For more than a decade, cryptocurrency industry pioneers envisioned digital coins as an alternative branch of finance, a sector that would operate outside the reach of big banks and government regulators.
But as digital currencies like Bitcoin and Ether became more mainstream, the crypto industry ran into a 1946 Supreme Court decision known as the Howey test, a legal analysis that determines whether a financial product is a stock. Becomes subject to the same strict rules as. And bond.
In recent years, regulators have seized on that legal precedent to argue that cryptocurrencies are just another security, like shares of Apple or General Motors. The crypto industry has responded to this and left it in a legal gray zone with an uncertain future in the United States.
Now the long-running dispute is moving closer to resolution, as federal judges have begun considering a series of lawsuits by the nation’s top securities regulator against some of the largest crypto firms. This month, judges heard two of the most important cases that could decide whether the multitrillion-dollar crypto industry can continue to grow in the United States.
Hillary Allen, an American university professor who specializes in financial regulation, said the legal fight is “an existential issue for crypto.”
The court battle has intensified over the past 18 months, as the Securities and Exchange Commission has brought enforcement lawsuits claiming crypto companies were operating as unregulated securities businesses. In response, the industry argued that the laws governing Wall Street trading should not apply to digital currencies. Both sides won initial victories in court, leaving the case unresolved.
But this month, federal judges held hearings in two cases that legal experts expect to be more decisive: the SEC’s lawsuits against crypto exchanges Coinbase and Binance, which explore core issues in the broader legal battle. Preliminary rulings in those cases are expected in the coming weeks, setting the stage for litigation that could ultimately reach the Supreme Court.
“We have built our legal strategy around a potential Supreme Court showdown,” said Paul Grewal, Coinbase’s chief legal officer. “These are issues that could have a potential impact on large parts of the economy.”
How the court rules could determine whether the crypto industry can penetrate deeply into the US financial system. If the SEC prevails, crypto proponents say, it will stifle the development of a new and dynamic technology, prompting start-ups to move offshore. The government has countered that stronger oversight is necessary to end the massive fraud that caused investors to lose billions of dollars when the crypto market imploded in 2022.
“The history of crypto markets shows that investors are at risk and being harmed by these platforms’ blatant disregard for regulatory requirements,” SEC spokeswoman Stephanie Allen said.
The origins of crypto date back to 2008, when a developer known by the pseudonym Satoshi Nakamato created the software behind Bitcoin. Early advocates saw crypto as a decentralized alternative to traditional finance, a communal project run by a wide network of people spread around the world.
But as the industry matured, companies resembling traditional finance firms began developing cryptocurrencies and aggressively marketing them. Enthusiasts bought digital coins in the hope that their value would increase. The government saw the emerging sector as an unregulated version of Wall Street, rife with fraud and manipulation. According to Cornerstone Research, a consulting firm, the SEC filed 46 crypto-related enforcement actions last year.
The SEC’s blueprint for crypto is guided by a 1946 Supreme Court case involving investments in Florida orange groves. This case led to the creation of the Howey Test, which is a legal standard for determining whether something constitutes a security if it is not a stock or bond.
Under the framework, a financial product becomes a security when it offers an opportunity to invest in a “common enterprise” with the expectation of profiting from the efforts of other people. Examples of securities under the Howey test include certain insurance products and even contracts of sale. chinchilla,
Classification as a security comes with a wide range of legal requirements: Companies offering securities must provide detailed disclosures and follow complex investor-protection procedures that can be costly to complete.
In public comments, SEC Chairman, Gary Gensler, has argued that most digital currencies qualify as securities under the Howey Test, because people invest in crypto expecting that the companies issuing the currencies will raise prices. He has said that only Bitcoin is beyond the reach of the SEC, because no central group or individual oversees it.
Under the SEC’s rule-making authority, Mr. Gensler had the option to develop new rules for the crypto industry. But instead he has argued that the industry should be governed by existing laws and established court decisions to protect investors from fraud.
The crypto industry has called that approach overly broad, protesting that it requires there to be a formal contract between the seller of the digital coin and the investor to arrange a securities transaction.
“Gensler’s approach is putting a square peg in a round hole,” said Teresa Goody Guillen, a partner at BakerHostetler and a former SEC litigation lawyer. They’re all securities.”
Mr. Gensler’s strategy faced an early test in the SEC’s lawsuit against digital currency issuer Ripple. In July, Analisa Torres, a federal judge in New York, 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 found that these investors did not expect to profit from Ripple’s actions as a business.
The decision was celebrated in the crypto world. But the enthusiasm waned a few weeks later when a judge in another case supported the SEC’s view that a different set of cryptocurrencies qualify as securities and rejected much of Judge Torres’s argument.
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 qualify as securities, providing an opportunity for judges to issue sweeping rulings that could apply to the universe of digital assets.
A hearing last week in the Coinbase case in federal court in Manhattan lasted five hours, with more than 500 people listening in via phone; About 250 people attended the Binance hearing in Washington on Monday. Both hearings revolved around the applicability of the Howey test to digital currencies.
Coinbase lawyers have argued that the SEC is trying to stretch the intent of the Howey test to cover crypto investments. Lawyers have said that without an explicit contractual agreement between the buyer of a digital coin and its issuer, a cryptocurrency is no different from any other “collectible” whose value can increase over time, like baseball cards or Beanie Babies dolls. .
At the hearing, Judge Katherine Polk Failla appeared to support some of Coinbase’s concerns about SEC overreach, saying the commission may be “too overly broad.”
He told a commission lawyer, “We’re all just appalled that you have such low limits on the standard” that some lawyers would argue that Beanie Babies are unregistered securities.
In the Binance case, Judge Amy Berman Jackson in Washington appeared more skeptical of the comparison between digital coins and collectible toys. But he expressed concerns about the SEC’s tactics and pressured government lawyers to explain the limitations of their argument.
The hearing comes just days after a major win for the crypto industry, when the SEC approved a new Bitcoin investment product for trading on Wall Street. Mr. Gensler had fought to block its introduction until a court ruled against the SEC in August, effectively forcing the agency out.
“This was an extraordinary thing that gave people reason to hope,” Coinbase’s Mr. Grewal said. “There is real optimism in the industry now.”