Legal uncertainty continues to cloud several of the cryptocurrency ecosystem’s most influential blockchains and respective tokens after high-profile enforcement actions from the United States Securities and Exchange Commission.
The SEC has been a common feature of news headlines through 2023, with its decision to institute legal action against Binance.US and Coinbase raising concerns of far-reaching consequences for the broader cryptocurrency ecosystem.
Key arguments laid out by the SEC against the two major exchange operators in the U.S. include allegations that many cryptocurrency tokens are deemed to be securities offerings. Both Binance.US and Coinbase are facing a raft of charges for allegedly operating as unregistered securities exchanges.
The SEC’s allegations against Coinbase also list the likes of Cardano (ADA), Polygon (MATIC), and Solana (SOL) as unregistered securities on the exchange, which had a marked effect on the value of these smart contract blockchain ecosystem tokens over the past few months.
The legal considerations are broad, with the SEC arguing that many cryptocurrency ecosystems and their tokens are securities and should fall under its remit. In having not registered with the agency, the likes of ADA, SOL, and MATIC have potentially fallen foul of its regulations.
CCN reached out to legal experts to unpack how the SEC has approached Bitcoin and the cryptocurrency ecosystem and what makes BTC exempt from being classified as a security while other tokens are currently in the crosshairs of the U.S. watchdog.
Preston Byrne has been advising technology companies on commercial law as a partner at BrownRudnick , with a keen focus on Bitcoin and cryptocurrencies. He tells CCN that the question of whether a token is a security or not is a legal consideration which depends on the facts and circumstances surrounding its creation and existence through the application of legal precedent.
Byrne notes that the only entity entitled to make this type of determination in a legally binding way is a U.S. judge or jury.
“The SEC seems to have concluded, in my view correctly, that Bitcoin doesn’t satisfy these criteria, as evidenced by the total absence of enforcement action in this area and some offhand remarks by then-SEC Chair Jay Clayton in 2018 and subsequently by current SEC Chair Gary Gensler,” Byrne said.
Byrne says that despite the SEC not making any official judgments on Bitcoin itself, arguments that the preeminent cryptocurrency does not meet the criteria of the long-established Howey Test have seen the SEC lean towards this direction of classification.
“The three-prong Howey test requires a finding that a contract, transaction, or scheme needs an investment of money in a common enterprise with an expectation of profits arising from the efforts of others. There are colorable arguments for Bitcoin and indeed many other coins also that not all these elements are present.”
Byrne adds that the SEC is taking a stern position on MATIC, SOL, and ADA in the Coinbase litigation. However, the judicial fact-finder, either a judge or jury, would be “in the driver’s seat” in terms of deciding whether the U.S. exchange is operating an unregistered securities exchange or not.
David Hoppe, the managing partner of Gamma Law , gave a more detailed breakdown of how Bitcoin does not fall within the scope of the SEC’s Howey Test. He outlines the SEC’s decision to not deem Bitcoin as a security based on the Howey Test based on four factors:
Hoppe notes the SEC concluded that Bitcoin did not meet the second factor, reasoning that Bitcoin is not a common enterprise because it is not managed by a central authority but by a decentralized network controlled by its users.
“Bitcoin is not a financial investment. It is not a claim on the future profits of a company or project. Bitcoin is not sold with the expectation of profits from the efforts of others. Its value is determined by supply and demand, not by the efforts of developers or manager,” Hoppe said.
Having outlined why the SEC does not view Bitcoin as a securities offering, Hoppe then touched on the agency’s view on other tokens perceived to be securities.
The SEC has not publicly stated the specific criteria it uses to determine whether a cryptocurrency is a security, but Hoppe put forward three factors that the agency is using to make these determinations.
Hoppe notes that the level of centralized control is one aspect. Where Bitcoin is decentralized in nature, other tokens are managed by a core team.
“This is in contrast to other cryptocurrencies, such as MATIC and SOL (at least), which are arguably controlled by central development teams or large holders,” Hoppe said.
The purpose of a cryptocurrency is another consideration for the SEC. Given that Bitcoin was created as a peer-to-peer electronic cash system, BTC was not intended to be held for capital appreciation, which Byrne suggests is at odds with tokens under SEC scrutiny.
“MATIC, SOL, and ADA are all designed to be used in decentralized applications, but arguably intended to provide a capital appreciation opportunity.”
He adds that the SEC has taken the position that the marketing of a cryptocurrency can be a factor in determining whether it is a security. If a cryptocurrency is marketed as an investment, then it is more likely to be considered a security.
From a legal perspective, there is consensus that Bitcoin is not judged to be a security. However, the status of the wider cryptocurrency ecosystem, which features a plethora of tokens operating on a variety of multi-purpose blockchains, is not so clear cut.
Byrne believes that SEC has been forthcoming about the logic behind its recent enforcement actions against the likes of Coinbase, Binance.US as well as the ongoing Ripple/XRP court case.
This is despite not providing more detailed information about how the likes of ADA, SOL and MATIC have been ruled as unregistered securities.
“Its reasoning is fairly clear. The SEC waited a very long time to take the position it did regarding altcoins and exchanges – roughly 10 years – but the interpretation they have adopted is one which was within their power to adopt,” Byrne said.
Meanwhile, Hoppe says the SEC could have been more forthcoming with its reasoning behind its decisions to label a number of tokens as securities in recent lawsuits. However, there are reasons why there has been a perceived lack of regularity clarity from the SEC and the Commodity Futures Trading Commission (CFTC).
“The nature of cryptocurrency is still evolving. Cryptocurrency is a relatively new technology and business model, and its legal status is still being debated. This makes it difficult for regulators to develop clear rules for the sector,” Hoppe said.
He also notes that the global nature of the cryptocurrency market makes it difficult for regulators to coordinate efforts and develop consistent rules. From a U.S. perspective, Hoppe says that the SEC and CFTC have different views on how to regulate cryptocurrency.
“The SEC has taken a more aggressive approach to regulating cryptocurrency, while the CFTC has taken a more hands-off approach. This has led to confusion and uncertainty in the market.”
This has led to a number of challenges for the cryptocurrency sector. Instances of crypto-related companies struggling to raise capital and list their tokens on exchanges is a prime example.
While the U.S. cryptocurrency ecosystem has expressed fears that regulatory oversight in the country will drive businesses abroad and negatively effect the industry, Hoppe anticipates clearer regulatory guidelines for in the near future.
“The SEC and CFTC have been working on developing regulations for cryptocurrency, and there is a growing consensus among regulators that a regulatory framework needs to be developed for cryptocurrency in order to provide clarity for companies in the space, protect investors and reduce the risk of fraud,” Hoppe said.
Hoppe added that the SEC could be more forthcoming with the industry to address repeated concerns. This could be done by providing more detailed explanations of its reasoning in its lawsuits, publishing guidance on how to comply with securities laws for cryptocurrency companies as well as holding public hearings on the regulation of cryptocurrency.
This would allow the SEC to hear from a variety of stakeholders and to get feedback on its proposed regulations.