Research Shows How SEC Actions Move Markets

As Gary Gensler takes the helm at the U.S. Securities and Exchange Commission, the cryptocurrency industry is awash with questions. What will be the SEC’s new enforcement priorities? Which crypto project will be the next to receive a complaint? Will SEC enforcement actions catalyze the onset of the next "crypto winter"?

While no one has all the answers, one repeated focal point is what impact SEC actions have on token prices. To analyze the impact, we carried out an analysis of how SEC announcements correlate with short-term price movements.

The takeaway: Depending on the nature of the announcement, the SEC does move markets in directionally intuitive ways, though given the fast-moving nature of the industry and limited data points, it's impossible to know if these trends will continue.

Lindsay Lin is partner and counsel at Dragonfly Capital. Nothing in this article is or should be construed as legal, investment or financial advice. Dragonfly Capital does not hold a position in any of the cryptocurrencies discussed.

One tangential data point is BitConnect: Starting on Jan. 4, 2018, bitconnect coin (BCC) dropped from about $450 per coin to $7 per coin over the course of a month after the company received cease-and-desist orders from Texas and North Carolina securities regulators. Those orders ultimately compelled BitConnect to shut down operations entirely. While those state securities regulators have a narrower scope of jurisdiction than the SEC does, their actions did lead to the demise of BCC.

Obviously, securities regulators certainly can have a large impact on price if a project chooses to shut down. But even if the project decides to continue operations, price can be affected. Why?

First, litigation is a costly and time-consuming process. Most projects already aren’t able to deliver code, products or partnerships fast enough, and litigation is a black hole for the company’s time with discovery, depositions, negotiations, court appearances and everything else. Additionally, the initial stages of securities litigation could cost hundreds of thousands to millions of dollars, leaving much less in the treasury for actual development.

Second, a securities lawsuit tarnishes a project’s reputation, often rightfully so. Potential business partners, investors and employees are hesitant to work with a company that is allegedly operating illegally and may need to imminently shut down. Community members may decide they do not want to bear the regulatory risk of the project and take their talents elsewhere.

Third, most cryptocurrency exchanges are not securities broker-dealers, and so exchanges will likely delist the token to minimize securities risk. That will hurt liquidity and make it more difficult for people to access and use the token.

Fourth, the SEC or another securities regulator may demand that a project register sales of its token as a securities offering. If the project does so, transactions of the token may be allowed to take place only on securities exchanges and applicant tracking systems (ATS), and they would be subject to securities trading restrictions. If the token is a payment token or used for decentralized activity, the friction of registration will almost completely kill its utility.

In short, there would be good reason for the value of a token to drop upon news that the SEC has sued a project.

That said, if a project reaches a favorable settlement with the SEC, it’s a different story. If the settlement requires a monetary fine but otherwise allows the token to trade like normal today, it may cause temporary brand harm but at least the project can continue development. Arguably, the project can even continue its course with greater regulatory certainty.

Analysis

I tracked SEC announcements against certain projects and these project tokens’ subsequent price movements in a one-day, seven-day, 30-day and 90-day timespan. Because a rising market lifts (or pumps) all boats (and vice versa), I examined token prices based on bitcoin's

This analysis is focused on longitudinal market price impact, so I excluded tokens that were required to repay investors’ contributions, offer rescission to token purchasers and/or register with the SEC as a security, such as bitclave (CAT), dropoil (DROP), gladius (GLA), Paragon’s PRG and Airfox’s AIR. Those tokens aren't publicly traded, and so there’s no market price.

I broke down the remaining tokens into two categories: news of a “favorable” resolution (defined as a settlement or final judgment that does not require rescission or registration of the token) and news of a SEC complaint. I include Kik’s KIN in both categories because Kik progressed in litigation prior to a final judgment.

• EOS (“In the Matter of Block.one”)
• SALT (“In the Matter of Salt Blockchain Inc. f/k/a Salt Lending Holdings Inc.”)
• KIN (“SEC Obtains Final Judgment Against Kik Interactive For Unregistered Offering”)

SEC Complaints:

• LBC (“Securities and Exchange Commission v. LBRY, Inc.”)
• XRP (“Securities and Exchange Commission v. Ripple Labs et al”)
• KIN (“Securities and Exchange Commission v. Kik Interactive Inc.”)

Results

I tracked the closing price of each token on T-1, T, T+1, T+7, T+30, and T+90, with T being the date of the announcement. Afterward, I calculated the percentage change of the price at each date from the close at T-1 to track the delta over time. To illustrate, a 0.00% change at T+7 would mean that the price did not change from T-1.

Projects that achieve a favorable resolution end up maintaining or exceeding the price of their tokens in BTC terms at T+90. They may even see an increase in price on the day of announcement, since a favorable settlement may be perceived as a “victory” and clears up regulatory uncertainty surrounding the token.

On the other hand, projects that are actively undergoing SEC litigation tend to suffer the day of announcement and end up suffering a drop in T+90 price relative to BTC, though in U.S. dollar terms they could be up due to overall market forces. This weakening against BTC suggests these projects may be losing market share and the strength of their ecosystems.

A caveat: There aren’t enough cases to form a rigorous finding. The analysis also doesn’t isolate other shocks that could’ve happened, such as new releases or key executives leaving. It could also be the SEC was more eager to take a favorable resolution during different periods of market activities. That said, a pattern does seem to emerge.

The goal of this article is to provide a surface-level analysis. For those who want to perform a more rigorous analysis, I’d recommend analyzing how a basket of 10 or 20 of the top tokens may move against BTC during the same time period as a control, and factoring in each token’s average volatility via tests of statistical significance.

Takeaway

Based on the data, it seems that projects that reach favorable resolutions with the SEC experience positive price movements against BTC, whereas projects undergoing litigation will experience negative price movements against BTC. However, note that it’s difficult to quantify what should be the true price impact of any such announcement. Thus, it’s difficult to say if a piece of news is “efficiently” priced in.

Market composition also matters. Most cryptocurrencies trade globally and different regulators have different definitions of what constitutes a security. Global traders may not care about the SEC’s designations if they reside in countries where securities laws are more lax regarding crypto. For example, the Japan Financial Services Agency has declared that XRP does not meet the definition of a security under Japanese law, in contrast to the SEC’s stance under U.S. law. Therefore, if the primary trading base of the token are non-U.S. users, prices may justifiably not move as much upon SEC news compared to tokens primarily traded by U.S. users.

As institutional holders, professional market makers, professional traders and more conservative investors (e.g., pensions and endowments) enter the industry and become a more dominant presence relative to retail, it’s likely SEC complaints may have more of an impact. Few parties subject to reporting and/or licensing requirements would want to assume the risk that they may be unlawfully performing unlicensed, unregistered securities activities.

In conclusion, SEC announcements do seem to matter to markets and in directionally rational ways. As the SEC enters a new era of enforcement with Gary Gensler leading the charge, it’ll be interesting to see whether these trends persist.