In the last months, the U.S. Securities and Exchange Commission has labeled dozens of cryptocurrencies as securities, but provided little explanation as to how they arrived at that conclusion. There is no question that these and many other cryptos are bought as investments, but the SEC claims that they also fall within the legal definition of a security. This would require the issuers to register the tokens with the SEC or meet the requirements for an exemption.
The suppression has been costly to the digital asset industry. The 19 cryptocurrencies named in the SEC’s cases against Binance and Coinbase have lost a combined $5 billion in value since the complaints were filed in early June. With the addition of tokens named in its lawsuits against the two prominent crypto exchanges, the number of assets the agency considers to be securities is at least 65. These include major cryptocurrencies such as bnb, busd, cardano, solana and polygon and collectively account for more than $100 billion in market value – a significant portion of the $1.2 trillion industry.
“The tokens mentioned in the complaints don’t have much in common other than being blockchain-based crypto assets,” argues Mike Selig, counsel at New York-based law firm Willkie Farr & Gallagher. They include assets from major blockchain networks, metaverse and gaming tokens, a stablecoin, and various utility tokens that provide specific functionalities, he points out. “By naming such a wide range of differentiated tokens, the SEC is effectively signaling to the market that it considers most tokens to be securities,” added Selig.
Speaking at the Piper Sandler Global Exchange and FinTech Conference in New York earlier this month, SEC Chairman Gary Gensler reiterated his view that the “vast majority” of crypto tokens pass the Howey test – a set of standards to determine whether a transaction qualifies as an investment contract and is therefore considered a security – and must be registered with the SEC. According to the Howey test, an “investment contract” exists when money is invested in a joint venture with a reasonable expectation of profit from the efforts of others.
He had also countered criticism that his agency had not given “fair notice,” saying that many crypto companies “may have made a calculated economic decision to take the risk of enforcement as the cost of doing business.”
However, the agency and Gensler himself were inconsistent at best in their arguments in those cases. “I think the Commission explained very well why a purchase of XRP was a securities transaction,” referring to its case against crypto payment company Ripple, says a former SEC official who had asked for anonymity, “but that’s not really happening here. Reading the complaints, I didn’t see the same level of analysis, you would have thought they were describing the facts and circumstances that made them think these were certainties.”
While the SEC claims that drastic measures to rein in the cryptocurrency business are simply a way to protect investors from the fraud and manipulation that are rampant in the digital asset market, a popular opinion among industry insiders is that the regulator is simply cracking down on the industry after multiple high-profile bankruptcies resulted in billions of dollars in losses.
Richard Mico, the US CEO and chief legal officer of payment and compliance infrastructure provider Banxa, agrees that there seems to be little logic in the SEC’s token classification. “An argument could be made that this mass labeling of these coins as securities is actually a well-intentioned but misguided attempt to slow the adoption of digital assets in the United States in general. But even if that were true, adoption is still happening — it’s only happening outside the United States, as we’re clearly seeing happening in places like Hong Kong, Dubai and the EU,” Mico said in an emailed response to Forbes.
Meanwhile, domestic exchanges have essentially been forced to remove those tokens. Just a few months after completing a $155 million acquisition of rival Apex Crypto, New York-based digital asset trading and custody platform Bakkt has delisted three of the largest cryptocurrencies by market capitalization listed by the SEC. are called: solana, polygon and cardano.
“Those are never easy actions to take. I mean, you are withdrawing revenue from the platform, both for yourself and for your partners,” says Bakkt General Counsel Marc D’Annunzio. “But the way I think about this is that it’s a decision we’re making in the short term given how unsettled the environment is, and as the sort of guardrails get a little bit clearer, we plan to offer coins again as soon as we reach a point where we are satisfied that we can do so in a compliant manner.
The share of delistings on US-based platforms has risen to 22% by 2023, up from 8% the previous year, driven primarily by Bittrex and Binance.US, according to crypto data provider Kaiko. Both exchanges have been sued by the SEC for violating securities laws.
While the SEC does not have the resources to name every crypto asset except bitcoin as a security in these complaints, the representative sample of popularly traded tokens it has chosen sets a precedent that can be extended to a wider variety of tokens. Selig said.
“Still, the Howey test determines what is and what is not an investment contract. The individual facts and circumstances associated with each token and its initial offering and sale must be evaluated under this test,” he says. “The SEC probably doesn’t want to spend the resources to litigate whether every single token is a security, but this is basically what the Howey test requires. We will likely continue to see new tokens offered and sold as non-securities under new legal theories until the SEC or Congress steps in to create a workable regulatory framework for crypto asset securities.
Meanwhile, Berenberg, a Hamburg-based bank, believes stablecoins and decentralized finance (DeFi) are likely to be the SEC’s next targets. After reviewing Gensler’s public statements and some of the lawsuits filed by the commission and other regulators in recent months, “we have concluded that the SEC’s next targets are likely to be (1) stablecoins, including both usdc and tether, which are likely to be will label as unregistered securities, and (2) DeFi protocols,” wrote Mark Palmer, Berenberg’s equity research analyst, in comment shared with Forbes.
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