Explainer: What is the significance of US regulator’s legal actions against major crypto trading firms?

NEW YORK – The United States Securities and Exchange Commission (SEC) has put the financial world on notice: It considers a range of widely traded digital assets to be securities, a position that could impose steep regulatory requirements on digital asset exchanges.

Recently announced legal actions

against some of the biggest names in crypto trading will put that proposition to the test.

Figuring out what does or does not make a coin a security is still a major point of contention. 

1. What is the SEC doing?

In July 2022, as part of an insider trading case, the SEC identified nine crypto assets that it considered to be securities.

On June 6, the agency sued Coinbase Global, the biggest US crypto trading platform, over allegations that it illegally listed numerous tokens.

In a separate case announced a day earlier, the SEC alleged that Binance Holdings also listed unregistered securities.

All told, as at June 6, the SEC under chairman Gary Gensler had signalled that it considers coins worth US$120 billion (S$161 billion) to be unregistered securities.

The SEC has said that its securities rules apply as well to crypto staking, which offers customers a return for letting their tokens be used to facilitate blockchain transactions.

2. What does it mean for something to be a security? 

On the simplest level, whether something is or is not a security under US rules comes down to how much it looks like shares issued by a company raising money.

To make that determination, the SEC applies a legal test that 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 organisation’s leadership.

In 2020, the agency sued Ripple Labs for allegedly raising money by selling the XRP digital token 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 former SEC chairman Mary Jo White as an attorney.

3. Why does calling a token a security matter? 

Among other things, it makes running a cryptocurrency exchange more expensive and complex.

Under US rules, the label carries strict investor protection requirements for platforms and issuers.

That means exchanges would face continuous scrutiny by regulators, which could lead to fines, penalties and, in the worst case, prosecutions if the criminal authorities ever became involved.

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 is against that approach? 

Crypto enthusiasts say that their ventures are decentralised in a way that makes old rules a poor fit, and crypto trading platforms argue that the assets they are listing should be considered commodities, not securities.

In the US, rules governing trading of commodities and their derivatives are focused more on ensuring that companies, producers and farmers can effectively hedge against risks of price swings in commodities.

5. What does the crypto community want?

There have been efforts on Capitol Hill to give the Commodity Futures Trading Commission (CFTC), 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 is fraud or manipulation in the underlying market, as it has in dozens of crypto cases.

The CFTC’s regulatory regime is considered less onerous than the SEC’s, so it is little surprise that the crypto crowd wants to be overseen by the CFTC.

In 2022, crypto executives and titans of traditional markets like Citadel Securities 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.

That effort stalled after the collapse of cryptocurrency exchange FTX, which was one of the most vocal companies pushing for the change.

More recently, two key House Republicans proposed giving authority to the CFTC to oversee certain tokens and create a pathway for coins that begin as securities to eventually be regulated as commodities. 

6. What coins are and are not considered securities?

Beyond the very biggest cryptocurrency, there is a lot of ambiguity.

US regulators including the SEC agree that Bitcoin, which is by far the largest digital asset, is not 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 Donald Trump’s administration; a senior SEC official signalled that while it may have started out as a security – the Ethereum Foundation used it to raise money – it had grown into something sufficiently decentralised 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, SEC chairman Gensler said that the fact that staked coins can earn interest might lead regulators to start treating it as a security.

The CFTC, however, deems Ether a commodity.

7. Is this an issue elsewhere? 

Yes. Globally, different regulators have taken a range of positions on whether to treat cryptocurrencies as securities.

Britain’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.

European lawmakers in April approved a law imposing common cryptocurrency rules across all 27 member states and calling for a new legal framework to regulate public offers of crypto assets. BLOOMBERG