Why does the SEC consider cryptocurrencies as securities, and how could this impact their prices?

Securities refer to financial instruments issued by a company or a government to finance certain activities. Investors can trade these instruments on the floor of stock exchanges, but online trading has recently become more popular. For instance, NASDAQ, one of the top stock exchanges, allows online trading only.

Trading or investing in securities is an exchange between two parties, where one (the issuer) is looking for capital and the other (the investor) for income. The government organizes and regulates this trading activity to protect investors, requiring that participants adhere to strict regulations.

The U.S. Securities and Exchange Commission (SEC) supervises securities trading in the United States. The Financial Industry Regulatory Authority (FINRA) and the Federal Reserve are other government organizations with regulatory interest in this market.

Are Cryptocurrencies Securities?

The cryptocurrency market has experienced phenomenal growth in recent years. This growth has, in part, been fueled by distrust of the government’s role in issuing fiat money. Many people have found cryptocurrencies appealing because they are largely unregulated and independent of intermediaries like banks and stock exchanges, allowing cryptocurrencies to operate almost instantaneously. However, this lack of regulation has contributed to the extreme volatility of cryptocurrency prices and the susceptibility to fraud in the crypto market.

Recently, scrutiny of the crypto market by financial authorities has increased. On March 9, 2022, the President of the United States, Joe Biden, signed the “Executive Order on Ensuring Responsible Development of Digital Assets.” This executive order requests federal agencies to evaluate the risks and benefits of cryptocurrencies. The SEC is pushing to have crypto market participants comply with applicable laws. The SEC argues that the top five crypto exchanges, accounting for 99% of cryptocurrency trading, likely are trading securities.

In the United States, all products and platforms engaging in the sale and offering of securities must register with the SEC under federal securities laws and provide disclosures to inform investors of potential risks. This requirement also applies to cryptocurrencies, crypto exchanges, and other crypto-related products and businesses. But then a critical question arises: are cryptocurrencies securities?

Since Bitcoin emerged in 2009, whether to consider cryptocurrencies as securities has been widely debated. Former SEC Chair Jay Clayton clarified back in 2018 that “true cryptocurrencies (i.e., those that simply act as replacements for traditional fiat money) are commodities rather than securities.” Examples of these cryptocurrencies are Bitcoin, Ether, and Litecoin. However, the current SEC Chair, Gary Gensler, has taken a stricter stance, claiming that “everything other than Bitcoin” is a security and, therefore, must be regulated.

The crypto market comprises thousands of products referred to as coins, tokens, currencies, and assets. Hence, to determine which crypto products are securities, the SEC considers whether they constitute “investment contracts.” For an asset to be considered an investment contract, it must meet the three criteria of the so-called Howey Test:

The investment of money,
In a common enterprise,
With a reasonable expectation of profits to be derived from the efforts of others.

In his vision for cryptocurrency regulation published on August 4, 2021, Gary Gensler applied the above criteria. He concluded that many crypto coins and tokens are securities, arguing that “If somebody is raising money selling a token and the buyer is anticipating profits based on the efforts of that group to sponsor the seller, that fits into something that's a security.”

In the last few years, the SEC has filed several lawsuits against crypto issuers and platforms for failing to register specific cryptocurrencies as securities. In the most recent cases against crypto exchanges Coinbase and Binance, the SEC named a total of 68 cryptocurrencies as securities.

There is a way to know which crypto assets the SEC considers securities. In the first week of August this year, CoinGecko, the world's largest independent cryptocurrency data aggregator, unveiled a new index tracking the top alleged SEC securities crypto coins and tokens. The index lists the crypto assets by market capitalization.

The Outcome of the SEC Lawsuit against Ripple Labs

The most notable lawsuit brought by the SEC was likely against Ripple Labs Inc. and a few of the company’s executives. The SEC filed the lawsuit in December 2020, alleging that Ripple Labs raised over $1.3 billion through an unregistered securities offering. Ripple Lab’s cryptocurrency, XRP, was the alleged security in this case. The SEC accused the defendants of failing to register their offers and sales of XRP in violation of the registration provisions of the federal securities laws.

On July 13, 2023, U.S. District Judge Analisa Torres ruled that Ripple Labs Inc. did not violate federal securities laws by selling XRP on public exchanges. In other words, XRP cannot be considered a security if traded on crypto exchanges. This ruling was the first win for a crypto company in a case brought by the SEC, a landmark victory that will set a precedent for other cryptocurrencies fighting similar legal battles. However, Torres also ruled that the sales of XRP to hedge funds and other sophisticated purchasers amounted to unregistered sales of securities totaling $728.9 million.

How Could Regulation by the SEC Affect Crypto Prices?

Some crypto investors and traders are panicking because of the possibility of the SEC's strict oversight of the crypto market. Others regard regulations as something positive for the industry and look forward to a regulated market. So, is it positive or not? Let us briefly discuss it.

Many institutional investors would like to invest in cryptocurrencies, but the lack of regulations has kept them away. Regulations will make disclosures mandatory, helping to create transparency for the overall investment class. Institutional investors need a risk profile for each investment. However, such risk profiles can only be built for crypto assets with regulations in place.

Many experts in the crypto market think that coming regulation will ultimately help stabilize cryptocurrencies’ prices. Many crypto assets have been on a downtrend since Q4 2021, and many retail investors worry that the bottom has yet to be hit. However, regulations could incentivize more institutional investment, driving the value and stability of many crypto assets.

Good times for the crypto market might be around the corner. If you want to invest in cryptocurrencies, you can buy over 3,500 coins and tokens on LetsExchange.io.

Disclaimer

Please keep in mind that the above information is based exclusively on our observations and is provided for informational purposes only. It doesn’t constitute any kind of financial advice nor represents an official forecast. Cryptocurrency is a highly volatile asset, and you are investing in it at your own risk.