For more than a decade, cryptocurrency industry pioneers envisioned digital currencies as an alternative branch of finance, a renegade sector that would operate outside the reach of big banks and government regulators.
But as digital currencies like Bitcoin and Ether became more common, the cryptocurrency industry collided with a 1946 Supreme Court decision that created what is known as the Howey Test, a legal analysis that determines when a financial product is subject to the same strict rules as stocks. and bonuses.
In recent years, regulators have seized on that legal precedent to argue that cryptocurrencies are just another security, like Apple or General Motors stock. The cryptocurrency industry has fought back, leaving it in a legal gray area with an uncertain future in the United States.
Now, the long-running dispute is moving closer to a resolution, as federal judges begin weighing a series of lawsuits from the country's top securities regulator against some of the largest crypto companies. This month, judges held hearings in two of the most important cases, which could determine whether the multibillion-dollar cryptocurrency industry can continue to grow in the United States.
Legal battles are “an existential issue for cryptocurrencies,” said Hilary Allen, a professor at American University who specializes in financial regulation.
The court fights intensified over the past 18 months, when the Securities and Exchange Commission filed enforcement complaints alleging that crypto companies were operating as unregulated securities businesses. In response, the industry argued that the laws governing trading on Wall Street should not apply to digital currencies. Both sides won early court victories that left the matter unresolved.
But this month, federal judges held hearings in two cases that legal experts hope will be more decisive: the SEC's lawsuits against cryptocurrency exchanges Coinbase and Binance, which explore issues at the heart of the broader legal battle. Preliminary rulings in those lawsuits are expected in the coming weeks, setting the stage for litigation that could ultimately reach the Supreme Court.
“We built our legal strategy around” a potential Supreme Court showdown, said Paul Grewal, chief legal officer at Coinbase. “These are issues that have potential implications for large sectors of the economy.”
How the courts rule could determine whether the cryptocurrency industry can delve deeper into the American financial system. If the SEC prevails, cryptocurrency supporters say, it will stifle the growth of a dynamic new technology, pushing startups to move abroad. The government has responded that strong oversight is necessary to end the rampant fraud that cost investors billions of dollars when the cryptocurrency market imploded in 2022.
“The history of cryptocurrency markets shows that investors are at risk and harmed by these platforms' complete disregard for regulatory requirements,” said SEC spokesperson Stephanie Allen.
Crypto's origins date back to 2008, when a developer known by the pseudonym Satoshi Nakamato created the software behind Bitcoin. Early proponents envisioned cryptocurrencies as a decentralized alternative to traditional finance, a community project run by a wide network of people spread around the world.
But as the industry matured, companies similar to traditional financial companies began developing cryptocurrencies and marketing them aggressively. Enthusiasts bought the digital currencies in the hope that they would increase in value. The government viewed the emerging sector as an unregulated version of Wall Street, rife with fraud and manipulation. Last year, the SEC filed 46 enforcement actions related to cryptocurrencies, according to Cornerstone Research, a consulting firm.
The SEC's plan for cryptocurrencies 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 makes something a security if it is not a stock or bond.
Under this framework, a financial product becomes a security when it offers the opportunity to invest in a “common enterprise” with the expectation of benefiting from the efforts of other people. Examples of securities under the Howey Test include some 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 carry out.
In public statements, SEC Chairman Gary Gensler has argued that most digital currencies qualify as securities under the Howey Test because people invest in cryptocurrencies in the hope that the companies that issue the currencies will drive up prices. prices. Only Bitcoin, he has said, is outside the reach of the SEC, since no central group or individual oversees it.
Under the SEC's regulatory authority, Gensler had the option to develop new regulations for the crypto industry. But instead, he has argued that the industry should be governed by existing laws and court rulings established to protect investors from fraud.
The crypto industry has called that approach too broad, responding that a formal contract needs to exist between the seller of a digital currency and an investor for the agreement to constitute a securities transaction.
“Gensler's approach has been to put a square peg in a round hole,” said Teresa Goody Guillén, a partner at BakerHostetler and former SEC trial attorney. “There has to be a regulatory regime for these new assets beyond simply saying they are all securities.”
Gensler's strategy faced an early test in the SEC's lawsuit against digital currency issuer Ripple. In July, a federal judge in New York, Analisa Torres, ruled that Ripple's cryptocurrency did not qualify as a security, at least when it was bought and sold on public exchanges by amateur investors. Judge Torres concluded that these investors did not expect to benefit from Ripple shares as a business.
The ruling was celebrated in the crypto world. But the enthusiasm was tempered a few weeks later when a judge in another case backed the SEC's view that a different set of cryptocurrencies qualified as securities and rejected much of Judge Torres' reasoning.
That split has raised the stakes for judges overseeing SEC lawsuits against Coinbase and Binance, which serve as marketplaces for dozens of digital currencies. In those cases, the SEC has argued that at least 20 cryptocurrencies qualified as securities, offering an opportunity for judges to issue broad rulings that could apply across the universe of digital assets.
Last week, a hearing on the Coinbase case in Manhattan federal court lasted five hours, with more than 500 people tuning in by phone; About 250 people tuned in to the Binance hearing on Monday in Washington. Both hearings revolved around the applicability of the Howey test to digital currencies.
Coinbase lawyers have argued that the SEC is trying to expand the intent of the Howey Test to cover cryptocurrency investments. Without a clear contractual agreement between the buyer of a digital currency and its issuer, lawyers have said, a cryptocurrency is no different from any other “collectible” that can increase in value over time, such as baseball cards or coins. Beanie Babies dolls.
At the hearing, Judge Katherine Polk Failla appeared to back up some of Coinbase's concerns about SEC overreach, saying the commission could be “extending itself too far.”
“We're all afraid that there are so few limitations on your standards” that some attorneys will argue that Beanie Babies are unregistered securities, he told a commission attorney.
In the Binance case, Judge Amy Berman Jackson in Washington seemed more skeptical of the comparison between digital currencies and collectible toys. But she expressed concern about the SEC's strategy and pressed government lawyers to explain the limits of her argument.
Those hearings came a few days after a big victory for the crypto industry, when the SEC approved a new Bitcoin investment product for trading on Wall Street. Gensler had fought to block its introduction until a court ruled against the SEC in August, effectively forcing the agency to act.
“That was something extraordinary that gave people cause for hope,” said Coinbase's Grewal. “There is real optimism in the industry now.”
