4min read
Published on: Jul 5, 2024
#Crypto 360
#Regulations
The SEC is a federal agency that regulates US securities markets. It was created in 1929 to protect investors after the Wall Street Crash. The authority has yet to consider a specific cryptocurrency regulation framework a must.
For some time now, cryptocurrency regulation has been at odds with the Securities and Exchange Commission (SEC) in the US. Some of the biggest industry players have had to cross paths with the financial regulator.
The country's federal securities regulator considers most cryptocurrencies to be securities and aims to subject these virtual assets to the existing securities rules and regulations. This conflict has led to several legal battles between the SEC and the crypto industry, and there is still no clarity on most cryptocurrencies’ status.
So, how does the US SEC regulate cryptocurrency? This article discusses the details of the US SEC’s cryptocurrency regulation framework.
Investing in cryptocurrency, just like investing in stocks or traditional financial products, comes with risks. Cryptocurrencies’ volatility makes them even more unpredictable and, hence, riskier. The SEC is a US federal agency that regulates the securities markets, created in 1929 to protect investors after the Wall Street Crash. No separate body regulates cryptocurrency in the US as a separate asset class.
The SEC oversees regulating cryptocurrencies that the regulatory body determines as securities. Such virtual assets must be registered with the SEC and comply with the securities regulations. Due to the SEC’s oversight of the crypto industry, crypto exchanges, brokers, banks, and retail traders investing in crypto assets are supposed to comply with securities laws in the US. Several crypto token issuers have disputed the SEC’s designation of those tokens as securities, and the matter has been brought to court several times.
As per the Howey vs. SEC (1946) case, an asset is a security if it can be considered an "investment contract” under the Securities Act of 1933 and the Securities Exchange Act of 1934. The Supreme Court has promulgated the Howey Test to designate an investment as security.
They presented four deciding criteria:
The SEC considers nearly all cryptocurrencies except Bitcoin (BTC) as securities because the regulatory body believes these digital assets meet all the four criteria mentioned above. Bitcoin is regarded as an exception because no other cryptocurrency is as decentralised. Whenever the SEC has labelled a cryptocurrency as a security, the issuer has fought against the designation, and the matter has gone to the courts. Below, we will discuss some of the most infamous court cases.
In December 2020, the SEC charged Ripple (XRP) and two senior executives, Brad Garlinghouse and Christian Larsen, for raising over $1.3 billion since 2013 through an unregistered offering of the XRP cryptocurrency. Ripple argued that XRP can’t be treated as a security.
In July 2023, the court ruled that XRP is a security when sold to institutional investors but not to retail investors on an exchange. The SEC has since been chasing Ripple with hefty fines yet unproven claims.
In December 2022, the SEC charged Samuel Bankman-Fried (aka SBF), the co-founder and ex-CEO of the crypto exchange FTX, for “orchestrating a scheme to defraud equity investors.” Since May 2019, Bahamas-based FTX raised over $1.8 billion from equity investors, including approximately $1.1 billion from 90 US-based investors. SBF was charged with eight criminal counts, including wire and securities fraud, money laundering, and unlawful campaign finance contributions.
"We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto. The alleged fraud committed by Mr. Bankman-Fried is a clarion call to crypto platforms that they need to come into compliance with our laws,” US SEC Chair Gary Gensler said.
In March 2024, SBF was sentenced to 25 years in jail and ordered to pay $11 billion. The collapse of FTX rang a warning bell to the broader crypto community to operate within the purview of law and adhere to US rules and regulations.
In July 2023, the SEC charged Binance, the world’s largest crypto exchange, and its founder, Changpeng Zhao “CZ,” with operating unregistered exchanges, broker-dealers, and clearing agencies and offering unregistered token securities to customers.
The leading cryptocurrencies alleged by the SEC to be securities include Solana (SOL), Cardano (ADA), Polygon (MATIC), Filecoin (FIL), Cosmos (ATOM), The Sandbox (SAND), Decentraland (MANA), Algorand (ALGO), Axie Infinity Shards (AXS), and Coti (COTI).
