SEC Crypto Enforcement Approach May Not Be Enough in the Long Term 

The Securities and Exchange Commission (SEC) has been using almost exclusively enforcement powers against token issuers to encourage them to register their digital assets as securities. Yet, as there isn’t a specific rule to determine which digital assets (cryptocurrencies, tokens, stablecoins, etc.) are considered securities, the number of legal disputes is increasing. Many of these cases go unnoticed because the parties have reached an amicable solution, but the SEC may need to consider other alternatives, like regulation or guidelines, to provide more legal certainty to the crypto community in the long term.

The SEC has been using the “Howey” test, which defines what an investment contract is, to defend that most of the digital assets are securities and therefore fall under its supervision. Under the Howey test, adopted by the U.S. Supreme Court in 1946, an investment contract exists if there is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Therefore, if digital assets, whether cryptocurrencies or tokens, are used as an investment contract, they may be qualified as a security and the SEC can demand disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934. This is exactly what the SEC is defending in its enforcement actions, and in particular in its lawsuit against Ripple, that a digital coin like XPR is a security, not a means of payments, and the company should have registered the asset. However, if the digital asset is used as a currency or as a commodity, these requirements are not applicable. Ripple claims that XRP is exempted from these federal laws.

At the core of this litigation is the question, yet unanswered by the SEC or by any other agency, of whether cryptocurrencies are securities or commodities, or what they are for regulatory purposes.

The SEC didn’t have a clear position when the litigation began, neither has it now, about what defines a digital asset as a security, so the case is based on statements made by SEC senior officials on what is and what isn’t a security. For instance, Ripple’s argument is that a senior official made a statement in 2018 saying that Ether, the second most valuable cryptocurrency, was not a security and that the market understood this speech as a public notice that digital coins would avoid classification as security. The SEC argues that XRP’s usefulness as a currency never materialized.

The enforcement actions taken by the SEC and the different digital assets coming to the market almost every day suggest that not all tokens and cryptocurrencies may fall under the same umbrella, but it isn’t clear what features need to have a digital asset to be considered a security or a commodity or a currency.

Read more: SEC Stays Focused on Cryptocurrency Enforcement, Imposes $2B in Fines in 2021

According to J.W. Verret, professor at George Mason University and advisor for the SEC, “the outcome of this lawsuit may be a game changer, no matter what happens. If the SEC loses, then they’re going to come to the table and talk about engaging with the [crypto] community. But even if they win, then there’ll be the dog that caught the car. Now what they’re going to make XRP register as a security, I can think of about 30 ways that that’s not going to work under the current regime where it has to be amended in some way.”

Regardless of this case, the SEC probably won’t be able to continue regulating by enforcement for much longer and it will need to provide more guidance to crypto investors and token issuers. Lawmakers may also try to introduce legislation in Congress to define cryptos and digital assets, but this would be a slow process and gridlocks may prevent any real progress at the time when it is needed.

Read also: SEC, CFTC Coordination May Be the Way Forward for Crypto Regulation

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