SEC Crypto Regulation – Forbes Advisor

In the first half of 2023, Bitcoin (BTC) and other cryptocurrencies have bounced back from 2022’s big losses. However, the ongoing crypto winter has exposed weaknesses in digital currency markets, including exorbitant risk-taking, illegal securities promotions and outright fraud.

More and more, the U.S. Securities and Exchange Commission (SEC) appears set on cleaning up the crypto industry. While some investors argue that more regulations will help legitimize the space, others are concerned that too much regulatory interference could diminish its decentralized appeal.

Is Crypto a Security?

One of the biggest debates in the regulatory conversation is whether cryptocurrency should be classified as a security, a commodity, a currency or something else. As of now, this is very much an unanswered question.

If crypto is deemed a commodity like crude oil, coffee or natural gas, its primary U.S. regulator would be the Commodity Futures Trading Commission (CFTC). This agency regulates currency trading, and it would cover crypto trading as well if cryptocurrencies are deemed currencies.

But if legislators and regulators come around to the idea that crypto should be considered a security—like stocks, bonds and exchange-traded funds—it would fall under the jurisdiction of the SEC.

SEC Chair Gary Gensler has made clear he believes the vast majority of cryptocurrencies are securities, based on the Howey Test, which comes from a 1946 Supreme Court ruling in the SEC v. W.J. Howey Co.

“All of these companies should come into compliance with the law, and until they do, we will continue to pursue them as the cop on the beat, and investigate and follow the facts and law,” Gensler has told Congress.

However, Gensler has also specifically mentioned Bitcoin as an exception, classifying it as a commodity.

What Is the Howey Test?

Under the Howey Test, a transaction is considered to be a security if it meets the following four criteria:

• Money is invested.
• There is an expectation the investor will earn a profit.
• The investment is in a common enterprise.
• Profits are generated via the efforts of others.

“Promoters are marketing and the investing public is buying most of these tokens, touting or anticipating profits based on the efforts of others,” Gensler said in a Sept. 8 statement.

SEC Crypto Crackdown Timeline

The SEC and other regulators have been attempting to reign in illegal activity in the crypto sector for years, but their crackdown has picked up steam in the wake of the collapse of crypto exchange FTX in November 2022.

The U.S. crackdown hasn’t come without blowback, however:

• In April 2023, Gensler appeared before Congress. Republicans on the House Financial Services Committee accused the SEC of driving cryptocurrency platforms overseas, threatening U.S. leadership in global digital asset innovation.
• Also in April, Coinbase filed a petition for a “writ of mandamus,” asking a court to order the SEC to respond to a 2022 plea Coinbase made for the SEC to make a clear set of rules to determine whether or not a token is a security and specify how issuers can legally register with the SEC.
• The CFTC got in on the action in March 2023, suing the world’s largest crypto exchange Binance and accusing the platform of allowing U.S. customers to trade unregistered securities.
• Earlier in March, the SEC issued Coinbase a Wells notice, notifying the exchange that the SEC has identified potential U.S. securities law violations. The SEC had previously issued a similar warning to stablecoin issuer Paxos.
• In February, the SEC ordered Kraken to discontinue its U.S.-based crypto staking business, which advertised annual returns as high as 21%. Kraken later paid $30 million in disgorgement and civil penalties.
• In January 2023, the SEC charged crypto lender Genesis and exchange Gemini with selling unregistered securities. Genesis filed for bankruptcy protection just days later.
• When FTX collapsed in November 2022, the SEC brought various charges against FTX founder Sam Bankman-Fried, as well as several other executives tied to FTX, for their alleged roles in defrauding investors. Three executives tied to FTX have since pleaded guilty to charges and are cooperating with prosecutors, including FTX co-founder Gary Wang, Alameda Research CEO Caroline Ellison and FTX director of engineering Nishad Singh.
• In July 2022, the SEC charged former Coinbase executives with participating in a $1.1 million insider trading ring.
• In February 2022, crypto lender BlockFi agreed to pay $100 million in penalties to the SEC for failing to register sales of its retail crypto lending product. BlockFi went on to file for bankruptcy protection in November 2022 following the FTX bankruptcy.
• In September 2021, the SEC charged BitConnect executives for allegedly operating a Ponzi scheme and defrauding investors out of $2 billion.
• In December 2020, the SEC filed a lawsuit against Ripple Labs and its executives, charging them with conducting offerings of unregistered securities. The case hinges on whether or not Ripple’s cryptocurrency XRP is, in fact, a security. The ongoing case will likely be settled sometime this year.

“We’ve been saying this for some time, but regulation is not only coming but it is necessary and welcome,” Christian Lopez, head of blockchain and digital assets at Cohen and Company Capital Markets, says.

“Much of the concern in the crypto world is lack of regulatory clarity—the industry would welcome sensible guidelines within which to operate, so long as it doesn’t stifle innovation,” Lopez says.

With this in mind, Lopez says the U.S. has fallen behind much of the rest of the world in providing a safe path forward for crypto innovators and entrepreneurs.

Celebrities Caught Up in Crypto’s Troubles

In addition to its charges against crypto exchanges and other platforms, the SEC has cracked down on a number of celebrities involved in illegally promoting crypto assets.

In October 2022, celebrity Kim Kardashian paid the SEC $1.26 million in penalties tied to promoting EthereumMax without disclosing payments she received in return.

The growing list of celebrities who have been charged with similar violations includes social media influencer Jake Paul, actress Lindsay Lohan, musician DeAndre Cortez Way (Soulja Boy), musician Aliaune Thiam (Akon), boxer Floyd Mayweather Jr, music producer Khaled Khaled (DJ Khaled) and basketball player Paul Pierce.

What Does the SEC Crackdown Mean for Crypto Investors?

The crypto crackdown could make it difficult for U.S. investors to trade their favorite digital currencies, and it threatens to undermine the decentralized nature that attracted many crypto investors in the first place.

However, many experts agree that cryptocurrency exchanges need clear regulations for investors to feel safe, especially after a wave of crypto exchanges, lenders and funds have gone bankrupt in the past year.

Nick Ranga, senior cryptocurrency analyst at AskTraders.com, says more rigorous crypto regulation is a double-edged sword for crypto investors.

“Stricter regulation of cryptocurrencies would certainly protect investors, who are the ones who lose out when exchanges like FTX collapse. Regulation would likely place limits on how crypto can be used and may also stifle innovation within the sector,” Ranga says.

Sam Callahan, lead analyst at Swan Bitcoin, says Bitcoin investors have no reason to be concerned about the SEC’s aggressive crackdown.

“Bitcoin has been deemed a commodity, and when one takes self-custody of their Bitcoin, they no longer need to trust an exchange or any intermediary. This is a key reason why Bitcoin is a unique asset—it lacks counterparty risk,” Callahan says.

Perhaps the best news for crypto investors concerned about the SEC crackdown is the price action in the crypto market. Bitcoin prices are up 70.3% in 2023, while Ethereum (ETH) and several other top cryptos have also gained more than 50% year-to-date.