Is Crypto a Security? Understanding the Legal Landscape

As the world shifts towards a more digital economy, cryptocurrencies have emerged as a revolutionary force, reshaping how we think about money and investment. However, this rapid evolution has also led to legal and regulatory challenges as jurisdictions scramble to understand and classify these assets.

Is your cryptocurrency a security under the SEC or a commodity according to the CFTC? This status can impact everything from what protections you as an investor receive to what rules companies must follow. In this article, we will delve into the nuances of the debate surrounding cryptocurrencies and whether they should indeed be considered securities.

The Great Crypto Debate: Is crypto security or commodity?

The classification of cryptocurrencies as either securities or commodities carries significant implications for regulatory oversight and industry practices. This ongoing debate is pivotal because it affects how these assets are regulated, marketed, and managed within financial systems.

Securities are primarily investment contracts where the investor anticipates profits derived predominantly from the efforts of others. This classification triggers a range of regulatory requirements, including registration with the Securities and Exchange Commission (SEC), disclosure obligations, and investor protections aimed at fraud prevention and market transparency. 

On the other hand, commodities are basic goods used in commerce. Interchangeable with other goods of the same type, they enjoy less stringent regulation compared to securities. Commodities are typically overseen by the Commodity Futures Trading Commission (CFTC) in the U.S., which focuses on open, competitive, and financially sound markets, without the same level of investment-specific safeguarding.

The distinction between these classifications affects everything from the legal responsibilities of crypto issuers to investor rights.

For example, if a cryptocurrency is deemed a security, the issuing company must comply with registration and disclosure requirements, which can be a burdensome process. This designation also affects how crypto exchanges operate, dictating whether they must register as securities exchanges or broker-dealers.

What is a ‘security’ under U.S. law?

Under U.S. law, a ‘security’ is broadly defined to include various types of financial instruments that investors can buy or sell, often with the expectation of earning a profit primarily through the efforts of others. This concept is encapsulated in the Securities Act of 1933 and the Securities Exchange Act of 1934, which provide a framework for the regulation of securities markets.

The legal definition of a security includes several specific instruments such as stocks, bonds, options, and others outlined in the “Howey Test,” a criterion stemming from the 1946 Supreme Court decision (SEC v. W.J. Howey Co.).

According to the Howey Test, an investment contract (and thus a security) exists if there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.

The SEC’s interpretation of what constitutes a security is critical because it determines the scope of its regulatory authority. The SEC has been particularly active in applying this definition to various investment schemes, including cryptocurrencies and ICOs. For example, if a cryptocurrency is marketed with the promise of profit derived mainly from the efforts of the promoter or a third party, the SEC may classify it as a security and therefore subject it to federal securities laws.

What makes a crypto asset a security in the U.S.?

The Howey Test, established by the Supreme Court in the case of SEC v. W.J. Howey Co., sets forth criteria to determine whether an arrangement involves an investment contract, which would be considered a security. According to the Howey Test, a transaction is deemed an investment contract if it involves:

An investment of money: There must be a capital contribution in the form of cash or other assets.

In a common enterprise: There is a pooling of funds or assets with other investors; the fortunes of each investor are interlinked with those of other investors in the enterprise.

With the expectation of profit: The investor anticipates earning a return on their investment.

Derived from the efforts of others: The profits expected from the investment are significantly influenced by the efforts, skill, or reputation of a promoter or a third party.

The application of this test to cryptocurrencies means that if a particular crypto asset is marketed with the promise that profits will be generated primarily through the efforts of others (e.g., developers or the user network), it might be classified as a security. This classification can be further influenced by the developers’ statements and marketing efforts. If they emphasize the potential for profits based on their actions or management, this supports the asset being viewed as a security.

Court rulings have reinforced this perspective, with several cases highlighting the relevance of developer or promoter actions and statements in affecting investor expectations and dependence. An example of this is the ongoing litigation involving Ripple Labs, where the SEC alleges that XRP was sold as an unregistered digital asset security, partly because of the company’s promotional activities that led investors to expect profit based on the efforts of Ripple’s management.

Which cryptocurrencies are securities?

This designation subjects these assets to strict regulatory scrutiny akin to traditional securities. In practical terms, it impacts how these crypto assets can be sold, traded, and marketed within the United States.

The SEC’s list of cryptocurrencies classified as securities was formulated through legal actions against major crypto exchanges like Binance and Coinbase. Among these crypto assets are well-known tokens such as Ripple’s XRP, Binance Coin (BNB), Solana (SOL), Cardano (ADA), and others like Polygon (MATIC) and Decentraland (MANA). The list also includes tokens associated with the Mirror Protocol project, which creates synthetic assets that mirror the prices of real-world assets like stocks. Tokens involved in significant initial sales, fundraising events, and those heavily promoted for their potential returns by their respective protocols also make the list.

SEC & crypto: how does the SEC regulate crypto?

The SEC’s regulatory approach to cryptocurrencies emphasizes identifying digital assets that qualify as securities. This classification subjects them to stringent oversight akin to traditional securities, such as stocks and bonds, including compliance with registration and disclosure requirements to protect investors and ensure market transparency.

A significant action by the SEC is its classification of numerous cryptocurrencies as securities, impacting how these assets are managed and traded within the crypto markets. This classification necessitates that exchanges where users can trade these identified assets comply with SEC regulations or face enforcement actions. However, despite the growing number of crypto platforms, only a few have successfully registered with the SEC, highlighting the challenges of regulatory compliance in this innovative market space.

