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Is cryptocurrency like stocks and bonds? The courts are getting closer to an answer.
For more than a decade, pioneers of the cryptocurrency industry envisioned digital coins as an alternative branch of finance, a renegade sector that would operate beyond the reach of big banks and government regulators.
But as digital currencies like Bitcoin and Ether became more common, the crypto industry ran into a 1946 Supreme Court ruling that created what is known as the Howey testa legal analysis that determines when a financial product becomes subject to the same strict rules as stocks and bonds.
In recent years, regulators have taken advantage of this legal precedent to assert that cryptocurrencies are just another security, like the shares of Apple or General Motors. The crypto industry has fought back, leaving it in a legal gray area with an uncertain future in the United States.
Today, the long-running dispute moves closer to resolution, as federal judges begin ruling on a series of lawsuits filed by the nation’s largest securities regulator against some of the biggest crypto companies. This month, judges held hearings in two of the most important cases, which could determine whether the multi-billion dollar crypto industry can continue to grow in the United States.
Legal battles are “an existential question for crypto,” said Hilary Allen, a professor at American University who specializes in financial regulation.
Legal fights have intensified over the past 18 months, as the Securities and Exchange Commission took legal action claiming that crypto companies were operating like unregulated securities companies. In response, the industry argued that laws governing transactions on Wall Street should not apply to digital currencies. Both sides scored early legal victories that left the case unresolved.
But this month, federal judges held hearings in two cases that legal experts expect will be more decisive: the SEC’s lawsuits against crypto exchanges Coinbase and Binance, which explore questions central to a broader legal battle. Preliminary rulings in these suits are expected in the coming weeks, paving the way for litigation that could ultimately reach the Supreme Court.
“We have built our legal strategy around” a possible Supreme Court showdown, said Paul Grewal, Coinbase’s chief legal officer. “These are issues that have potential implications for large parts of the economy. »
How the courts’ ruling could determine whether the crypto industry can move deeper into the US financial system. If the SEC prevails, crypto advocates say, it will stifle the growth of a new and dynamic technology, pushing start-ups to move abroad. The government has countered that rigorous oversight is needed to stop widespread fraud that costs investors billions of dollars when the crypto market imploded in 2022.
“The history of crypto markets shows that investors are at risk and suffering from these platforms’ complete disregard for regulatory requirements,” said SEC spokesperson Stephanie Allen.
The origins of crypto date back to 2008, when a developer known by the pseudonym Satoshi Nakamato created the software behind Bitcoin. Early advocates envisioned crypto as a decentralized alternative to traditional finance, a joint project run by a vast network of people scattered across the world.
But as the industry matured, companies resembling traditional financial firms began developing cryptocurrencies and marketing them aggressively. Enthusiasts purchased the digital coins in the hopes that their value would increase. The government viewed the emerging sector as an unregulated version of Wall Street, rife with fraud and manipulation. Last year, the SEC filed 46 crypto-related enforcement actions, according to Cornerstone Research, a consulting firm.
The SEC’s crypto plan is guided by a 1946 Supreme Court case involving investments in Florida orange groves. The case led to the creation of the Howey test, a legal standard for determining what constitutes a security if it is not a stock or bond.
In this context, a financial product becomes a security when it offers the possibility of investing in a “common enterprise” in the hope of profiting from the efforts of others. Examples of securities subject to the Howey test include certain insurance products and even contracts for the sale of chinchillas.
Classification as a security comes with a wide range of legal requirements: Companies offering securities must provide detailed information and comply with complex investor protection procedures that can be costly to implement.
In public remarks, SEC Chairman Gary Gensler argued that most digital currencies qualify as securities under the Howey test because people invest in crypto hoping that the companies that issue the currencies will do so. raise prices. Only Bitcoin, he said, is beyond the reach of the SEC because no central group or individual oversees it.
Under the regulatory authority of the SEC, Mr. Gensler had the ability to craft new regulations for the crypto industry. But he instead argued that the sector should be governed by existing laws and court rulings established to protect investors from fraud.
The crypto industry has called this approach too broad, emphasizing that there must be a formal contract between the seller of a digital coin and an investor for the agreement to constitute a securities transaction.
“Gensler’s approach was to put a square in a round hole,” said Teresa Goody Guillén, a partner at BakerHostetler and a former SEC litigation attorney. “There needs to be a regulatory regime in place for these new assets beyond just saying these are all securities.
Mr. Gensler’s strategy was put to the test early in the SEC’s lawsuit against digital currency issuer Ripple. In July, a New York federal judge, Analisa Torres, governed that Ripple’s cryptocurrency was not considered a security – at least when it was bought and sold on public exchanges by amateur investors. Judge Torres reasoned that these investors did not expect to profit from Ripple’s actions as a company.
The decision was celebrated across the crypto world. But enthusiasm was tempered a few weeks later when a judge in another case agreed with the SEC’s view that a different set of cryptocurrencies were considered securities and rejected much of the reasoning of Judge Torres.
The split raised the stakes for judges overseeing the SEC’s lawsuits against Coinbase and Binance, which serve as marketplaces for dozens of digital currencies. In these cases, the SEC argued that at least 20 cryptocurrencies qualify as securities, providing judges with the ability to make broad rulings that could apply to the entire universe of assets digital.
Last week, a hearing in the Coinbase case in Manhattan federal court lasted five hours, with more than 500 people tuning in by phone; About 250 people attended the Binance hearing on Monday in Washington. Both hearings focused on the applicability of the Howey Test to digital currencies.
Coinbase lawyers argued that the SEC was attempting to expand the intent of the Howey test to cover crypto investments. Without a clear contractual agreement between the buyer of a digital coin and its issuer, the lawyers said, a cryptocurrency is no different from any other “collectible” whose value could increase over time, such as cards. baseball or Beanie Babies dolls.
During the hearing, Judge Katherine Polk Failla appeared to agree with some of Coinbase’s concerns about SEC overreach, saying the commission may “be overly broad in scope.”
“We’re all concerned that your criteria is so narrow” that some attorneys claim Beanie Babies are unregistered titles, she told a commission lawyer.
In the Binance case, Judge Amy Berman Jackson of Washington seemed more skeptical of the comparison between digital coins and collectible toys. But she expressed concern about the SEC’s strategy and pressed government lawyers to explain the limits of their argument.
These hearings came days after a major victory for the crypto industry, when the SEC approved a new Bitcoin investment product for trading on Wall Street. Mr. Gensler fought to block its introduction until a court ruled against the SEC in August, forcing the agency’s hand.
“It was an extraordinary thing that gave people a reason to hope,” said Mr. Grewal of Coinbase. “There’s real optimism in the industry right now.”