Is crypto a security? An American judge is about to rule

After more than two years of protracted legal wrangling, all the evidence has been heard, and nothing remains but for Judge Analisa Torres of the Southern District of New York to issue a verdict. Those with a stake in the outcome, which will reverberate throughout the crypto sector, have attempted to predict when a verdict might land, based on the judge’s past ruling patterns. Some believe a solution is only days away.

By bringing the indictment, the SEC has asserted jurisdiction over cryptocurrency. At the center of the case is the question of whether XRP, the crypto token on which Ripple’s services are based, should be classified as a security – a tradable financial instrument such as a bond or derivative – or something else entirely.

If the court rules that XRP is a security, it will follow that almost all other crypto-tokens are as well, making them subject to SEC oversight. Not only would this impose burdensome registration and reporting requirements on crypto firms, but it could also have legal ramifications for entities that have issued tokens or helped people trade them without SEC approval. Even large US-based exchanges can suddenly find themselves in the crosshairs.

That, says defense attorney John Deaton, who provided expert testimony on the case on behalf of holders of XRP, would be “very bad news” for crypto businesses.

In the absence of legislation clarifying the classification of cryptoassets in the United States, the question of whether they should be treated as securities must be assessed on a case-by-case basis using the Howey test. Under the test, an investment contract (in this context, a security) is defined as “an investment of money, in a joint enterprise, with a reasonable expectation of profit, to be derived from the efforts of others.”

When the SEC charged Ripple and its executives, it declared that XRP met these criteria and that the company, by raising funds through the sale of XRP, was in violation of federal securities law.

Although Ripple is not itself the issuer of XRP, which sits on top of the open source XRP Ledger, some of its leaders were part of the group that developed the token. The firm had also received a donation of 80 billion XRP in the early 2010s (worth around $30 billion currently) to develop use cases – some of which were sold.

Ripple challenges the SEC’s analysis on two fronts: It argues that the sale of XRP does not qualify as an investment contract because no contracts were signed when the transactions took place, and separately, that XRP does not satisfy the parts of the Howey test. .

Stuart Alderoty, head of legal affairs at Ripple, says the company is confident that XRP does not meet any of the Howey criteria, but is particularly convinced that there is no joint venture – a group entity that affects the fortunes of XRP investors – among other XRP holders, only “common interest.”

However, the SEC has long said that the majority of cryptocurrencies are securities, because people invest with the goal of making money, and although tokens sit on top of decentralized blockchain networks, in practice many projects are sufficiently centralized to meet the definition of a joint enterprise. .

The SEC declined to comment for this article.

Speaking at a conference in September, SEC Chairman Gary Gensler called for crypto companies to register with the agency. “Given that many crypto-tokens are securities, it follows that many crypto-intermediaries deal in securities and must register with the SEC in some capacity,” he said.

However, US government agencies have contested the SEC’s right to regulate crypto. In a lawsuit filed March 9 against crypto exchange KuCoin, New York Attorney General Letitia James argued that ether (the cryptocurrency of the Ethereum network), among other crypto assets, should be treated as collateral. But the Commodities and Future Trading Commission (CFTC), another US financial regulator, argues that ether is a commodity and should therefore fall under its purview.

The SEC has been cracking down on the crypto industry over the past four months following the implosion of crypto exchange FTX in November, which took away hundreds of millions of dollars in client funds. Since then, the SEC has launched a series of quickfire actions against crypto companies serving the US market.

In January, the regulator charged crypto exchange Gemini and crypto lender Genesis Global Capital for a service that allowed US customers to earn interest on their assets, which the agency alleged was an unregistered securities offering. In a Twitter threadGemini co-founder Tyler Winklevoss called the allegations “a manufactured parking ticket” and announced that “we look forward to defending ourselves,” but neither the company nor Genesis responded to a request for comment.

This was followed in February by a settlement with another exchange, Kraken, which agreed to suspend its crypto staking service in the US, and a threat to sue crypto firm Paxos over its BUSD stablecoin. In both cases, the SEC again claimed that the parties violated securities laws. In a statement, Paxos wrote that it “categorically disagrees with the SEC.”

However, the agency has faced setbacks in recent weeks in its bids to block crypto exchange Binance from buying the assets of bankrupt crypto lender Voyager Digital, and asset management firm Grayscale from marketing a bitcoin exchange-traded fund (ETF).

Because the case is being held in a district court, the outcome will not set a “binding precedent,” said James Filan, a defense attorney and former federal prosecutor. It is therefore not required that the judgment be included in judgments in similar cases in the future. However, the ruling could establish what is known as “persuasive precedent,” he says, which could influence the thinking of judges in future cases.

If the SEC were to win, it would be given the advantage in its “turf war” with the CFTC, Filan says. The crypto industry will not escape oversight in either scenario, but the CFTC is seen by the exchanges (including FTX) as a soft touch by comparison.

If the SEC is established as crypto’s main regulator, companies may have to register their US-facing services with the agency. But many crypto firms have had a “hall pass” to operate in gray areas, says securities lawyer Aaron Kaplan. An SEC victory would mean they would have to unwind their various business areas to meet regulatory requirements.

“This would be very difficult for many crypto companies to achieve,” says Kaplan. “As such, [they] could choose to move and operate outside the United States … Those who do not will need to evolve and conform—or die.”

Ripple has already announced that it will appeal in the event of a loss. Doing so would send the case to the Second Circuit — and then potentially the Supreme Court. Alderoty does not expect the SEC to appeal, but instead to argue that the result was an anomaly. Filan suspects, however, that the agency will feel it has little choice if it hopes to maintain its claim to jurisdiction.

As a consequence of the lawsuit, Alderoty says, Ripple has been forced to pull back efforts to expand in the United States and instead focus on other territories, such as Singapore. Since the charges were filed, the firm has chosen to operate virtually “as if the SEC won,” to ensure that the business remains viable regardless of the outcome. If Ripple wins the case, it will be able to lean back into the US.

Crypto markets are likely to react to the ruling when it arrives, as traders price in either renewed clarity on the legality of crypto services provided in the US, or the prospect of further enforcement action.

“We know the crypto market will quickly incorporate the ruling, and token prices will almost certainly be affected,” said Katherine Snow, director of legal at crypto research firm Messari.

No one knows exactly when the judgment will land; it could be days, weeks or months. Until then, the crypto industry will have to wait, because “anyone who tries to predict the outcome,” says Filan, “is either going to be lucky or wrong.”