gary Gensler, Chairman of the United States Securities and Exchange Commission (SEC), has always stated that all digital tokens except Bitcoin fall under the jurisdiction of the SEC. Bitcoin, he says, is a commodity. In an interview with New York Magazine in February, Gensler said that “basically these tokens are stocks because there’s a band in the middle and the public is anticipating profits based on that band.”
With this description, Gensler is referring to the Howey test, based on a 1946 Supreme Court decision in SEC v. WJ Howey Co. Howey sold citrus orchards to Florida buyers, who leased the orchards to the company, which then grew the trees and sold the oranges on behalf of their buyers, sharing the profits. Howey subsequently failed to register with the SEC, arguing that his transactions were not investment contracts. Howey lost the case when the court ruled that sale-leaseback agreements were after all investment contracts, thus establishing the Howey test.
The Howey Test has four criteria for determining whether something constitutes an investment contract:
- A money investment
- in a joint venture
- waiting for a win
- result from the efforts of others
During a House Financial Services Committee congressional hearing in April, Gensler reaffirmed his position that “most crypto tokens are securities” and should be regulated by the SEC. According to him, the market is “rife with incompliance” and, in the name of protecting investors, should be regulated according to the standards applied to traditional finance: “It’s the law; it is not a choice. Calling yourself a DeFi (decentralized finance) platform, for example, is no excuse for defying securities laws.
The SEC has stepped up its enforcement of the crypto industry, going after companies and projects that it believes are selling unregistered securities. The agency reported about 50 separate enforcement actions against digital asset firms and requested an additional $78 million in funds to expand its business.
But his actions have not gone without criticism. During this hearing, the chairman of the committee, Rep. Patrick McHenry, RN.C. said, “Your approach spurs innovation overseas and jeopardizes American competitiveness. Regulation by enforcement is neither sufficient nor sustainable. You are punishing digital asset companies for supposedly breaking the law when they don’t know it will apply to them.
Gensler appeared to show little sympathy, saying that “we have a clear regulatory framework built on 90 years” and that exchanges are “just a bunch of intermediaries in this market who think they have a choice. They do not have the choice. They are generally not compliant, and they have to come into compliance. »
Do we really have “a clear regulatory framework” for digital assets in the United States? And should all digital tokens fall under the jurisdiction of the SEC? Before answering these questions, let’s start by understanding the legislative and regulatory structure and landscape in the United States and their implications on the digital asset space.
The regulations today
The United States has a “dual banking system,” which means that the provision of digital asset services can be regulated at the state or federal level. In both cases, state and federal regulators and enforcement agencies have moved ahead of Congress and the White House to regulate digital asset activity.
As regulators continue to discuss regulatory authority, policymakers have drafted proposals for digital asset legislation. For example, the bipartisan Responsible Financial Innovation Act (RFIA) would classify most digital assets as commodities, assign primary oversight responsibility to the Commodity Futures Trading Commission (CFTC), and establish requirements for stablecoins.
In March 2022, the Biden administration issued an executive order outlining a whole-of-government approach to addressing risks arising from the growth of digital assets and blockchain technology while supporting responsible innovation. In September 2022, the first results were reported, but questions remain as to which US regulators hold the power and authority to govern digital assets.
The Financial Stability Oversight Council (FSOC), an interagency advisory body comprised of state and federal banking, commodities, securities and consumer protection authorities, released a summary report concluding that there is no comprehensive regulatory framework in the United States for digital assets.
In the absence of this framework, the regulation of digital assets is based on their regulatory classification of assets, which may overlap. Specifically, digital assets can qualify in several categories:
- Payments: These fall under the jurisdiction of the Office of the Comptroller of the Currency (OCC) and the Money Services Business (MSB)
- Commodity: These fall under the jurisdiction of the CFTC
- Security: These fall under the jurisdiction of the SEC
When Gensler says that all digital assets (except Bitcoin) fall under the jurisdiction of the SEC, it implies that digital assets cannot function as payment or a commodity or have any utility other than trading as as security, such as shares on the stock market.
