What Cryptos, Whiskey, and Gift Cards Have in Common

What's a security anyway?... What cryptos, whiskey, and gift cards have in common... The SEC looks at regulating cryptocurrencies... What that means... The positive spin... You should always know what you're buying...

Yesterday, new SEC Chair Gary Gensler mentioned 'whiskey barrels' during a discussion about cryptocurrencies...

His point? Well, that's an interesting story...

The Securities and Exchange Commission ("SEC") once contended – and in 1973, the Supreme Court agreed – that a business selling Scotch whiskey barrels from London, advertised as high-yield investments, was in violation of the Securities Act of 1933.

As the whiskey aged over a period of years, it became more valuable, claimed newspaper ads from a company called Lundy. Follow-up brochures to interested buyers teased it as a safe investment that could earn a 20% or 25% annual return.

And while the company said it was selling "whiskey warehouse receipts" of the barrels sitting in London – to essentially finance its operations – it also said the purchasers of the barrels in the U.S. could take personal possession of them if they ever wanted.

In other words, if you bought a whiskey barrel, you could store it in your own garage and slowly watch it appreciate in value...

What the company didn't say in the newspaper ads was that shipping whiskey barrels from London to the U.S. (plus insurance, which didn't cover 100% of losses) would make the purchase unprofitable for the buyer. Plus, dealing with the taxes and permits created a greater headache than a whiskey hangover.

So the SEC – the agency charged by Congress with regulating securities markets and protecting investors by making sure companies disclose accurate information – stepped in with a lawsuit. The company challenged it... and the case reached the Supreme Court...

You can read the court's decision for yourself here, but the salient point for today's Digest is that the court found that the whiskey warehouse receipts on imported whiskey from London were considered "securities" – a very broad term that covers almost anything – and more specifically an "investment contract."

Thus, they were subject to regulations, which they were violating by misleading investors, and the newspaper ads quickly disappeared...

It's not outrageous to suggest that cryptocurrencies are covered by the same laws, the SEC chair said yesterday...

Appearing before the U.S. Senate Banking Committee for the first time since taking over as SEC chair four months ago, Gensler said that the agency is eyeing ways to regulate the crypto industry.

In some ways, it already is – informally, at least. A few months ago, popular cryptocurrency exchange Coinbase announced plans to debut a crypto lending program that would pay customers 4% interest to use their crypto money, presumably to make loans to other customers.

Hundreds of these decentralized finance ("DeFi") projects exist today. And our resident crypto expert Eric Wade covers several of them – along with this exciting, emerging space – in his Crypto Cashflow service where subscribers can make meaningful income on their crypto holdings.

We've previously described this as being the bank you used to know. The thing is, if Coinbase started offering a DeFi product, it would be just a sliver of this new world going mainstream...

The SEC essentially shut the project down, telling Coinbase it would need to register the program as a "security," not unlike an initial public offering ("IPO") would, Coinbase CEO Brian Armstrong said, and that the company would be sued if it launched the product... Just like the whiskey barrel sellers roughly 50 years ago.

Yesterday, we learned a bit more about why...

Gensler said the SEC is looking at the sale of crypto tokens, crypto trading and lending platforms, stablecoins, crypto derivatives, and custody of assets... and he's not unfamiliar with these terms as you would think a government regulator might be.

Gensler, a former Goldman Sachs banker and chair of the Commodity Futures Trading Commission ("CFTC"), recently spent time teaching a course about cryptocurrencies and blockchain at the Massachusetts Institute of Technology.

I (Corey McLaughlin) listened to probably too much of his testimony yesterday, but it was for your benefit. Here's the "CliffsNotes" version...

Gensler said during questioning: "I'm not negative or minimalist about crypto. I just think it would be best if it's inside the investor protection regime that Congress laid out." He said he's in favor of innovation – "That's how we have the lights in this room," he pointed out – and at his core believes in a competitive market.

He said in a prepared testimony, "We just don't have enough investor protection in crypto finance, issuance, trading, or lending. Frankly, at this time, it's more like the Wild West or the old world of 'buyer beware' that existed before the securities laws were enacted. This asset class is rife with fraud, scams, and abuse in certain applications. We can do better."

