SEC vs. Crypto: Why so many lawsuits and why does it matter?

Cryptocurrency regulations worldwide form a mosaic of diverse approaches. Some nations foster a crypto-friendly environment, while others tread cautiously, prioritizing investor protection. Striking the balance between encouraging technological advancements and mitigating risks remains an ongoing challenge as global authorities grapple with defining the boundaries of this evolving financial frontier. The case of the U.S. Securities and Exchange Commission (SEC) is remarkable in this field.

It seems like they’re taking an increasingly aggressive approach against crypto-related companies. Besides, it’s not only nationwide but also international. If any company, token issuer, or crypto-related project in general offers their services to U.S. investors, in any capacity, then they should be prepared to deal with the SEC. That’s why a lot of companies just decide to exclude US users from their platforms.

Currently, it’s not like a lot of crypto-related companies, foundations, or projects aren’t abiding by legal rules, though. They are, all over the world. But still, they don’t want to deal with the US SEC. And they’ll have to, if considered that they’re handling securities in the form of digital assets. Let’s learn more about this and how it could affect all the industry.

A long story

Maybe the most famous and long case around this topic is SEC vs. Ripple. In case you don’t know it already, Ripple is one of the oldest crypto ecosystems with its own token, XRP. Their protocol has been around since 2012, and their coin is in fifth place by market capitalization with over $37.5 billion [CMC]. They operated for nearly eight years without issues before the SEC decided that they were probably breaking US securities laws by offering unregistered securities —XRP.

“Probably” is an important word there. All the legal processes have shown that US regulators aren’t quite sure about the legal status of cryptocurrencies and, therefore, the institution that should oversee them. Is XRP a security? Is it a commodity? It took three years of legal battle for both sides to reach a sort of tie in July of this year. According to the court decision (still appealable), XRP was a security in the beginning when offered to be bought by institutions.

Now, it’s not a security anymore and, therefore, is outside the regulatory reach of the SEC. The legal issues continue, though. Perhaps Ripple, as a company, will end up paying a juicy fine, but we can say for sure that this isn’t exactly the end of XRP and its protocol. Sadly, it’s also not the end of regulatory concerns around cryptocurrencies.

More and more cases

Ripple is far from being the first “crypto-case” handled by the SEC. Or in other words, it’s far from being the first lawsuit or legal warning against crypto-related projects done by the SEC. They’ve been suing people in crypto since 2013. On its website, we can discover at least 150 more cases in the industry. Some claims are, we can say, quite reasonable (against scams and frauds), but others are allegations of handling unauthorized securities.

Among those cases, we have very familiar names in the crypto industry, like ICOBox, ICO Rating, Block.One (for EOS), Telegram (for TON), Poloniex, BlockFi, Genesis, Gemini, Nexo, Kraken, Justin Sun (for TRON and BitTorrent), Bittrex, Binance, Coinbase, and Celsius —to name a few. They even sued some celebrities for promoting allegedly unregistered securities (ICOs), including Floyd Mayweather and Kim Kardashian.

Another remarkable case was the one against The DAO by Slock in 2017. They launched a quite successful Initial Coin Offering (ICO) the year prior and raised $60 million in ETH. Just afterward, they were hacked badly, and all their funds were drained. A polemical discussion started in the crypto community because Ethereum ended up making a forceful hardfork (software/chain update) to “roll back” the robbery. Not everyone agreed to break decentralization like that, and that’s how Ethereum Classic (ETC) was born.

However, the part pertaining to the SEC was that, according to them, The DAO team offered unregistered securities to US investors. That was illegal and punishable. Also, it was the first high-profile ICO to be accused of such a thing by the SEC, accompanied by specific guidelines. So, it marked a turning point in the field for all crypto users. But why could a token be a security, and what does it imply for us?

Security vs. Commodity

In the United States, the regulatory landscape treats securities and commodities distinctly. The Securities and Exchange Commission (SEC) oversees securities, while commodities fall under the purview of the Commodity Futures Trading Commission (CFTC). The second one is known to be less strict and entails lower compliance costs for the involved companies. Dealing with securities and the US SEC is a path full of obstacles.