But we know that is clearly not the case. For example, coins like Dogecoin and Shiba Inu have no economic utility or merit, and are mostly traded and speculated. Despite this, some companies have already started to accept meme coins as payment; So, even if these tokens have no use, they can still be used as a method of payment. In such a case, they look like a foreign currency (FX) rather than a security, and FX falls under the jurisdiction of the CFTC.
Many also argue that Ether, the token used to facilitate transactions on the Ethereum blockchain, is a utility and not a security. Ethereum is a platform for developers to build decentralized apps, like iOS for the iPhone (iOS being a centralized platform), which means Ether should fall under CFTC jurisdiction.
CFTC Chairman Rostin Behnam in a Senate Agriculture Committee hearing called Ethereum a commodity, not a security. Behnam further argued that Ethereum has been listed on CFTC exchanges for some time, which creates a “direct jurisdictional hook” for the agency.
Crypto exchange Coinbase has filed a lawsuit against the SEC asking that the regulator be compelled to publicly share its response to a petition, filed in July 2022, on whether it would allow the crypto industry to be regulated using existing SEC frameworks. The SEC has not offered a specific public response to Coinbase’s petition, but in recent months it has aggressively stepped up enforcement actions and warnings against crypto exchanges, including Coinbase.
Gensler responded to the Coinbase lawsuit in a video to point out that what crypto exchanges do is very obviously marketing and selling securities, even though the debate on the subject has been obscured, and again referenced the Howey test. “An investment contract exists when you invest money in a common enterprise with a reasonable expectation of benefits from the efforts of others. Intermediaries for investment contracts, whether stock exchanges, brokers, dealers, clearing houses, must comply with securities laws and register with the Securities and Exchange Commission.
Do all digital assets pass the Howey test?
Howey’s test isn’t entirely clear, and using a 1946 orange grove case to decide whether a digital asset is a security or not might need to be updated to take into account changes in the technology, globalization and financial instruments. For example, stablecoins, which are pegged to the US dollar, could be considered a security. But the purpose of a stablecoin is to be used as a means of payment on digital and web3 platforms and no profit or expectation of profit is involved.
And what about central bank digital currencies (CBDCs)? What if the United States launched a digital currency that is a pure digital dollar – would that be a security?
There are tens or hundreds of thousands of tokens – anyone can create one. The real problem is with projects that accumulate significant capital through the issuance of tokens. It’s fair to say that at the time of the issuance process, most of them would pass the Howey test, but what does that mean years later, for continued trading and use of tokens as in the case of Ether?
DeFi applications are another critical example. By construction, they are not a company controlled by a centralized authority – nobody controls a decentralized application (that’s the whole point). Who would be responsible in this case? The developers? If you decide to regulate developers, it could deter innovators from building apps and significantly stifle innovation. Before deciding whether and how to regulate DeFi, we might consider the approach taken by the Banque de France, which published a discussion paper entitled “Decentralized or disintermediated finance: what regulatory response”, containing 38 questions and asking for answers from the public. .
It is clear that we do not have a clear regulatory framework for digital assets in the United States and that all digital tokens and platforms (i.e. DeFi) should not be subject to the regulations of the DRY.
How can we get more regulatory clarity?
Federal legislation would certainly create guardrails around the SEC and help determine which federal agencies are responsible for regulating different types of digital assets. A clear framework by lawmakers would bring clarity to the industry. People who want to invest in digital assets will feel more confident if there is a clear framework, knowing that they are protected, whether it be the SEC or the CFTC, or if Congress has proposed a new agency that would oversee digital assets.
Another potential outcome is a Supreme Court decision, such as the Howey case. Since the Howey test is a precedent set by a court ruling, is it possible that courts could set a similar precedent for digital assets?
Absent congressional action, you could have a landmark case like the Ripple affair playing out right now.
Clearly, greater regulatory clarity on digital assets is needed, and sooner rather than later. It is vital that US lawmakers take a more proactive approach to dispelling confusion and ambiguity.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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