He said many of the "tokens" that traded on crypto exchange Coinbase, for example, "may be securities." And he said other cryptos could be considered commodities.

He had discussions with current CFTC leaders about how to "partner up using our existing authority to protect investors," which ties in with the point above about how he thinks some cryptos are commodities.

He also quoted past court decisions to help him adopt a broad definition for what is a "security." Indeed, here's what current law says, covering dozens of specific things... and more...

The term "security" means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a "security," or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

In short, a lot of things can be a 'security' and subject to SEC scrutiny...

And Gensler said yesterday many cryptos "may be" securities...

Translation: they should be regulated. Meaning "decentralized" cryptos may be subject to "centralized" laws, although as I will explain today, at this moment in time, the SEC is simply not equipped to enforce their laws... even if cryptos do indeed fall under them.

I'm not here today to say cryptos should or shouldn't be regulated, but mainly to raise the point that this discussion is likely to become more prominent in the months and years ahead... and what that might mean for you and your current or future crypto positions.

And as we'll share today, Eric, our Crypto Capital newsletter editor, does have a strong opinion on the matter (saying cryptos aren't securities) and should not be regulated... "How about NO," he wrote us in an e-mail yesterday after we shared our notes with him...

I may be the last guy hanging onto the last thread of the last rope on this one as everyone else seems to be begging for the SEC to shackle America to more regulations... but I say NO. Not many of them are securities.

In the meantime, Crypto Capital analyst Stephen Wooldridge II offers another take... that regulation, even if you don't think it should happen, may actually attract more money to cryptos in the long run...

Some of this may feel a bit more "in the weeds" than our usual Digest fare and there is some hard-to-understand nuance to it. But at the very least, this discussion is worth having today if you own any cryptos or even if you don't...

Are cryptos more like your natural gas bill or gift cards?

Eric has so much to say on this topic that he told us he plans to cover it during part of his presentation next month at our Alliance Conference in Las Vegas... And if you haven't heard, it's back in person this year.

But he did share a preview about what he might say in regard to potential crypto regulation... In short, he's not a fan. He says the details of the fledgling industry – and what exactly cryptos are – are important to understand.

As Eric's subscribers know, he's well-versed in the details. If you still don't really "get" cryptos or understand the blockchain technology that makes them work, I suggest you read Eric's work on the subject to get caught up. Because what he's about to say will make a lot more sense.

Today, Eric uses the analogy of a "natural gas bill" to help describe his thoughts about potential crypto regulation...

I pay my natural gas bill every month. Is that a security? No. Why not? Utilities are regulated... and some have stocks, and bonds... and natural gas is even a regulated commodity, right?

The difference is, it's patently ridiculous to consider even for a second in the scenario that using gas and paying for it is a security even when every entity who extracts, processes, distributes, sells, delivers, and charges for the gas is regulated and may be a commodity or a security.

But paying for natural gas is not a security.

He continued...

Blockchain is a technology. Payments are built on top of it. Most coins and tokens have value because they give me access to the very same services that the coin or token represents but no ownership.

Just like me paying my gas bill doesn't give me ownership of a natural gas pipeline. And me paying for a magazine doesn't give me ownership of Condé Nast publications. Nor riding in an Uber gives me ownership of Uber.

Just because something has value doesn't mean it's a security, Eric says...

But for some reason, because people can exchange these tokens with each other – which most do not represent ownership or indebtedness... since they can be swapped around, the SEC hammer and CFTC hammer think they're nails.

Eric then brought up another great example that should be used in this discussion – gift cards. If "stablecoins" – pegged in value to the U.S. dollars – are to be considered securities...

Does that mean my Starbucks Gold card is now a security? Is an Apple iTunes gift card a security? How can it not be? They can be exchanged with other people for value, right? No, because it's ludicrous to think a gift card is a security.