Regulation of secondary market trading in cryptocurrencies involves oversight of how these assets are bought and sold after their initial issuance, typically on crypto exchanges or other trading platforms. This segment is crucial because it’s where the liquidity of a digital asset is most visible and accessible to the general public, including retail and institutional investors.

Which cryptocurrencies are regulated by the SEC?

Any cryptocurrency that meets the criteria of being a security, as per the Howey Test, falls under the regulation of the SEC. This includes a range of digital assets that the agency has actively pursued in legal actions against entities like exchanges, which facilitate their trading.

While many cryptocurrencies have been labeled as securities, this legal classification often requires validation in court, as seen in the ongoing case with Ripple (XRP).

Is Bitcoin a security?

Bitcoin was created by Satoshi Nakamoto, who designed it to function as a decentralized digital currency. Nakamoto’s vision of Bitcoin did not include it being classified as a security. This perspective aligns with Bitcoin’s decentralized nature and open-source development, where profits from Bitcoin ownership are not tied to the efforts of any specific individuals or entities. Instead, Bitcoin operates on a peer-to-peer network, where transaction verification and issuance of new bitcoins are decentralized processes performed by network participants (miners).

Bitcoin’s classification as a non-security stems from its fundamental characteristics as an anonymous and open-source protocol. Unlike traditional securities, which typically involve investments in enterprises with profit expectations from centralized efforts, Bitcoin’s value proposition lies in its utility as a medium of exchange and store of value within a decentralized network.

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Is Ethereum a security?

While Ethereum, like Bitcoin, operates on a decentralized network, the SEC has not clearly defined it as a non-security primarily due to its early funding model, which included a presale or ICO (Initial Coin Offering). However, recent developments indicate a shift.

In June 2024, the SEC concluded its investigation into whether Ethereum should be classified as a security, determining not to pursue any claims that sales of ETH are securities transactions. This decision reflects a recognition of Ethereum’s commodity-like characteristics, akin to Bitcoin, despite previous uncertainties.

Which cryptocurrencies are banned by the SEC?

The SEC does not typically “ban” cryptocurrencies outright, but rather regulates certain assets it deems to be securities under its jurisdiction. At the core of this classification, the Howey Test considers whether an asset involves an investment of money in a common enterprise with a reasonable expectation of profit derived from the efforts of others. If a cryptocurrency meets these criteria, it is subject to SEC regulations.

The SEC has identified a significant number of cryptocurrencies as securities, primarily through enforcement actions against platforms like Binance and Coinbase where these cryptocurrencies were being traded. This includes well-known tokens like Ripple’s XRP, Binance Coin (BNB), and others such as Solana (SOL) and Cardano (ADA).

However, it’s important to clarify that the SEC’s classification of these cryptocurrencies as securities does not mean they are banned. Rather, it means that the trading of these cryptocurrencies must comply with federal securities laws, which may include registering them with the SEC or following strict reporting and operational guidelines.

Which crypto exchanges are regulated by the SEC?

As of 2024, the number of crypto exchanges specifically regulated by the U.S. Securities and Exchange Commission (SEC) remains relatively small. The SEC’s regulatory framework primarily targets exchanges that list securities, requiring them to comply with federal securities laws, including registration and compliance obligations.

Several major exchanges, such as Kraken and Gemini, have engaged with the SEC and other regulatory bodies to ensure they meet compliance standards. For example, Kraken is regulated by top financial authorities like the ASIC in Australia and the FCA in the UK, reflecting its commitment to adhering to stringent regulatory requirements. Similarly, Gemini has obtained approval from regulatory bodies such as the UK’s FCA and the US’s NYSDFS, underscoring its position as a compliant trading platform.

Which crypto exchanges has the SEC issued enforcements against?

The SEC has been actively issuing enforcement actions against several major crypto exchanges.

Notably, Coinbase and Binance have faced significant legal challenges from the SEC:

Coinbase: Charged for operating as an unregistered securities exchange, broker, and clearing agency, and for issues related to its staking-as-a-service program. The SEC’s allegations highlight Coinbase’s failure to register its operations, which they claim deprives investors of necessary protections like fraud prevention and proper disclosure, essential for those trading in crypto asset securities.

Binance: Faced charges for operating an unregistered exchange and offering unregistered securities, including its own digital asset securities such as BNB and Binance USD (BUSD). The case emphasizes the exchange’s extensive operations and alleged disregard for necessary regulatory practices.

Bittrex: The SEC charged Bittrex and its co-founder, William Shihara, with operating an unregistered securities exchange, broker, and clearing agency. The SEC’s allegations were centered on Bittrex’s operations that included offering and selling what the SEC considered unregistered securities. This involved Bittrex’s interaction with crypto assets and the platform’s failure to register as a national securities exchange.

Aspects of crypto markets open to regulation

Despite being more than 15 years into the era of Bitcoin and the broader crypto industry, the regulatory landscape remains largely unsettled. As blockchain technology continues to evolve and redefine financial paradigms, the lack of global consensus on how to regulate various aspects of the crypto market—from cryptocurrencies and ICOs to NFTs, DAOs, and stablecoins—persists. This regulatory ambiguity complicates efforts to balance innovation with necessary protections for market participants.

Disclaimer: Please note that the contents of this article are not financial or investing advice. The information provided in this article is the author’s opinion only and should not be considered as offering trading or investing recommendations. We do not make any warranties about the completeness, reliability and accuracy of this information. The cryptocurrency market suffers from high volatility and occasional arbitrary movements. Any investor, trader, or regular crypto users should research multiple viewpoints and be familiar with all local regulations before committing to an investment.

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