When the SEC shot down Grayscale’s pitch for a bitcoin spot ETF, the crypto investment firm could have given it another try by filing a new proposal. But Grayscale was bent on going to court, the company signaled. And it’s not the only company to adopt an aggressive legal posture against a regulator.
Litigation has emerged as an important tool for crypto as it wrestles with unclear rules and a slow legislative path to clarity. Grayscale’s legal offensive and other disputes bubbling up shows how important the courts have become for settling disputes with regulators like SEC. In many cases, outcomes of court battles could have far-reaching consequences for the industry — especially if crypto companies win.
Grayscale CEO Michael Sonnenshein had talked about his company’s plans to lawyer up weeks before the SEC’s decision. He said the company hired prominent Washington attorney Donald Verrilli to prepare for a legal battle. Chief Legal Officer Craig Salm said “the court is the natural next step for us to take.”
“We’re at a stage where we have disagreement over how the existing regulations are being interpreted,” Salm told Protocol. “We can’t go to Congress … We can’t do nothing.”
There is a long history of the courts shaping how financial rules are interpreted. The Howey Test that the SEC still uses to determine whether an asset is a security is derived from a 1946 Supreme Court decision about orange groves.
Victory is never assured, but the courts can offer an outlet for well-funded crypto companies to flex their resources. “If you have enough money to file or defend enough lawsuits, you can more easily wear down your opposition, even if they are a major regulator, and even if you lose, you can win in the long term if the decisions made chip away at the regulatory apparatus itself," said Mark Hays, a senior policy analyst on fintech at Americans for Financial Reform, a group that has advocated for stronger consumer protections in crypto regulation.
Marc Fagel, a former San Francisco regional director for the SEC, noted that companies that “proactively sue the SEC for its rules or status denials” will find that “the current Republican-dominated courts are favorable for them.”
The crypto industry is eyeing a fresh legal opening with the Supreme Court decision limiting the ability of the EPA to draft regulations related to climate change, a ruling that some think could have wide-reaching implications for all federal agencies.
The ruling “challenges the regulation by enforcement approach that the digital asset industry has been forced to navigate,” Perianne Boring, founder and CEO of the Chamber of Digital Commerce, a major crypto lobby group, said in a tweet the day the decision came out. “Without clear Congressional authorization, federal agencies must tread carefully,” she added.
It’s not clear how the EPA decision will affect crypto cases. Todd Phillips, director of financial regulation and corporate governance at the Center for American Progress, pointed out that the Supreme Court's ruling is focused on the authority agencies have to address major questions not directly assigned by Congress.
“If an agency is trying to tackle some new issue that it has never tackled before — an issue that it seems Congress did not really intend for the agency to address — then courts are going to look at it,” Phillips said. But the SEC has long regulated securities, and has taken the position that many crypto assets are securities, "so it is not like the SEC is trying to address a problem it has never addressed before," he said.
Fagel, who represented some crypto clients when he worked in the private sector, speculated that the ruling could even prompt more enforcement measures, “at least until the courts push back on the SEC’s interpretation of current securities law.”
That’s what Grayscale is hoping for in its lawsuit.
A Grayscale victory could open doors for other industry players that see a bitcoin ETF as a way to open crypto to more investors. The SEC has consistently rejected the proposals, citing concerns that investors would not be adequately protected from fraud or market manipulation.
Another closely watched legal brawl is the SEC suit against Ripple, which the regulator accused of failing to register $1.4 billion of XRP as securities. The lawsuit, which was filed in 2020, was damaging to Ripple, causing the value of XRP to fall dramatically.
But the legal battle is now seen as a potential turning point for crypto. If Ripple wins, it could weaken the SEC’s argument that most cryptocurrencies should be registered as securities.
“That could open the door for other other tokens out there being deemed not to be a security,” Fagel said. “It could shrink the SEC’s jurisdiction.”
But litigation can also be risky for crypto companies. Cathy Yoon, chief legal officer at MPCH, cited the costs of pursuing legal action if a case drags on. “In the end, even though you've won, you might not be able to continue” in business, she said.
Legal costs are rising at a time when the crypto industry could be facing more lawsuits from investors and consumers reeling from the market meltdown.
Roughly half of the more than 400 crypto-related court cases tracked by the law firm Morrison Cohen since 2014 were private cases: either a person suing a company or a company suing a person or another firm. Jason Gottlieb, a partner at the firm and lead author of the firm's Cryptocurrency Litigation Tracker, said private actions are the fastest growing form of crypto litigation.
Some private lawsuits have focused on regulatory questions. Coinbase, crypto lender BlockFi and Solana Labs have each been hit with lawsuits from users or investors alleging, in part, that the companies offered unregistered securities.
Katherine Dowling, chief compliance officer and general counsel at Bitwise, said litigation can be “an avenue” for a crypto company. But “I don't see it as the most efficient avenue.”
“I could see companies taking that step because the regulatory environment is not clear,” she told Protocol. But court rulings are typically based on the facts of a specific case, which can limit their application.
Legislation and clearer regulations, drafted in consultation with the industry, are still the preferred path, she said: “It shouldn't only be enforcement actions. There needs to be dialogue and more definitional clarity, so that businesses that are trying to do the right thing have a clear path forward.”