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The Latest in Cryptocurrency Regulation–Still a Moving Target

2023 has been an extremely tumultuous year for the cryptocurrency sector. It was only three years ago that crypto assets seemed poised to achieve mainstream status. The meteoric rise in the value of Bitcoin and Ethereum invited a wave of excitement and speculation as digital assets spiked in value across the boards.

Countless new issuers and exchanges appeared across the crypto landscape offering their own unique blockchain based financial instruments. And everyday investors clamored to get their own piece of this new pie.

Indeed, members of the public who at first viewed the virtual currency exchange with suspicion were increasingly coming to see it as a meaningful outlet for their investment funds. And then, just as quickly as cryptocurrencies rocketed into the mainstream, the sector’s reputation was dashed wholesale by a series of high profile scandals.

The most prominent of these was the case of FTX, in which founder and CEO Sam Bankman-Fried propped up an empty token sale to facilitate money laundering and embezzlement. When FTX collapsed, countless investors were harmed. The FTX collapse is just one of several instances of investor abuse in the crypto space over recent years.

Revelations of these scandals were followed by a precipitous free fall in the value of digital assets throughout the crypto space. Indeed, 2022 was a period that many observers have termed a crypto winter–a period of declining value, stifled innovation, and diminished investment. Investor confidence in the very concept of cryptocurrency had been badly shaken by its sheer volatility and vulnerability to abuse.

It also revealed a problematic reality. As of today, there is an absence of clear, consistent and comprehensive crypto regulation. This vacuum of regulatory authority has opened the door widely to bad actors like Bankman-Fried.

At the time of writing, this is a problem that remains very much unsolved. In fact, the courts continue to wrestle with questions surrounding regulation of the blockchain to this very day. It isn’t entirely clear what the future holds for crypto regulation.

But if you’re trying to get a handle on the current situation in the crypto space, you’re curious about what the present role of crypto is in our broader financial markets, or you’re just trying to anticipate what your own crypto assets are likely to be worth in a few years, we’re here to bring you up to speed on the current legal wrangling around cryptocurrency regulations.

If you’re curious about what the short-term future holds for the value of your crypto assets, check out our answer to the question–will crypto recover?

Otherwise, read on to find out what’s happening with cryptocurrency on the legal and regulatory front.

FTX and The Crypto Winter

As noted above, last year’s plunging crypto values were instigated by a series of scandals that demonstrated just how desperately the blockchain space needs a regulatory framework. The most prominent of these scandals involved a cryptocurrency exchange called FTX.

According to an article from Investopedia, “FTX’s collapse took place over a 10-day period in November 2022. The catalyst was a Nov. 2 scoop by crypto news site CoinDesk that revealed that Alameda Research, the quantitative trading firm also run by Bankman-Fried, held a position valued at $5 billion in FTT, the native token of FTX. The report disclosed that Alameda’s investment foundation was also in FTT, the token that its sister company had invented, not a fiat currency or other cryptocurrency.”

In the midst of this ten-day period, rival exchange Binance announced its intent to purchase FTX before quickly backing out of the deal over solvency concerns. Those concerns proved immediately valid. Bankman-Fried stepped down from his office as FTX declared bankruptcy. 

In the days that followed, hundreds of millions in FTT tokens were exchanged for Bitcoin and subsequently disappeared in an alleged hack. This occurred just as Bankman-Fried fled the country. He was apprehended in the Bahamas on January 3rd, 2023, and extradited to the United States where he awaits trial.

Today, the Securities and Exchange Commission is engaged in efforts to recover the millions lost to investors directly through Bankman-Fried’s embezzlement scheme. But it is also worth noting that the crypto industry altogether lost more than a billion dollars in value in the aftermath of the FTX scandal.

Naturally, this represents a clear case of criminal behavior and demonstrates the vulnerability of this unregulated asset class to money laundering, embezzlement and other forms of fraud. But it has also spurred the SEC onward in its crusade to bring some type of far reaching regulatory framework to the crypto space. And contrary to the FTX case, the legal implications of this crusade are a lot less clear cut.

