For years, the crypto industry has been in a state of confusion about which tokens are in fact securities and which are not. A case filed by the SEC alleging insider trading by a former Coinbase employee and two accomplices could provide some clarity — but it also threatens to roil the industry and Washington as the march to regulate digital assets continues.
In the complaint, the SEC argues that nine of the 25 tokens that the three individuals traded in are securities under the Howey Test, a longstanding judicial standard that would mean they should be regulated by the SEC.
SEC Chair Gary Gensler has often said that he believes that many tokens that are now trading are securities, while bitcoinmay be a commodity. It has also brought enforcement actions against certain tokens that it considers securities that have violated certain laws.
The insider trading complaint makes a direct case that nine tokens are securities: AMP, RLY, DDX, XYO, RGT, LCX, POWR, DFX and KROM. If a judge agrees, that would create a precedent to bring those nine tokens under SEC regulation, and would possibly apply to similar tokens.
Aside from the ongoing Ripple case, which was filed under a prior SEC chief, it’s the biggest move yet by Gensler’s SEC to regulate crypto through an enforcement action. The action also goes after much smaller tokens whose backers may not have the ability to take on a big legal battle against the SEC like Ripple.
Coinbase declined to comment but updated a blog post on its token-listing process, stating that it provided information from its internal investigation to the Justice Department. It also resisted the notion that any of the tokens trading on Coinbase are securities.
“We understand that the SEC has separately filed securities fraud charges related to this wrongdoing today,” Coinbase wrote. “The DOJ did not charge securities fraud. No assets listed on our platform are securities, and the SEC charges are an unfortunate distraction from today’s appropriate law enforcement action.”
The case also brought to the forefront a behind-the-scenes struggle between federal agencies seeking to regulate crypto.
CFTC Commissioner Caroline Pham called the SEC’s Coinbase case “regulation by enforcement” Thursday in a statement shared on Twitter. She appeared to take issue with the SEC seeking to have a judge deem these nine tokens securities. In the process, she shed light on her thinking about which tokens the CFTC might categorize as commodities under its oversight.
“The SEC complaint alleges that dozens of digital assets, including those that could be described as utility tokens and/or certain tokens relating to decentralized autonomous organizations (DAOs), are securities,” she wrote. She added, “Major questions are best addressed through a transparent process that engages the public to develop appropriate policy with expert input.”
Whether she and her fellow commissioners believe that all utility tokens and other tokens run by DAOs are not securities and should be regulated by the CFTC is not clear, but she noted that there are still “open questions” about utility tokens and DAO-related tokens.
“There is a large inside-government, internal struggle between the agencies” because of the “malleability of digital assets,” Michael Fasanello, chief compliance officer at LVL, told Protocol. Those players include the CFTC, SEC, FinCEN, IRS, OCC and FDIC. Fasanello believes there shouldn’t be one agency in charge of crypto but a coordinating body like the Office of the Director of National Intelligence, which was set up to coordinate intelligence after the failures of 9/11.
The stakes are high: While the Lummis-Gillibrand bill winds its way through Congress and the Biden administration orders additional studies of crypto, the case could determine which tokens are securities and which aren’t.
That matters for not just those nine tokens but also the many others that have similar characteristics and freely trade on Coinbase and other exchanges.
If those nine are deemed securities, Coinbase and others could have to remove them and similar tokens from their exchanges.
Coinbase published a post on Thursday calling on the SEC to initiate rulemaking on digital assets, including clarity on which tokens are securities, arguing that current securities laws don’t work for digital assets.
Ultimately, the case itself is a push for Congress to act. Since a court case will make precedent, it sends a message to lawmakers to take action. That’s because there’s only so much agencies can do on their own.
“Part and parcel to succeeding with these charges, and with this prosecution, is of course, defining how these securities meet the Howey Test,” Fasanello said. “But the other side of doing that being as specific as they were with it, is a way of signaling to Congress, ‘Hey, this is how serious we feel about these issues. We really want you to put this into law.’”