In the end, the regulation of stablecoins – which are used by banks, as we reported earlier this year, and has also already been cleared by the U.S. Treasury Department – "would beat up the cryptocurrencies that are trying the hardest to honor the broken traditional finance system."

So again, stay tuned for more on this from Eric at our Alliance conference next month...

In the meantime, here's the case for 'this might not be as bad as it sounds'...

Stephen, who joined the Crypto Capital research team earlier this year, considers the reluctance of people to get into crypto investing and says increased regulation may end much of that hesitancy...

As Stephen told us...

In my head, seeing this [discussion from the SEC] means that crypto is reaching milestones. What I mean by that is it's inevitable and unavoidable that these discussions will take place, especially as crypto becomes more and more of a household topic. And I believe a lot of outside investors are hesitant to get their crypto feet wet until they hear what the SEC and government have to say about cryptos (even though that sort of goes against core crypto ideology).

Personally, I know that almost my entire family is reluctant to step into crypto investing until some sort of concrete thing is laid out by the U.S. government on their stance. And no amount of my talking about the technology will change that. While I don't agree with the hesitation, I can understand it to an extent.

At the very least, it's good to have it shown in a relatively positive, or at least anti-negative, light (re: pro-innovation) even though it was also called the "Wild Wild West."

The exposure these discussions can bring, Stephen says, sometimes turns out to be a positive thing for adoption, as long as they're framed well enough. To that point...

Why does this even matter to individual investors like us?

A good question indeed. It matters for a few reasons...

As our Venture Value editor Bryan Beach wrote on the topic back in an August 6, 2019 Digest, Bloomberg columnist Matt Levine has smartly written many times that "Every! Thing! Is! Securities! Fraud!"

As Bryan wrote...

Why? Because when a company does something bad, the easiest road to punishment for regulators has become to contort the facts into a convoluted "securities fraud" narrative.

This can protect investors, sure, but it can also often lead to fines against companies that ultimately hurt stock prices and innocent shareholders, Bryan said, which is the exact opposite of what the SEC is designed to do.

He offered up his own example as an ExxonMobil (XOM) shareholder, which in recent years spent tens of millions of dollars defending itself against a lawsuit alleging that the company "lied to the public about the risks of climate change." As Bryan wrote...

The whole situation seems so outrageous I reached out to a securities lawyer to make sure I wasn't missing something...

Unfortunately, I wasn't.

It may seem odd to extract a penalty from shareholders like me for the sins of Exxon's management. But the lawyer explained the daisy chain of command...

If Exxon's management purposely defrauds mankind, the malfeasance drifts up to the board of directors... and ultimately up to the shareholders (i.e., business owners) who elected that board of directors.

The buck stops with the shareholders. This seems silly. But it does, in a way, make sense. I mean, who else would pay the penalty, if not the owners?

What's more, Bryan said, the targets of regulators are often decided by politics... which is the exact thing that the most ardent crypto bulls want to avoid. That's one of its big selling points...

Ironically, Gensler was also repeatedly asked about climate change impacts of companies yesterday...

Several senators asked whether those impacts should be disclosed to the public, and the general consensus among the committee and Gensler seemed to be that "people want to know about this stuff."

The same was not said about cryptos, which makes us think: Do people really want the crypto space to be regulated like the stock or bond market? Isn't the whole concept of it to be "outside the system"? Which, as we constantly point out, is broken.

Let us know what you think by sending an e-mail to feedback@stansberryresearch.com.

Another legitimate question is "What would regulation look like anyway?" For now, nothing is going to happen overnight, or even soon...

At the moment, the SEC isn't equipped to regulate cryptos, even if they want to...

Even Gensler admitted yesterday the agency can't keep up with the innovation happening in the crypto industry today...

He said the SEC, which employs 4,200 staff, "could use a lot more people" and funding to follow the "6,000 projects" in crypto out there today, as it also works to investigate China-linked companies and evaluate a host of IPO filings.

Regulations, even well-minded ones, are only as good as the ability to enforce them. We might be a court case or two – like the whiskey barrel one – from having any clarity on these questions.

As Stephen points out...