The U.S. Securities and Exchange Commission (SEC) and Crypto Regulation

The Securities and Exchange Commission (SEC) is the primary regulatory agency charged with oversight and enforcement of securities laws. At the moment, this agency does not have an official mandate to enforce rules in the crypto space…unless it can prove that crypto tokens are securities.

Therefore, this is the primary question at the heart of several concurrent legal cases in the crypto space. But an answer to this question has been difficult to ascertain. 

As recent scandals demonstrate, securities laws are far from clear as concerns cryptocurrency regulations. The SEC has proposed to solve these problems by attempting to prove through legal action that crypto tokens are securities, that said securities should be registered with the SEC before trading can legally take place around these assets, and that enforcement actions are warranted against those the Commision has deemed guilty of trading unregistered securities.

The rapid pace of the SEC’s legal actions has only hastened in recent months. As a legal analysis from Patterson and Belknap explains, “Under the helm of SEC Chairman Gary Gensler, the Securities and Exchange Commission has argued that many cryptocurrencies qualify as ‘securities’ under federal law, and therefore fall within the SEC’s bailiwick. The SEC hasn’t shied away from acting on this asserted authority: just since the start of the new year, it has brought 24 cryptocurrency enforcement actions.”   

How these cases ultimately play out in the courts could inform the future of crypto regulations. Then again, the courts may fail to establish any meaningful precedent. Indeed, there is much confusion around the best way to characterize and classify the crypto exchange.

One reason for the confusion may be the legal precedent that the SEC is using to try and prove its case. The Commission argues that the sale of tokens, or facilitation of the exchange of tokens, qualifies as something called an “investment contract.”

An investment contract is considered a security, and must therefore be registered through the SEC. If, indeed, the sale of crypto tokens does qualify as an investment contract, various crypto issuers, crypto exchanges, and digital asset depository institutions have already violated the SEC’s rules by trading unregistered securities. This accounts for the preponderance of cases now before the courts.

But how do we determine whether or not a transaction qualifies as an “investment contract”? Well, in spite of the innovative technology at the heart of this conversation, our answer actually comes from a standard that is nearly eight decades old. This standard is called the Howey Test, and the SEC has argued that its conditions qualify cryptocurrency transactions as investment contracts.

A Bit More on The Howey Test

The Howey Test is a standard that was established in 1946 to determine whether or not certain arrangements should be classified as investment contracts. In short, says Cointelegraph, “The Howey test consists of four elements often referred to as prongs. According to the test, a transaction is a security if it is (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, or (4) to be derived from the efforts of others. All four test conditions must be met, and the test can only be applied retrospectively.”

For a little bit of history, the Howey Test was originally devised around an investment contract involving an orange growing business. Investors provided funds in support of the development of orange groves based on the explicit promise that the proprietors would do everything in their power to build a profitable enterprise using these initial investments. In return, investors would receive a share of the profits.

This arrangement was deemed an investment contract, and therefore, qualified as a security requiring registration with the SEC. Subsequent cases involving perceived investment contracts have all been judged according to this test.

In explaining why it believes that an Initial Coin Offering from a crypto issuer should be regarded as a security, the SEC argued that “The U.S. Supreme Court’s Howey case and subsequent case law have found that an ‘investment contract’ exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. The so-called “Howey test” applies to any contract, scheme, or transaction, regardless of whether it has any of the characteristics of typical securities.”

In the SEC’s view, the sale of digital assets as a method of raising capital and the accompanying promise that the value of these assets will rise in correspondence with the successful pursuit of the company’s broader profitability render any suc transaction an investment contract. 

As the SEC’s argument recognizes, “The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold (which includes secondary market sales). Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply.”

