The distinction between cryptocurrencies and traditional financial models has always been a hot topic of debate among market participants and regulatory bodies. The United States Securities and Exchange Commission (SEC) has been at the center of these discussions due to its role in determining which assets are considered securities.
Although the SEC has not yet established a definitive standard for evaluating whether cryptocurrencies are securities, it has indicated that the following criteria will be considered:
The Securities Act of 1933
The “Howey Test” – a set of criteria used to determine if something is a security: an investment contract, transaction, or business model where individuals invest money in a venture with the expectation of profits solely from the efforts of others.
Key precedents set by the United States Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) – which led to the creation of the “Howey Test.”
Applying these standards to the crypto market, the SEC has identified several types of cryptocurrencies that meet these definitions. The list of 37 “securities” crypto mentioned by the SEC in legal documents includes:
The inclusion of Filecoin (FIL) on this list has sparked controversy, as FIL has been widely traded on various U.S. exchanges, and the Grayscale Filecoin Trust was previously proposed by Grayscale Investments.
Grayscale Investment had filed a registration statement with the SEC to convert their Filecoin Trust into a publicly traded company on the securities market in April 2023. However, the SEC’s unexpected decision yesterday led to Grayscale withdrawing the Filecoin Trust registration, leaving stakeholders grappling with the consequences.
Implications of Trading “Securities” Cryptocurrencies
Engaging in the buying and selling of unregistered securities is typically considered a violation of U.S. law. This regulation requires securities to be registered with the SEC before conducting public trading.
Although there are exceptions, such as selling to accredited investors or private exchanges, trading unregistered securities can lead to significant penalties, including fines and disgorgement of profits.
With the SEC’s new classification, individual investors and exchanges face the following issues:
For exchanges listing “securities” crypto
They may face legal scrutiny, similar to the case of Coinbase.
Several other U.S. exchanges, such as Binance US, have listed over a dozen cryptocurrencies that the SEC deems illegal, leading to legal actions and potential ramifications for their operations.
The risk of penalties and legal consequences if they continue listing these “securities” without proper registration or clear classification with the SEC, as seen with Kraken in mid-2022.
For individual investors
This new classification may complicate their trading activities and impact their portfolio’s profitability:
Before trading “securities,” they need to consider factors such as the laws and regulations governing these transactions.
These tokens may face delisting by exchanges to avoid potential legal penalties.
Delisted tokens will experience reduced liquidity, making trading more difficult.
The Future of Security Tokens in Crypto
Recent actions by the SEC in classifying certain types of cryptocurrencies as securities indicate a significant shift in the legal landscape. Critics argue that:
The enforcement measures and recent decisions by the SEC could hinder innovation in the blockchain and crypto industry.
Coinbase CEO Brian Armstrong also believes that while the crypto industry needs regulatory oversight, the regulations should be appropriate to avoid stifling advancements in the field. Implementing a ban instead of suitable regulations would lead crypto companies to relocate outside the United States, as seen with FTX, causing the U.S. to lose its technological edge to competitors.
Blockchain projects often raise funds through Initial Coin Offerings (ICOs), which can now be considered “securities” under the SEC’s interpretation. As a result, these projects must comply with strict, cumbersome, and costly regulatory requirements, making it challenging for small projects to adhere to them.
This makes it difficult for U.S. investors to access investment opportunities in new projects through ICOs since some projects will register operations outside the United States and block investors with U.S. IP addresses.
It also reduces liquidity, restricts market access, and poses potential legal consequences for unregistered security transactions.
Short-term solutions for trading security tokens
Given the legal complexities surrounding the sale of unregistered securities and specific exemption cases, obtaining professional legal advice has become necessary for all parties involved in this space.
Investors, project creators, and especially crypto exchanges need to equip themselves with deep understanding of the legal environment to successfully navigate project development.
While the SEC’s recent decisions have introduced complexity for market participants in crypto, they also highlight the need for clear regulations in this rapidly evolving field.
Through professional legal advice and proactive approaches, stakeholders can address the challenges posed by these developments and continue to engage in the dynamic cryptocurrency market.