower definition of what constitutes securities than the SEC, and transactions that the SEC considers to be securities issuances may not constitute securities issuance within the jurisdiction of the FCA. Another example is the announcement by the Japan Financial Services Agency that XRP does not meet the definition of securities under Japanese law, which is contrary to the position declared by the SEC under US law.
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