Based on the SEC’s position, the onus should fall upon those operating in the crypto space to determine whether or not the initial sale of tokens, the facilitation of token exchange, or even the sale of tokens on the secondary market qualifies as an investment contract. Those crypto entities which have already failed to take these questions into consideration have run afoul of a legal threshold with longstanding historical precedent, argues the Commission.

But this is merely one side of the coin. Indeed, there are those who don’t believe that the sale of a digital or virtual currency qualifies as an investment contract even with a full reading of Howey. As the SEC presses forward with suits against crypto exchanges and the issuers of digital currencies, members of the blockchain sector argue that the Commission’s legal strategy represents a misreading of the Howey Test.

Indeed, this is the debate at the core of a more prominent recent case surrounding technology company Ripple Labs and its native XRP token.

The Ripple Case and the Torres Decision

In 2020, the SEC brought charges against executives from Ripple for selling the XRP token, which the Commission claims is an unregistered security. The SEC argued that the sale of XRP met the four prongs of the Howey Test and that the transactions surrounding these tokens should be legally regarded as investment contracts.

Just this summer, the case finally came before the United States District Court for the Southern District of New York. Judge Analisa Torres offered a ruling that left many observers scratching their heads.

As the analysis from Patterson and Belknap explains, “The SEC’s desire to regulate crypto suffered a blow on July 13, when Judge Analisa Torres of the United States District Court for the Southern District of New York issued her opinion on cross-motions for summary judgment in SEC v. Ripple Labs (“Ripple Labs”).  Judge Torres ruled that while Ripple Lab Inc.’s (“Ripple”) sale of its crypto asset XRP to institutional investors constituted the unregistered sale of a security in violation of Section 5 of the Securities Act of 1933, its sale of XRP to less sophisticated “Programmatic Buyers” did not.”

Stated more simply, Judge Torres found that Ripple was guilty of selling unregistered securities to institutional investors because it made explicit promises to these investors about their intent to pursue profitability and provide return on investment. On the other hand, Ripple was not guilty of selling unregistered securities to everyday investors because no such promise was made to this class of investors.

In essence, Judge Torres argued that the Howey Test offered regulatory protection to institutional investors (i.e. brokers, hedge funds, and other financial entities) while not offering these protections to programmatic investors (i.e. the vast majority of Americans who do their trading through online brokerages).

In their legal analysis, Patterson and Belknap warned that the Torres ruling was counterintuitive and therefore highly vulnerable to appeal. This proved entirely true. In fact, appeal would not even be required. The flimsy logic of the decision was obliterated a few weeks later by a judge on the very same bench as Torres.

The Terraform Case and the Rakoff Decision

Judging on a similar case involving stablecoin issuer Terraform, Judge Jed Rakoff, also from the United States District Court for the Southern District of New York, argued that there was absolutely no material difference between the sale of a crypto token to an individual investor or an institutional investor. In either instance, the sale represents an investment contract. And under the terms of Howey Test, an investment contract is a security which must be registered with the SEC.

As Mintz reported, “In SEC v. Terraform Labs Pte. Ltd. and Do Hyeong Kwon, the defendants moved to dismiss the SEC’s complaint arguing that the cryptocurrency tokens Terraform Labs (“Terraform) developed and sold were not “investment contracts” (and thus “securities”) under the Howey test.  According to the defendants, Judge Torres’s decision in Ripple was “fatal” to the SEC’s case that Terraform’s digital assets were sold as investment contracts.  But Judge Rakoff disagreed, emphatically rejecting the ruling in Ripple and Judge Torres’s application of the Howey test. Judge Rakoff concluded that, at the Rule 12 stage, the SEC had met its burden of alleging that the tokens qualified as securities.”

This decision, while a clear victory for the SEC, is hardly a precedent surrounding broader cryptocurrency regulation. This is true for a few reasons. First and foremost, Terraform made it very clear in the immediate aftermath of the decision that it intends to appeal its case. Whether appeals will ultimately lead this case to the Supreme Court and the establishment of an actual precedent remains to be seen.

