SEC: many crypto are securities

Yesterday, SEC Chairman Gary Gensler gave an interview in which he said he believes that many crypto are actually securities. 

Many cryptocurrencies “don’t just resemble securities — they are,” @SECgov Chairman @GaryGensler says.

That being the case, he adds, service providers including crypto exchanges “have an obligation to come in and register.”

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— CoinDesk (@CoinDesk) September 8, 2022

The SEC, or Securities and Exchange Commission, is the US agency that oversees precisely the financial markets for securities, so Gensler’s statement cannot be ignored. Moreover, if it corresponds to reality, the crypto market could be disrupted in the future by interventions of the agency. 

The SEC’s view on many cryptocurrencies: most are securities

In the US, a security is a financial asset that cannot be legally placed on the markets and promoted without explicit SEC approval. 

Thus, cryptocurrencies that were to be recognized as securities placed on the market without such approval would have to be removed from exchanges, otherwise the exchanges would be shut down. Although the SEC operates only in the US, a great many other countries have similar laws in this regard. 

To date there are more than 12,000 cryptocurrencies, tokens and stablecoins, so even if more than 90% of these were to be declared securities, there would still be hundreds left to be considered something else. 

These would certainly include Bitcoin and Ethereum, since several times in the past the SEC itself has had occasion to say that it considers them commodities. 

Therefore, on the one hand, we have the hypothesis that many cryptocurrencies could be in the markets illicitly, while on the other hand, we have the certainty that there are several that, instead, can continue to be there without problems. 

The real issue is determining which cryptocurrencies should be considered securities, and which should not. 

The Howey Test used by the SEC to figure out whether cryptocurrencies are securities

The SEC uses the so-called Howey Test to determine whether an asset should be considered a security, and the outcome of this test can also have legal value. From a strictly technical standpoint, the Howey Test is used to determine whether a transaction qualifies as an “investment contract,” thus revealing whether the asset being traded should be considered a security subject to the disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934. 

The concept behind this test is that an investment contract exists whenever there is an investment of money in a joint venture that generates a reasonable expectation of profits from the activities of the joint venture. 

The definition of “a common enterprise” is what might cause many cryptocurrencies to be regarded as securities, because in many cases there is not a normal registered company behind a crypto project, but there are also DAOs and Foundations that, however, might also fall under the concept of “common enterprise.” 

In other words, one should not mistake formality for substance, because if someone or something issues a cryptocurrency or token with the express purpose of remunerating investors through its work, it could be accused by the SEC of selling an unregistered security, since cryptocurrencies and tokens are not registered with the SEC. 

The famous Ripple-SEC case

The most famous case in this regard is that of Ripple, a company against which the SEC itself filed a lawsuit accusing it of putting a security on the market passed off as a utility token, namely the cryptocurrency Ripple, later renamed XRP. 

That lawsuit is still ongoing, almost two years now, and apparently it must be quite difficult to prove that XRP in its early days was sold as a security. 

It is possible that the future attitude of the SEC toward other cryptocurrencies will depend on the outcome of this lawsuit, with potentially even very serious consequences for the crypto markets. 

Although BTC and ETH do not fall under this definition, to the extent that it has already been claimed that they should be considered commodities, a problem could arise because of staking. 

In fact, those who are staking their ETH on third-party nodes that validate the blocks are in fact doing so because they have a reasonable expectation of making profits from the activities of the node belonging to the third party, namely from the activity of those who offer them the opportunity to invest ETH by staking them. 

For now, it really seems that a lot depends on the outcome of the lawsuit against Ripple, because should the SEC lose it will be very difficult for it to go down that road and start accusing other cryptocurrencies of being securities as well. But if, on the other hand, it wins that case it could open up a much broader and deeper new phase in which Gensler’s SEC could accuse hundreds, if not thousands, of crypto projects of equally violating the law. 

In other words, the SEC vs. Ripple case will likely set precedent in both cases, whether the SEC wins or Ripple wins. 

The clear definition of Bitcoin: it is a commodity

In either case, Bitcoin will not be considered a security because it does not promise gains to anyone. In addition, there is no party collecting investment in exchange for the promise to pay returns generated through its activity. 

In reality, also Ethereum works this way, but with the introduction of staking, nodes offering such a return opportunity may have to seek approval from authorities such as the SEC in order to do so legally. The risk therefore is there, but in the end it could also turn out to be limited to a request for approval of the mandatory prospectus to propose the investment to the service’s clients. 

A completely different matter concerns those who create cryptocurrencies for the purpose of raising investments in exchange for the promise to pay returns generated by their work. Even if these were entities that are not formally recognized as companies, i.e., DAOs or Foundations, for example, it is hard to imagine that they could really manage to escape the requirement to comply with these regulations. 

The process of getting approval from the SEC

Moreover, it might be quite difficult for these organizations to succeed in obtaining the approval of the SEC. In the case of normal financial firms properly registered, it might not be particularly complex, if they meet all the classic requirements. But in the case of entities not registered as financial firms, and without the necessary requirements to be recognized as such, it might indeed be impossible. 

Added to this is the fact that it takes time to obtain such approvals. Thus, should the SEC begin to intervene to block the trading of cryptocurrencies deemed to be unregistered securities, at first the consequence could be their delisting from exchanges, or even a forced closure of the exchanges themselves. 

The situation is still in flux, and it may not be long before it is clarified which cryptocurrencies should be considered securities, and how to make them legally tradable on the exchanges. The SEC is not helping much in understanding what its real stance will be in this regard, but it does seem to be intent on taking concrete action, albeit neither how nor when is clear. 

The problem should not be underestimated, partly because financial returns are by far the main motivation for many investors when buying cryptocurrencies, as well as the one that drives mere speculators to try to make money just by buying and reselling at a higher price. 

The “Wild West” of cryptocurrencies could end the very moment the SEC begins this sort of “cleansing” of crypto markets, forcing those promising financial returns to apply for approval of their offerings.