Crypto by its very decentralized nature is a hard thing to regulate, so it'll be interesting to see what the next year or two look like.

As someone who considers the risks (and rewards) of the markets, I generally say 'Let us be'...

Government is big enough already, and it's supposed to work for "We the People," not the other way around.

If I want to blow my money on something, it's my fault... And failure can be valuable if you learn from it. Now, if someone else's fraud or malfeasance makes me lose my money, that might be another story...

But I also understand that not everyone agrees with this approach and many new or unprepared investors can fall into traps easily... Most people who have been in the markets long enough have their own stories.

This is why we always say make sure you understand what you are really doing with your money when you invest in "something." That something isn't always what it seems, and it has layers of mechanics to it that most people never consider.

We used the popular environmental, social, and governance ("ESG") funds – which purport to invest the trillions under their management in companies that align with the considerations in their title – as the most recent example.

In the September 1 Digest, we wrote...

Just some quick research will reveal that many of these funds aren't all that much different from the S&P 500 – or any other leading index for that matter.

The top five holdings in the Vanguard ESG U.S. Stock Fund (ESGV), for example, are Apple, Microsoft, Alphabet, Amazon, and Facebook. The "Big Five" make up 22.1% of the fund by market cap, just about the same as they do for the S&P 500.

Gensler actually raised the same point during his testimony yesterday. He said investors should understand what's under the hood of funds...

There are asset managers are marketing themselves as green or sustainable or carbon-free, and just as we walk into the grocery store and it might say fat-free, it's like 'What's behind that marketing?'

As another example, when you buy DeFi tokens that are paying 8% interest or way more – which Eric recommends in his Crypto Cashflow service – make sure you at least think of why you are actually being paid the interest.

In many cases, you're being paid a nice 8% return because of the risk you are taking by handing over your assets to another (unregulated) entity that is in turn lending out "your money." But you can rarely find such generous interest payments anywhere else in the world today. That's what makes a free market...

With the DeFi space's market cap at roughly $90 billion, as we write, it seems like a lot of people are just fine with that.

This thinking doesn't only have to apply to a hot topic like crypto regulation or climate change either...

For example, if you're buying a 10-year U.S. Treasury note today, what are you really doing?

When you break down the mechanics of these investment vehicles and the context of the U.S. and global economies, you're saying you're good with losing purchasing power with your dollars – a 10-year note yields 1.28% while the Fed's "official" inflation measure was 4.2% in July...meaning you're actually going to lose nearly 3% if you hold that T-bill to maturity while inflation hovers at 1% to 2%.

But at the same time, you also believe the U.S. dollar is better positioned for strength than the rest of the world's currencies or bond offerings. And you're OK with losing "less" than you might elsewhere because of that safety element...

This is all to say, whether the SEC considers cryptos to be securities... or more like gift cards or your gas bill, as Eric suggests... just make sure you know what you're buying. It's not always as advertised.

To this point, here's a link to a recent presentation Eric put together about the DeFi space, why it's becoming so popular, and how you can best navigate it. We're confident you won't find anyone else better equipped to guide you through the crypto world than him.

At the end of his presentation, Eric offers a great opportunity to subscribe to his Crypto Cashflow newsletter and get access to all of his exciting research and monthly recommendations in this space.

Consider giving it a watch... and Alliance members and existing subscribers, if you haven't already, make some time to check out this service and the latest research from Eric right here.

The Fed Won't Tighten Again Until World War III

Marc Faber, publisher of the Gloom, Boom, and Doom Report, says the U.S. dollar is headed for destruction in a 1960s-like scenario. In an exclusive interview with our editor-at-large Daniela Cambone, Faber says no asset is safe these days – and if you think the Federal Reserve is going to "tighten," think again...

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 9/14/21): Analog Devices (ADI), Asana (ASAN), Intuit (INTU), and Palo Alto Networks (PANW).

A quiet mailbag today. What are your thoughts on potential crypto regulation?... Let us know with an e-mail to feedback@stansberryresearch.com.

All the best,

Corey McLaughlin
Baltimore, Maryland
September 15, 2021