Given the general lack of clarity around crypto regulation, it’s hard to say for certain where such a decision might land. Moreover, even if this decision does land the ball in the SEC’s court, it’s not necessarily clear that this would create a universal legal precedent applying to the exchange of crypto tokens more broadly–which seems to be the SEC’s primary objective.

Indeed, there are many legal experts who argue that the Howey Test simply doesn’t fill the regulatory gaps currently surrounding the crypto space.

Returning to the Howey Test

It is understandable that the Howey Test has been invoked by the SEC, as well as by various plaintiffs against crypto firms. But as some legal professionals suggest, the test is not being applied correctly.

One of the oft-restated and key takeaways from the Howey Test is that “the oranges are not securities.” In other words, in that original precedent setting case, investors did not invest in oranges. They invested in the broader arrangement in which oranges are merely a commodity. The security is the arrangement itself.

Those who dispute the SEC’s position on crypto suggest that identifying the sale of tokens as investment contracts is akin to identifying oranges as securities. These don’t represent the totality of the agreement, and therefore should not be regarded as an investment contract.

Moreover, say critics of the legal and regulatory efforts, the very nature of decentralized finance makes the Howey Test a poor fit for evaluating what cryptocurrency is or isn’t.

This may account for some of the confusion and disagreement we’ve seen on the legal landscape, best highlighted by the diverging opinions in the Southern District of New York. Attempting to fit the pieces of the blockchain into the Howey Test may simply be the wrong avenue to establishing a legal framework around crypto.

And this makes a lot of sense when you consider the innovative and unprecedented nature of digital currencies on the blockchain. This represents a whole new asset class, so it may be reasonable to conclude that this test was not built to accommodate certain key questions.

So what does that mean? Essentially, it means that the only real way forward is for Congress to produce meaningful legislation both codifying crypto regulation and tasking the appropriate agency with the task.

Congressional Proposals

This, in essence, brings us up to speed on cryptocurrency regulations as of late 2023. Evidence abounds that regulation is needed. But evidence equally abounds to suggest that regulators and legal professionals are still attempting to better understand these new asset classes and how they fit into more traditional financial markets.

This is why guidance is needed in the form of consequential legislation. At this point it will essentially require an act (or numerous acts) of Congress to help move the ball forward. 

Indeed, as Mintz reports, “the Ripple decision did not have that effect, nor (likely) will the Terraform decision. Yet some congressional momentum has started to gather, with the House Financial Services Committee recently advancing a bipartisan bill out of committee aimed at: (1) clearly defining when crypto assets qualify as securities under the federal laws; (2) expanding the Commodity Futures Trading Commission’s scope of regulatory authority over the crypto industry; and (3) clarifying the SEC’s scope of authority over the industry.”

Consequently, this Congressional act would place regulatory authority in the hands of an alternative agency such as the Commodity Futures Trading Commission (CFTC), which might ultimately expand the funding and mandate of this alternative regulatory agency. The CFTC, some members of Congress believe, is ultimately more sympathetic to innovation and evolution in the blockchain space relative to the SEC.

This could ultimately lead to more clarity around the regulatory treatment of cryptocurrencies, more direct guidance toward compliance for crypto entities looking to operate lawfully, and a more harmonious relationship between regulators and the crypto industry.

Still, Mintz recognizes that “It is too early to know whether such a bill could pass a divided Congress, let alone be signed by the Biden Administration. Yet until Congress acts, the question of when and how a digital asset becomes a ‘security’ subject to the federal securities laws and requiring registration remains far from settled.”

This means that crypto firms are still operating in something of a Wild West. The rule of law is coming to cryptocurrency in one way or another. But how long that will take, and what that legal framework ultimately looks like, are anybody’s guess.


One thing is clear. It will be to the benefit of the crypto sector and investors alike to arrive at a consensus on the best path forward–one that balances investor protection with the fostering of innovation. 

Speaking of innovation, check out our look at the top ten reasons it’s worth investing in cryptocurrency, regardless of the current regulatory environment.