- The SEC has targeted several cryptocurrencies as unregistered securities, causing lawsuits and delistings.
- The recent SEC actions have led to concerns about the future of the crypto industry in the US.
- The SEC uses the "Howey Test" to determine if a digital asset is a security.
- Lack of clarity and vague criteria have led to criticism of the SEC's approach.
- The industry may seek favorable jurisdictions until clarity is obtained.
- There is a chance for the development of a framework that accommodates the unique characteristics of cryptocurrencies.
has recently rattled the crypto market with its crackdown on unregistered securities, leaving investors and businesses in a state of uncertainty. The lack of clarity surrounding the classification of cryptocurrencies as securities has led to a flurry of lawsuits, regulatory disputes, and even delistings from popular exchanges. As the industry grapples with the repercussions of the SEC's actions, it becomes increasingly clear that a solution must be found to provide much-needed regulatory clarity and foster mainstream adoption.
Before we dive into the recent events and the rationale behind SEC’s actions - for our non-US audience - let’s quickly discuss what SEC’s role is in the financial markets!
The United States Securities and Exchange Commission (SEC
) regulates the securities
industry, including stock exchanges, brokers, publicly-traded corporations and other entities that deal with financial transactions and investments.
It is similar to UK's Financial Conduct Authority (FCA) and Germany's Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)
The SEC plays an important role in protecting investors, maintaining fair and efficient markets, and enabling businesses to securely and efficiently raise capital. It does so by enforcing transparency, preventing fraud, stamping out manipulation and forcing participants to meet certain disclosure practices.
Traditionally, the regulator has had limited oversight of the cryptocurrency market, since few cryptocurrencies are thought to meet the criteria necessary to be considered securities, and, hence, fall under the domain of the SEC. That said, the SEC has taken action on rare occasions, arguing that some assets are unregistered securities and charging the exchanges that support them with a variety of securities laws violations.
Recently, the SEC highlighted 16 prominent digital assets
as potential unregistered securities, shaking the cryptocurrency market and reigniting concerns about the future of the cryptocurrency industry in the United States.
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Since 2019, the SEC has deemed a total of 68 cryptocurrencies to be securities. The first known example is Gladius Network — which the SEC submitted cease-and-desist proceedings
against in February 2019 due to the "reasonable expectation of profits from the efforts of Gladius and its agents."
In 2020, the SEC took one of its most significant enforcement actions to date, after it sued Ripple (XRP
) for conducting a $1.3 billion unregistered securities offering
. The suit is still ongoing but is expected to be settled this year.
Between 2021 and early 2023, the SEC targeted dozens more projects for hosting unregistered security offerings or for being an unregistered security. Some of the more prominent examples include Dragonchain
), Telegram Open Network
), and OmiseGO (OMG).
Most recently, the SEC targetted two big CEXs
and declared 16 new cryptocurrencies as securities, including the likes of Solana
), Internet Computer
), and more.
“Despite repeated technological innovations disrupting incumbent business models, centralization still tends to reemerge", said
current SEC Chair Gary Gensler in an interview prior to the 2022 SIFMA Annual Meeting.
In a recent interview with New York Magazine, Gensler also proffered the opinion that every cryptocurrency except Bitcoin is a security.
This has been met with a great deal of blowback from the broader cryptocurrency community, with many arguing that Gensler’s opinion doesn’t constitute law.
Nonetheless, in response to the recent turn of events, several prominent exchanges announced plans to delist many of the cryptocurrencies listed by the SEC in its recent suits.
U.S. Judge Denies Freeze on Binance.US Assets
As one of the exchanges named in the recent SEC suits, Binance.US is now in the process of defending its position against the regulatory body.
A federal judge handling the case between the SEC and Binance.US declined to issue a restraining order for now, allowing the exchange to continue with operations as usual.
for more details.
Currently, the SEC uses the “Howey Test
,” a method derived from a 1946 Supreme Court case, to determine whether a digital asset is a security
These criteria are somewhat broad and applying them to digital assets requires a nuanced understanding of each asset's characteristics.
If a digital asset transaction meets the following four criteria, then it is considered a security in the eyes of the SEC.
1. Investment of money: An exchange of value must occur, such as the tokens being sold or exchanged for other assets or cash.
2. Expectation of profits
: The investor enters into a transaction with the hopes of making a profit — generally because of claims made by the ICO
organizers. This is particularly obvious when a token is explicitly marketed as an investment product.
3. Common enterprise: This one is interpreted differently in different jurisdictions, but it generally means the success of investors and issuers are tied together — such that if the token performs well, everybody benefits (holders, investors, founders, etc).
4. Profits from the efforts of others: If investors expect the token to increase in value because of the efforts of the people raising the money, this condition is met.
That said, there are cases where a cryptocurrency has met the Howey criteria but was still either ruled not a security or given an exemption by the SEC. This includes both Paycoin and Hashcoin, which were deemed not securities
by a jury in the federal district court for the district of Connecticut.
Despite the Howey criteria, the SEC frequently faces criticism from blockchain advocacy groups, regulatory advocates, academics and researchers, and crypto-native companies, who argue that the rules are too vague and do not take into consideration the global nature of cryptocurrencies or their unique characteristics.
There are also concerns that the Howey criteria may not be appropriate for the complex and highly diverse world of digital assets, since they were originally intended to be applied to tangible investments.
Despite years of requests for clarity by major industry players, the distinction between cryptocurrencies and securities remains hazy.
Though the United States currently lacks a clearly defined framework for determining if a digital asset is a security or not, some common themes have emerged in recent years among projects dubbed securities by the SEC.
Some of these themes include:
1. Premined supply
: Cryptocurrencies that hold back a portion of the supply, such as for distribution to the team or other stakeholders, are at higher risk of being considered securities. Since this pre-mined supply can give the team an advantage over secondary market
buyers and incentivize them to take steps to grow the value of the token for their own benefit.
2. Excessive marketing and promotion
: How a digital asset is marketed and promoted can influence its classification. If it is marketed as an investment opportunity with the promise of future returns, it is more likely to be seen as a security. This practice was far more common in the early days of initial coin offerings (ICOs
3. Lack of utility: Tokens that lack a functional use case at the time of sale are more likely to be considered securities, since it may be assumed that investors are purchasing the token in the expectation of profit rather than its utility. Tokens with vague or no planned utility might also fall afoul of the “expectation of profits criteria.”
The recent SEC claims have brought significant uncertainty to the cryptocurrency market, leading to delistings, pivoting business models, and a decline in prices.
Nonetheless, regulatory clarity — even if initially disruptive — is a necessary step toward mainstream adoption. In light of the SEC's actions, the industry will inevitably take steps to develop in a way less likely to fall afoul of securities law. But the development of the US’ crypto landscape will likely be stifled until clarity is obtained, as major industry players seek to build in more favorable jurisdictions
With the ongoing dialogue between the industry and regulators, there is a chance that an evolution of the Howey Test or an asset class-specific framework could emerge that better accommodates the unique characteristics of cryptocurrencies.
One potential example is the “Hinman
test”, which suggests that if an asset is sufficiently decentralized such that purchasers can no longer expect a person or group to carry out managerial efforts, then the asset probably does not represent a security.
The road ahead may be challenging, but it also holds the potential for greater market stability and investor protection.
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