Crypto Regulation: Is Cryptocurrency A Security? – Forbes Advisor – Forbes

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors’ opinions or evaluations.

The Securities and Exchange Commission (SEC) and other U.S. market regulators are getting serious about reigning in the crypto market.

But there is one big unsettled question central to their goals: Is cryptocurrency a security?

The latter half of the crypto portmanteau belies the dilemma: currency, a deliberate choice by the movement’s founders, underscoring their ambition to supplant fiat currencies as both a store of value and a means of exchange.

It’s fair to say that since Bitcoin (BTC) launched in January 2009, crypto has become the “Wild West” of financial markets. In the past, its decentralized nature kept it from the prying eyes of governments and other regulatory bodies.

Crypto’s lack of oversight is the very thing that’s so compelling for many enthusiasts. But with few regulations in place, the doors are wide open to nefarious actors who prey on naive investors.

The May crash of stablecoin TerraUSD wiped out more than $600 billion in value and caused a rash of insolvencies—not to mention deepening the crypto winter. The Biden administration responded by outlining a framework for crypto development that included nods in the direction of crypto regulation.

Let’s look at the state of play in crypto regulation—and see if we get clarity on whether or not crypto is a security.

SEC’s Gensler Believes that Cryptocurrencies Are Securities

SEC Chair Gary Gensler is on record voicing his displeasure with the current state of crypto regulation

Gensler famously said in June that crypto exchanges that don’t cooperate with the SEC are “operating outside of the law” and may be at risk of enforcement action.

At the heart of Gensler’s pitch for making the SEC the sheriff of crypto is the argument that cryptocurrencies are securities.

But what are securities? The Securities Act of 1933 and the Securities Exchange Act of 1934 lay out the definition of a security in painful detail. But a more helpful guide can be found in the Howey Test.

The Howey Test comes from a 1946 Supreme Court ruling in the SEC v. W.J. Howey Co., which has been reaffirmed in the courts several times. Under the Howey Test, a transaction is considered to be a security if it meets the following four criteria:

  • Money is invested.
  • There is an expectation the investor will earn a profit.
  • The investment is in a common enterprise.
  • Profits are generated via the efforts of others.

“Promoters are marketing and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others,” Gensler said in a Sept. 8 statement.

In a recent appearance on CNBC, he reiterated his case on crypto. “The law is clear. I believe based on the facts and circumstances most of these tokens are securities,” he said.

And that means those cryptos must be registered with the SEC under federal laws for securities.

The SEC Has Been Cracking Down on Crypto

The SEC announced in May that it was nearly doubling its Crypto Assets and Cyber Unit in May. Since then, the SEC, Commodity Futures Trading Commission (CFTC) and Department of Justice (DOJ) have become more active with crypto enforcement. Take a look at some of the laundry list of charges:

  • On Sept. 19, the SEC charged crypto influencer Ian Balina with failing to disclose compensation he received from promoting an unregistered sale of Sparkster crypto assets.
  • On Sept. 22, the CFTC settled charges against bZeroX and its founders for violating the Commodity Exchange Act (CEA) and CFTC regulations.
  • On Sept. 28, the SEC charged The Hydrogen Technology Corp. and its former CEO for the unregistered sale and price manipulation of crypto asset securities.

Bloomberg reported that the SEC was investigating popular crypto exchange Coinbase (COIN) for allowing users to trade unregistered securities. The SEC also filed an insider trading complaint against a former Coinbase product manager and identified nine cryptocurrencies as securities, and Coinbase insists it doesn’t list securities.

Two additional cases have been particularly high-profile in the recent regulatory crypto enforcement actions.

Kim Kardashian’s SEC Fine

In early October, reality TV star and social media influencer Kim Kardashian agreed to pay a $1.2 million settlement to the SEC tied to charges that she failed to disclose compensation she received for promoting crypto asset EthereumMax on Instagram in June 2021. The SEC fine was over four times more than what she made from the promotion.

Based on the penalty doled out to Kardashian, the SEC might be more interested in the visibility of its crypto crackdowns.

Ripple and the SEC

The other major ongoing cryptocurrency regulatory battle is in the courtroom between the SEC and Ripple (XRP) over the sale of its cryptocurrency XRP.

The SEC has brought charges against Ripple, alleging that the company’s sales of XRP are illegal securities offerings and that “they raised over $1.3 billion through an unregistered, ongoing digital asset securities offering.”

Ripple counters the accusation, claiming XRP is a virtual currency, not an investment contract, and therefore not subject to SEC securities laws.

Gordon Allott, CEO of BroadPeak Partners, says the Ripple case should be settled soon and taking on the SEC is an uphill battle. “What you do with your crypto can turn it into a security. If you use crypto issuance to fund your operations, it will get the SEC’s attention.”

Crypto and The STOCK Act

Attorney William Powers, a partner at Nossaman, said that the Stop Trading on Congressional Knowledge Act of 2012, otherwise known as the 2012 STOCK Act, could provide crypto investors with insight into where Congress stands on the issue.

The 2012 STOCK Act requires all members of Congress to publicly disclose transactions of “stocks, bonds, commodities futures, and other forms of securities” within 45 days on their websites.

The U.S. House and U.S. Senate ethics guidance explicitly calls for members of Congress to disclose cryptocurrency transactions, seemingly implying that they are classified under the STOCK Act as “other forms of securities.”

Several members of Congress have subsequently disclosed their crypto trades.

These disclosures demonstrate that there “appears to be consensus” that cryptocurrencies are considered a type of security covered under the STOCK Act, at least when it comes to trading by members of Congress, Powers said.

Future SEC Regulations for Crypto

Currently, U.S. crypto regulation’s future remains in the air as regulators continue investigating the market and determining the best path forward.

The U.S. Treasury Dept. is expected to complete an “illicit finance risk assessment” on decentralized finance (DeFi) and non-fungible tokens (NFTs) in early 2023. Meanwhile, Gensler has asked SEC staff to “fine-tune compliance for crypto security tokens.”

But more regulations may not necessarily be bad for crypto investors, some experts say.

“Having cryptocurrency regulations in place would mean that projects, exchanges, and all cryptocurrency-related businesses are held to a higher standard and as such, are beneficial to investors. Additionally, it protects investors’ interest, allowing for legal recourse against crypto scams and projects that breach these regulations,” says Bobby Ong, co-founder and chief operating officer of CoinGecko.

But Jeremy Wagner, financial analyst at Trading Pedia, says crypto regulation will also cost crypto enthusiasts. “More regulation could also lead to more restrictions on how cryptocurrencies can be bought, sold, and used. Additionally, more regulations could make it more difficult for innovative new projects to launch in the cryptocurrency space.”