Cryptocurrency traders have been put on notice that the US Securities and Exchange Commission considers a range of widely traded digital assets to be securities, a position that could impose regulatory requirements that many boosters say could be crippling. But figuring out what does or doesn’t make a coin a security is a complicated question.
1. What is the SEC doing?
Its chair, Gary Gensler, and his Trump-era predecessor, Jay Clayton, have said that many digital assets have the hallmarks of securities. Gensler spent the past year warning that the agency was planning to take a hard line in enforcing its rules over those tokens. Anxieties among crypto traders rose when the markets regulator took the unusual step in late July of identifying nine crypto assets that it considered to be securities as part of an insider trading case. Seven of them were traded on Coinbase, the US’s biggest crypto trading platform. Separately, Bloomberg News has reported that Coinbase is facing an investigation by the SEC into whether it listed assets for trading that should have been registered with the agency.
2. What does it mean for something be a security?
In its most simple form, whether something is or isn’t a security under US rules is basically a question of how much it looks like shares issued by a company raising money. To make that determination, the SEC applies a legal test, which comes from a 1946 Supreme Court decision. Under that framework, an asset can be under SEC purview when it involves investors kicking in money with the intention of profiting from the efforts of the organization’s leadership. In December 2020, the agency sued Ripple Labs Inc., for allegedly raising money by selling the XRP digital token, which at the time was the third biggest, without registering it as a security. The SEC claimed that the company was funding its growth by issuing XRP to investors betting that its value would rise. The case is now a massive legal battle with Ripple having hired a former SEC chair, Mary Jo White, as an attorney.
3. Why does calling a token a security matter?
For starters, such designations would make running a cryptocurrency exchange more expensive and complex. Under US rules, the label carries strict investor-protection requirements for platforms and issuers. This burden would put smaller platforms at a disadvantage compared to deeper-pocketed competitors. What’s more, exchanges would face continuous scrutiny by regulators, which could lead to fines, penalties and, in a worst case, prosecutions if criminal authorities ever got involved. It could also mean losing future funding from investors who may be skittish of those increased compliance burdens and regulatory scrutiny. Supporters of more regulation believe securities designations would result in more information and transparency for investors because of the SEC disclosure requirements that would apply.
4. Who’s against that approach?
Crypto enthusiasts say that their ventures are decentralized in a way that makes old rules a poor fit, and crypto trading platforms argue that the assets they’re listing should be considered commodities, not securities. In the US, rules governing commodity trading, and their derivatives, are more focused on ensuring that companies, producers and farmers can effectively use derivatives to hedge against risks of price swings in commodities than on the role of small-time investors.
5. What does the crypto community want?
There have been efforts on Capitol Hill to give the Commodity Futures Trading Commission, the US derivatives watchdog, more power to regulate crypto assets directly. Currently it primarily oversees crypto futures and has the ability to take enforcement action if there’s fraud or manipulation in the underlying market, as it has in dozens of crypto cases. Crypto executives and titans of traditional markets like Citadel Securities have joined an industry push behind a bill from top lawmakers on the Senate Agriculture Committee that would give the derivatives regulator more turf -- at the expense of the SEC. Opponents of that approach say that the SEC’s securities-focused rules offer more protections for mom-and-pop investors.
6. How do the agencies divide crypto?
To an extent, their approaches reflect their origins. The SEC was formed in the wake of the market crash of 1929 and sees its core mission as protecting investors by requiring copious disclosures by financial entities. The CFTC traces its roots to the Agriculture Department and helping farmers protect against droughts. The CFTC -- and the US’s rules around commodities and their financial derivatives -- are widely seen as a less onerous regulatory regime. So it’s little surprise that the crypto crowd desperately wants the CFTC to be their regulator and not the SEC.
7. What coins are or aren’t considered a security?
The short answer is that beyond the very biggest cryptocurrency there’s a lot of ambiguity. US regulators including the SEC agree that Bitcoin, which is by far the largest digital asset, isn’t a security. It was started by an unknown person or persons going by the pseudonym Satoshi Nakamoto and does not exist as a way to raise money for a specific project. The second-biggest token, Ether, was deemed not to be a security during the Trump administration by a senior SEC official who signaled that while Ether may have started out qualifying as a security -- the Ethereum Foundation used it to raise money -- it had grown into something sufficiently decentralized that it probably no longer was one. But after Ethereum changed to a system in which coins that are “staked” play a role in recording transactions, Gensler said that the fact that staked coins can earn interest might lead regulators to start treating it as a security. The CFTC deems Ether a commodity, and the CME lists futures on it as well as Bitcoin.
8. What’s next?
Gensler has said the agency could waive some of its rules to better suit digital assets, while also ensuring investors are protected, if exchanges work with the agency to register. However, he hasn’t provided a road map of how exactly that could be accomplished. Meanwhile, lawmakers are weighing several proposals that could give the CFTC and US banking regulators more power over parts of the the asset class. At the same time, the SEC’s insider trading case, if it comes to trial, could also result in a clearer picture of what kinds of tokens qualify as securities and which should be considered commodities. In September, the White House released a series of reports that had been submitted by different agencies, saying that together they make up the first “comprehensive framework for responsible development of digital assets.” But the reports didn’t resolve what has been a patchwork of overlapping approaches and jurisdictional battles.
9. Is this an issue elsewhere?
Yes. Globally, different regulators have taken a range of positions on whether to treat cryptocurrencies as securities. The UK’s Financial Conduct Agency regulates digital assets it considers investments that come with rights to repayment or a share in profits, while “payment tokens” like 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, to be securities. In June, the European Union reached a provisional agreement to impose common cryptocurrency rules across all 27 member states and to develop a new legal framework to regulate public offers of cryptoassets.
• A Treasury Department report on issues related to crypto regulation.
• A look at the crypto industry’s push in Washington to avoid securities regulation.
• Gary Gensler’s first interview on crypto after taking over as SEC chair with Bloomberg Businessweek.
• A BGOV OnPoint of cryptocurrency legislation being considered by Congress.
• A Bloomberg QuickTake from 2018 shows how long these fights have been going on for.
• The executive order on crypto regulation signed by Biden.
• An article on the SEC’s fight with Ripple.
• The UK FCA’s breakdown of regulated versus unregulated tokens.
More stories like this are available on bloomberg.com
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