Cryptocurrency traders have been notified that the US Securities and Exchange Commission considers a range of widely traded digital assets to be securities, which will impose regulatory requirements that many boosters say will be crippling. But figuring out what makes a coin a safe and what doesn’t is a complicated question. For example, a federal judge ruled in July that one particular token, XRP, was a security when sold directly to institutional investors, but not when sold to the public on exchanges.
1. What does the SEC do?
Chair Gary Gensler, who has long argued that many digital assets have the hallmarks of securities, continues to take a harder line. On June 6, the agency filed a lawsuit against Coinbase Global Inc., the largest crypto trading platform in the US, accusing it of illegally listing several tokens. In another case announced yesterday, the SEC alleged that Binance Holdings Ltd. also listed unregistered securities. In both of those lawsuits, the SEC designated 19 digital tokens traded on the platforms as securities — a move that investors considered so damaging that it led to a sharp selloff. In the week after the first lawsuit was filed, the combined market value of the coins fell by nearly $23 billion.
2. What does it mean for something to be a security?
In its simplest form, it’s a question of whether or not something is safe under US law, basically like shares of stock issued by a company trying to raise money. To make that determination, the SEC applies a legal test that stems from a 1946 US Supreme Court decision. Under that framework, known as the Howie test, an asset can be considered a security when it involves investors making a transaction with the intention of profiting from the efforts of the firm’s management — and thus under SEC limits.
3. Why is calling a token a security concern?
Among other things, it makes running a crypto exchange more expensive and complicated. Under US law, the label carries strict investor-protection requirements for platforms and issuers. That means exchanges face continued scrutiny by regulators, which could lead to fines, penalties and, in the worst case, prosecutions. Supporters of additional regulations believe that securities designations will result in greater information and transparency for investors as SEC disclosure requirements apply.
4. Who opposes that approach?
Crypto enthusiasts say their ventures are so decentralized that they undermine old rules. Crypto trading platforms argue that the assets they list should be considered commodities, not securities. In the US, laws governing the trading of commodities and their derivatives are increasingly focused on ensuring that companies, producers and farmers can effectively hedge against the risks of price declines in commodities.
5. What are the courts saying?
There was a decision in July that many in the crypto industry took as a win. In 2020, the SEC sued Ripple Labs Inc. for allegedly raising money by selling the XRP digital token without registering it as a security. The SEC claimed that the company was financing its growth by issuing XRP to investors, betting that its value would rise. On July 13, US District Judge Analisa Torres in New York ruled that Ripple’s sale to sophisticated investors met the test for an investment contract because those buyers would have understood that “Ripple was making a speculative valuation of XRP with potential profit.” But the judge said this does not apply to publicly bought crypto on exchanges. Many industry leaders and experts saw the latter part of the ruling as a potential blow to the SEC’s jurisdiction. Still, the decision is only the opinion of a district court and does not apply to other parts of the country.
6. What does the crypto community want?
There have been efforts in the US Congress to give derivatives watchdog the Commodity Futures Trading Commission more authority to directly regulate cryptoassets. Currently it primarily oversees crypto futures and has the ability to take enforcement action if there is fraud or manipulation in the underlying market. The CFTC’s regulatory regime is considered lighter than the SEC’s, so it’s no surprise that the crypto crowd wants the CFTC to oversee it. In 2022, crypto executives and titans of traditional markets like Citadel Securities joined an industry movement behind a bill that would give the CFTC more turf. That effort stalled after the collapse of cryptocurrency exchange FTX, which was one of the most powerful companies pushing for change. In June of this year, two House Republicans released a new proposal that would give the CFTC the authority to oversee certain tokens and eventually regulate coins that start out as securities as commodities.
7. What is the CFTC’s vision?
Chairman Rostin Behnam pushed back against the notion that the agency is a “light-touch regulator.” At a June 6 House Agriculture Committee hearing, he said the CFTC has brought more than 85 cases, resulting in more than $4 billion in fines and restitution. CFTC rules are “much broader, more prescriptive, and more specific to protect consumers and protect markets.” The CFTC was one of the first market regulators to bring enforcement action against Binance.
8. Which coins are considered safe?
Beyond Bitcoin – the largest cryptocurrency – there are many ambiguities. US regulators, including the SEC, agree that Bitcoin is not a security. It was started by an unknown person or persons going by the pseudonym Satoshi Nakamoto, and did not exist as a way to raise money for a specific project. Ether, the second largest token, was considered not a security during the administration of President Donald Trump. While it may have started as a security — the Ethereum Foundation used it to raise money — it has grown into something decentralized enough that it probably won’t be one anymore, a senior SEC official has indicated. But Gensler said that after Ethereum moves to a system where “staked” coins play a role in recording transactions, the fact that staked coins can earn equal interest may prompt regulators to consider it a security. However, the CFTC considers Ether a commodity.
9. Is this a problem elsewhere?
Yes. Globally, various regulators have taken several positions on whether cryptocurrencies should be considered securities. The UK’s Financial Conduct Agency regulates digital assets, which are considered investments with rights to repayment or a share in profits, while “payment tokens” such as bitcoin or “utility tokens” that provide access to a service are unregulated. Singapore regulates both types, but under different laws. It considers coins that are digital representations of other assets, such as unlisted shares, as securities. In May, the European Council approved a legal framework to introduce common cryptocurrency laws across all 27 member states. In June, Hong Kong launched a new licensing system to regulate crypto exchanges that trade in tokens such as Bitcoin and Ether. Despite pushback from reluctant banks, the UK is crafting its own crypto regulations and marketing itself as a welcoming destination for digital-asset firms.
• A US Treasury Department report on issues related to crypto regulation.
• The Tainted 19: SEC says digital tokens are securities.
• More Quicktakes on Bitcoin ‘Halving’ and Crypto ‘On-Ramps’
• SEC Chair Gensler spoke to Bloomberg Businessweek about crypto.
• Executive order on crypto regulation signed by Biden.
• UK FCA’s breakdown of regulated vs unregulated tokens.
–With help from Ben Bain.
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