Most cryptocurrencies are securities. That, at least, is the opinion of Gary Gensler, chairman of the Securities and Exchange Commission. In numerous interviews and speeches, Gensler reiterated his view — and that of his agency — that “most crypto tokens are investment contracts under the Howey test.” This means that they are securities and if their issuers do not register them as such, the SEC could easily take legal action.
In fact, this has already happened on more than one occasion, with the SEC taking action in recent years against Ripple, Telegram, and LBRY, as well as against several trading platforms (such as Nexo, Paxos, and Gemini). And if the ongoing case between the SEC and Ripple ends with the ruling of the presiding judge in favor of the regulator, then there could be a wave of such actions in the coming years.
In fact, an SEC victory against Ripple could provide confirmation that most cryptocurrencies, including Ethereum (ETH), should be classified as securities under American law. As such, it could result in a contraction of the U.S. cryptocurrency industry as platforms and projects move toward registering with the SEC, though it could end up inadvertently benefiting Bitcoin, which the SEC doesn’t consider a security.
Why the SEC already classifies cryptocurrencies as ETH as securities
While written law and legal precedent still remain somewhat obscure in terms of classifying cryptocurrencies as securities (or not), there is a growing body of talk and evidence that the SEC believes most are securities.
Let’s take Gary Gensler’s speech at the Penn Law Capital Markets Association’s annual conference in April 2022. Here is one of the most revealing statements:
“The fact is that most crypto tokens involve a group of entrepreneurs who raise money from the public in anticipation of profits – the hallmark of an investment contract or security under our jurisdiction. Some, probably just some, are like digital gold; They may not be titles.”
Gensler echoed this line of reasoning elsewhere, doing so recently in a February 2023 interview with New York Magazine’s Intelligencer. In this particular piece, he suggests that Bitcoin is not a security, although it is not entirely clear whether this is the official position of the SEC.
“Everything but bitcoin, you can find a
website, you can find a group of entrepreneurs, they could create their legal entities in an offshore tax haven, they could have a foundation […] At first they could drop their tokens abroad and contend or pretend that it will take six months before returning to the United States […] But in the center, These tokens are securities because there is a group in the middle and the public is anticipating profits based on that group. ”
This position is quite clear. The SEC considers most cryptocurrencies to be securities and has acted in accordance with this view, taking legal action where it has deemed it possible and consequential to do so. This likely includes coins like Ethereum, particularly in light of the latter’s shift to a proof-of-stake consensus mechanism.
What will happen if Ripple loses its lawsuit against the SEC
However, things could get significantly worse for cryptocurrencies if the SEC ends up winning its case with Ripple. As Ripple CEO Brad Garlinghouse recently stated in interviews, the outcome of this case “will be critical for the entire industry,” to the extent that it sets a precedent that could lead other cryptocurrency projects and companies to face legal action.
In fact, Ripple’s Chief Legal Officer, Stuart Alderoty, has already advised crypto firms in the US to settle abroad, given how uncertain the law currently is. A win for the regulator will only make this situation worse, as it will provide the SEC’s opinions with legal confirmation, while also encouraging the regulator to prosecute other companies.
Assuming an SEC victory, the biggest loser could end up being the United States, as its cryptocurrency sector could flee to friendlier shores. However, for all companies and exchanges that remain within American jurisdiction, the effects are likely to be chilling.
Any U.S.-based stock exchange would be at risk of violating securities laws. They may have to do what Coinbase did in December 2020, when it removed XRP in response to the SEC’s action against Ripple. This would leave them with very few cryptocurrencies to list legally, perhaps reducing its supported coins to Bitcoin and its forks (e.g. Litecoin, Bitcoin Cash), as well as a small smattering of genuinely decentralized and community-founded tokens.
Needless to say, this would be extremely damaging as far as prices are concerned. XRP fell about 63% within a week after Coinbase’s delisting, underscoring how negative the loss of U.S. investors and traders can be to demand.
On the other hand, it is entirely questionable that an SEC win would be extremely bullish for bitcoin and (to a lesser extent) its forks. As Gary Gensler has repeatedly suggested, the securities regulator does not consider bitcoin as a security, so investors and trading platforms in the US would be completely free to hold and transfer bitcoin. Therefore, we could see BTC’s dominance of the cryptocurrency market increase dramatically, potentially pushing it to new highs.
That said, the LBRY-SEC case raises hope that, even with a negative outcome, US-based exchanges may still be free to list XRP (and by extension, many other similar cryptocurrencies). This is because an appeal hearing found that the sale of LBC tokens by third parties does not represent the offering of unregistered securities. This means that third parties, such as exchanges, are legally free to continue supporting trading in LBC.
Of course, it remains to be seen whether exchanges in the US will feel comfortable enough to put LBC up for sale, or whether they would feel comfortable enough to list numerous other cryptocurrencies in the event of a decisive defeat of Ripple. However, it remains highly questionable whether the prospects of such a defeat are actually quite low.
As we have written numerous times before, Ripple has secured a number of important decisions and rulings in its case so far. More recently, the court ruled out the opinion of an expert witness called by the SEC, which the regulator had hoped would show that Ripple had created a reasonable expectation of profits among XRP buyers. This exclusion of the witness supports arguments that the SEC has not sufficiently proven its case in court and that a settlement may soon be coming, one that allows Ripple to continue its activity more or less as before.
For this reason, the market can realistically hope that we will not enter a scenario where most cryptocurrencies are definitively classified as securities. But only time will tell…