As reported by Bloomberg, cryptocurrencies grew massively in 2021, with about $1.5 trillion market capitalization. Cryptocurrencies eventually garnered attention worldwide, such that President Joe Biden signed an executive order to secure the use of digital assets.
The U.S. Securities and Exchange Commission (SEC) recently paid attention to cryptocurrencies. The security institution’s aim is to inform investors of potential cryptocurrency risks and reduce digital asset volatility.
Despite the Securities and Exchange Commission’s interest in maintaining orderliness and reducing fraud within the crypto ecosystem, some traders are quite displeased about its involvement. Conversely, read on to find out more information about SEC, including its actions and cases.
Key Features of Cryptocurrencies
Cryptocurrencies are digital forms of money that allow individuals to trade among themselves without an intermediary. The key features of cryptocurrencies are; anonymity, transparency, decentralization, permissionless, and independence.
Cryptocurrencies are powered by blockchain technology, with the first-of-its-kind being Bitcoin. However, the crypto market is highly volatile, making it difficult for financial analysts to determine future prices. You may read this DroomDroom’s article, which explains the factors affecting the crypto market price volatility.
Informed investors closely monitor market demands and supply, including market capitalization, to predict profitable investment returns. This confirms that cryptocurrency is not a trading system that yields automatic profits for every of its users.
The Securities and Exchange Commission Mandate
Based on research, the U.S. Congress passed the Securities Exchange Act in 1934 due to the stock market crash that happened in October 1929. The sole aim is to ensure investors are treated fairly, and every financial misconduct faces the law. Thus, every financial services firm, such as asset managers, adversity firms, and broker-dealers, must register with the Securities and Exchange Commission. Investors are also granted access to relevant databases, periodic financial reports, and analyses, to help them make informed financial decisions.
Securities and Exchange Commission’s Approach to Cryptocurrencies
The Securities and Exchange Commission is getting involved in cryptocurrencies to identify possible securities. Jay Clayton explained the concept of securities and cryptocurrencies in 2017 during the PLI 49th Annual Institute on Securities Regulation.
Most products from cryptocurrency exchanges qualify as securities, and should therefore be registered under federal securities laws.
In June 2018, he further stated during an interview with CNBC.
True cryptocurrencies like Bitcoin, Ether, and Litecoin are commodities, since they truly act as store of value or means of exchange. However, some of these digital products are rather securities.
How is an asset classified as a security or commodity?
According to the Securities Exchange Act, there are digital forms of traditional securities (bonds, stocks, and notes). Thus, the Securities and Exchange Commission formulated a Howey Test to confirm if truly a digital asset is a security or not. Based on the Howey Test, a digital asset must contain an investment contract to be considered a security. A digital asset contains an investment contract when:
- It involves an investment of money.
- It’s a common enterprise.
- It has a reasonable expectation of profits.
- The expected profit is based on other people’s managerial efforts.
If somebody is raising money selling a token and the buyer is anticipating profits based on the efforts of that group to sponsor the seller, that fits into something that’s a security.
Gary Gensler, SEC’s Chair
Aside from the Howey Test, the Securities and Exchange Commission also uses a Reves Test. Instead of an investment contract, the Reves test identifies whether an offering or financial instrument is a note. Using this testing alternative, the following factors are usually considered:
- Buyers and sellers’ motivation.
- The distribution plan.
- The reasonable expectation of the investing public.
- Any risk-reducing considerations.
Major SEC Cryptocurrency Cases
Major Securities and Exchange Commission lawsuits have been against cryptocurrency issuers, lenders, exchanges, and every other active player. The Securities and Exchange Commission’s lawsuit against Ripple Labs Inc. is the most prominent.
Here are brief highlights of the significant court cases between the Securities and Exchange Commission and certain crypto players.
BlockFi Lending LLC
In February 2022, Securities and Exchange Commission sued BlockFi, a leading cryptocurrency lending platform, for a fine of $100 million. The ecosystem’s activities were centered around investors lending their crypto assets to BlockFi, with an expected interest rate. Here is an article that further explains crypto lending and how it works.
About 600,000 investors participated in this lending system. Wherein investors also charged BlockFi on the 1st of March, 2022, for not informing them about their unregistered accounts.
