SEC: every token is a security, except Bitcoin

An interview with current SEC chairman Gary Gensler to New York Magazine recently caused quite a stir.

The interview was about the crypto winter, the FTX case, and the current state of the crypto markets, but the most interesting passage was about cryptocurrencies, security token, and Bitcoin.

The SEC and the CFTC: all crypto and tokens are securities token, excluding Bitcoin

At one point the interviewer, Ankush Khardori, brought up the issue of crypto regulation, and in particular what appears to be a real clash between the SEC and the CFTC.

The CFTC (Commodity Futures Trading Commission) is the US government agency which, as its name implies, oversees the commodities market, as well as futures.

Khardori says that the CFTC is generally considered a more flexible and less assertive financial regulator than the SEC.

The Securities and Exchange Commission (SEC), on the other hand, deals specifically with securities, as its name implies, as well as exchanges. So theoretically the two agencies should deal with different things, specifically the SEC with the stock market, and the CFTC with the commodity and futures market.

Hence there should be no conflict between the two agencies, so much so that Gensler himself in the interview says:

“I love the CFTC. You’re not going to get me to say anything negative about the CFTC.”

But Khardori points out that the new bill under discussion in the US Congress concerning cryptocurrencies divides oversight of the crypto market between the CFTC and the SEC, with the SEC supposed to deal with those cryptocurrencies that are security token, or investment contracts, while the CFTC is supposed to deal with payment tokens, which are commodities.

Security or commodity?

The problem is that according to Gensler all cryptocurrencies would be securities.

He explicitly said:

“Everything other than Bitcoin.”

This passage sparked an uproar, because there are cryptocurrencies like Ethereum, or Litecoin, that don’t look much different from Bitcoin.

Gensler also explained his reasoning.

He says the SEC would already now have all the legal tools it needs to intervene in the crypto markets, in part because he believes that virtually every type of crypto transaction falls under the SEC’s jurisdiction, except for spot transactions in Bitcoin and those by which people pay for purchases of goods or services in cryptocurrencies.

Indeed, he argues that there are groups of entrepreneurs, foundations or individuals behind cryptocurrencies, and that these to date use a variety of complex and legally opaque mechanisms simply to promote their tokens and attract investors by promising financial returns.

By contrast, Bitcoin to date has no one behind it, and there is no one promoting its sale by promising financial returns.

The curious thing is that even journalist Ankush Khardori admits this, despite the fact that he is not a cryptocurrency expert. Instead, Khardori is a legal expert, so much so that until the early 2020s he was a federal prosecutor specializing in financial fraud.

According to Gensler, tokens that involve the existence of a group of “intermediaries” between investors and the protocol are securities, whereby investors believe it is that group that makes them money.

With Bitcoin, there is no such group, in the sense that no one can promise to increase the value of Bitcoin through their own work or intervention. It is only the market that determines its value.

Whereas for Ethereum and Litecoin there is basically a group that develops the project, and whose work most likely determines investors’ eventual future gains.

After all, Ethereum was born with an ICO, held in 2014, in which $16 million was raised. It is clear that those who bought the tokens during the ICO expected that those who received their money would then get the project off the ground and skyrocket the market value of ETH (which then actually happened).

Indeed, Khardori himself adds that the assertion that investors in cryptocurrencies hope to profit from the efforts of those intermediaries, in much the same way that shareholders of publicly traded companies hope to see their investments appreciate over time, is critical to understanding Gensler’s argument.

The problem with securities

Commodities can be sold freely in the market in a totally legal manner.

In contrast, to legally sell securities one must offer them to the public only by accompanying them with a prospectus approved by agencies such as the SEC.

Such a prospectus does not exist for cryptocurrencies, and there is no SEC approval either. Hence, in the US, cryptocurrencies that will be considered securities (unregistered) can no longer be sold legally in the absence of an SEC-approved prospectus. Something similar could also happen in other jurisdictions later on.

The fact is that it seems really hard to imagine that if Ethereum is declared a security in the US, it could get the SEC’s approval. This is not impossible, but it is by no means easy.

Instead, for most other cryptocurrencies it may simply be impossible.