In case you’re wondering, a commodity is a raw material or tangible product that can be bought and sold, such as gold, oil, or agricultural goods. Its value is determined by supply and demand dynamics. On the other hand, securities are financial instruments representing ownership, debt, or the right to future cash flows. The key distinction between them lies in the nature of the asset and the financial rights it bestows.

For digital assets, it’s advisable to apply the Howey Test to discover if a token could be a security. According to FindLaw, a transaction (or token) is an investment contract (security) if it meets certain features:

• “It is an investment of money.
• There is an expectation of profits from the investment.
• The investment of money is in a common enterprise.
• Any profit comes from the efforts of a promoter or third party.”

For instance, Bitcoin, Ether, GBYTE, and other well-established cryptocurrencies without Initial Coin Offerings (ICOs) could be considered, let’s say, not securities (maybe commodities, but it’s not fully clear yet). Most ICO-related tokens are considered securities, though, because they promise future returns without the investors being involved in the process of making them.

Implications for Crypto Players

A massive exodus of crypto companies and projects from the United States has been the main consequence. Most ICOs nowadays, for example, have established a full ban against US citizens on their official terms. Several crypto exchanges have paid millions in fines and then have retired from the US market, including Poloniex, Binance, and Bittrex. In addition, other exchanges are known for delisting “problematic” tokens if the SEC considers them securities.

XRP suffered that fate in several exchanges worldwide, not only in the US, and that could be the case now for more digital assets. In their recent lawsuits against crypto exchanges, the SEC mentioned that they consider the native Binance coins (BNB and BUSD), Solana (SOL), Cardano (ADA), Polygon (MATIC), Filecoin (FIL), Cosmos (ATOM), Sandbox (SAND), Decentraland (MANA), Algorand (ALGO), Axie Infinity (AXS), and Coti (COTI) as securities as well.

The mere affirmation has already brought consequences for the assets. Binance is phasing out support for BUSD, while Solana, Cardano, and Polygon have been delisted from several crypto exchanges. This could affect their prices too, and, therefore, their investors worldwide might be affected.

Beyond these considerations, the bigger picture is showing that the tight crypto rules the SEC wants to apply are hitting a lot of crypto investors not only inside the US but also abroad. Other jurisdictions worldwide might want to imitate those rules, leading to damage in innovation and lower crypto adoption by the most needed sectors (e.g., unbanked people).

For their part, crypto companies would need to follow complex rules and audits and invest prohibitive figures in compliance costs if they want to access the US market. Binance is, maybe, the best example of it. Changpeng Zhao, its CEO, pleaded guilty to violating US anti-money laundering restrictions in November 2023. The decision was part of an astounding $4 billion agreement between the exchange and the US government.

The bright side

To be fair, we must remember that the US SEC isn’t trying to be a villain. Their mission is protecting US investors that deal with risky assets, so, their approach could also bring some advantages. As it intensifies its enforcement actions, fraud prevention takes center stage, shielding investors from the pitfalls witnessed in recent platform collapses like FTX and Terra (LUNA).

The SEC's emphasis on disclosure standards ensures transparency, enabling better-informed investment decisions. Market integrity is bolstered through curbing price manipulation and vigilant surveillance, fostering fair practices. Legitimacy and broader adoption could follow suit, as the SEC's regulatory umbrella appeals to traditional investors and institutions. Additionally, the SEC's involvement addresses global concerns, promoting cross-border collaboration in tackling crypto-related crimes.

Moreover, it seems like only a few tokens would fall into the SEC’s jurisdiction for now. Crypto investors must consider that the Howey Test and, therefore, all regulations for securities, could apply to their projects and tokens. Then, they should give their best to avoid failing that test. It’s always better for crypto coins to be considered commodities (or just not securities) and fall into more flexible regulations.

Featured Vector Image by storyset / Freepik