BlockFi agreed to pay a sum of $50 million settlement to SEC, whereas the regulator has decided to waive $30 million if investors are eventually repaid. This decision was made when BlockFi filed for bankruptcy following the downfall of a crypto exchange, FTX.
Kik Interactive Inc
The Securities and Exchange Commission filed a lawsuit against Kik Interactive Inc over its Initial Coin Offering (ICO) in June 2019. The charges were against the unregistered tokens sold to U.S. investors. Kik Interactive Inc also launched a Kin token, with a remarkable record of $50 million during its presale. Conversely, the ICO also raised $98 million when it was launched in 2017.
After some back and forth and disagreement from Kik Interactive Inc, the court agreed to SEC’s charged penalty of $5 million. This happened in September 2020, when the judge confirmed that Kik was engaged in the illegal offering of securities.
Unfortunately, ICO is one of the common ways cybercriminals scam crypto users. You can read this article on how to spot and avoid crypto ICO scams. This will prevent help in making smart investment decisions.
On the 6th of June, 2023, SEC filed a court case against Coinbase. This was just a day after suing Binance for mishandling customer funds and inflating trading volumes. According to the regulator, Coinbase made billions of dollars from getting involved in crypto trading, including Polygon, Solana, and Cardano. Other cryptos identified as securities by the SEC are; Filecoin, Internet Computer, Flow, Near, Nexo, Chiliz, Voyager, and Dash.
Coinbase stood its ground that the SEC could only list its assets as securities if they contained investment contracts. Nevertheless, the case outcome may affect the market rate.
On the same day, Securities and Exchange Commission filed Coinbase’s crypto assets; its stock closed at a lower percentage of 12%. However, this is quite reasonable compared to Binance’s huge market decline within 24 hours of the SEC’s lawsuit. It was reported that Binance users withdrew over $3 billion during this period.
On the 13th of July, 2023, Ripple announced its victory on Twitter, causing many of its community to jubilate. The SEC lawsuit was finally canceled in Ripple’s favor!
XRP is not a security.— Ripple (@Ripple) July 13, 2023
This victory for @Ripple is a win for the entire industry and a step toward regulatory clarity in the U.S.
A huge thank you to @bgarlinghouse, @chrislarsensf, and @s_alderoty for their leadership and the #XRPCommunity for their continued support.
In December 2020, the Securities and Exchange Commisssion sued Ripple for conducting unregistered securities offerings worth $1.3 billion. In this case, the charge was against XRP, which Forbes had reported as the 6th-ranked cryptocurrency. The regulator claimed that XRP sales on public exchanges violated federal securities law.
Ripple argued that its token cannot be classified as a security, as buyers don’t have a reasonable expectation of profit tied to other people’s efforts. Even though the court ruled in Ripple’s favor, the Securities and Exchange Commission also had a partial win. The court discovered that about $728.9 million of XRP were sold to sophisticated buyers. The court assumed that this marketing approach placed a value proposition on XRP.
Unfortunately, cybercriminals are taking advantage of Ripple’s latest positive news. These scammers use airdrops and giveaways to scam people, so we advise you to take extra precautions with your asset.
DroomDroom published an article on top platforms to find profitable crypto airdrops. You can check it out, and save yourself from falling into cyber scam.
A lot of scammers are taking advantage of the recent good news to try to cheat and steal. There are no airdrops, giveaways, or special offers associated with this ruling.— David "JoelKatz" Schwartz (@JoelKatz) July 13, 2023
Criticisms Surrounding SEC’s Crypto Regulations
The U.S. Securities and Exchange Commission alerts investors to be extra cautious in dealing with crypto assets securities. This means a crypto asset registered as a security doesn’t eliminate certain financial risks.
Aside from the inability to ultimately maintain cyber security, several crypto firms criticized the irregularities in Securities and Exchange Commission’s regulations. Crypto companies demand SEC’s comprehensive framework and clear rules for easy obligation.
Crypto regulations are inevitable, especially in the U.S., where cryptocurrency is more widely adopted, unlike China. China’s ban on crypto mining in 2021 was quite understandable, as it addressed illegal activities. However, the U.S. government took a different approach by establishing the SEC regulator to help curb cyber scams. This proves that crypto may emerge safer, stronger, and more acceptable in the U.S.