In January 2024, both parties again sparred over whether the tokens offered on Binance were securities. Binance argued that those tokens cannot be considered securities and urged the court to dismiss the SEC’s case. On the other hand, the regulator insisted that it has the right to regulate those assets as securities. In November 2023, CZ pleaded guilty to violating US anti-money laundering (AML) laws in the US and agreed to step down as CEO. In April 2024, CZ was sentenced to four months in prison.
In July 2023, the SEC also charged Coinbase, the largest crypto exchange in the US, with operating an unregistered securities exchange and offering unregistered securities to its customers. In March 2024, the court remarked that the SEC had adequate grounds to allege Coinbase's irregularities.
The exchange contended that the regulator had no right to oversee the crypto industry without a Congressional mandate. However, the court said the regulator is well within its rights to regulate Coinbase’s activities as, according to them, these “transactions fall comfortably within the framework that courts have used to identify securities for nearly eighty years.”
According to a Financial Times report, Coinbase CEO Brian Armstrong even alleged that the SEC had urged Coinbase to delist every cryptocurrency except Bitcoin (BTC) before it sued the exchange.
Grayscale Investments, a leading American digital currency asset management company, applied to the SEC to convert its spot Grayscale Bitcoin Trust (GBTC), listed on the New York Stock Exchange (NYSE) Arca, into an exchange-traded fund (ETF). The SEC denied the application, arguing there is enough potential for rampant fraud and manipulation in the market, becoming one of many asset managers to get rejection by the regulatory authority. Cathie Wood's ARK, Fidelity, and Invesco also faced rejection in the same matter.
However, Grayscale was the first to file a lawsuit against the SEC in October 2022. In August 2023, the court ruled that the SEC rejected Grayscale's application as "arbitrary and capricious" as it didn’t offer sufficient reasoning. The court’s decision significantly boosted digital asset managers' efforts to introduce spot Bitcoin ETFs in the US market.
It was a court case that was closely watched by the crypto industry in the US and worldwide. In January 2024, the SEC approved the listing of 11 spot Bitcoin ETFs in the US:
SEC Chair Gary Gensler accepted, though begrudgingly, the court’s decision in the Grayscale case, forcing the decision to approve these ETFs. Hong Kong and Australia have followed suit by approving the listing of spot Bitcoin ETFs in their respective markets.
The SEC believes there is no urgent need for a crypto-specific framework in the US as the country's existing securities rules and regulations are sufficient to regulate cryptocurrencies. Industry leaders have been arguing for crypto-specific regulation to be legislated by the US Congress.
Coinbase formally petitioned the SEC for crypto rulemaking in July 2022, which the SEC denied in December 2023, arguing that existing laws can sufficiently regulate cryptocurrencies. In March 2024, Coinbase accused the SEC of arbitrarily and capriciously denying crypto rulemaking.
In June 2023, the Congress introduced the Financial Innovation and Technology for the 21st Century Act (FIT21). FIT21 is a bill to explicitly regulate cryptocurrencies under US law, even as the SEC argued that the bill would introduce new regulatory gaps and undermine decades of precedent regarding the oversight of investment contracts.
The lower house of Congress passed FIT21 in May 2024 and awaits approval in the Senate. As expected, the crypto community has shown enthusiasm for the bill. We expect a tug-of-war between the SEC and the crypto sector to continue over the next few years. The development of the crypto industry in the US also influences other parts of the world. More and more countries are bringing legislation to regulate cryptocurrencies in their respective legislations.
Now, the question arises: With the recent approvals of spot bitcoin and Ethereum ETFs and the constant pressure from the US SEC for the crypto industry, will the cryptocurrency industry manage to remain truly decentralised?
This article is for informational purposes only and not intended as investment or financial advice. It contains opinions and speculations that are subject to change without notice.
The author and publisher disclaim any liability for decisions made based on the content of this article. Readers are advised to conduct their own research and consult a financial advisor before making investment decisions.
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