Fintech

What the fate of 9 small tokens means for the crypto industry

The SEC says nine tokens in the Coinbase insider trading case are securities, but they are similar to many other tokens that are already trading on exchanges.

Two tokens being lassoed.

While a number of pieces of crypto legislation have been introduced in Congress, the SEC’s moves in court could become precedent until any legislation is passed or broader executive actions are made.

Illustration: Christopher T. Fong/Protocol

When the SEC accused a former Coinbase employee of insider trading last month, it specifically named nine cryptocurrencies as securities, potentially opening the door to regulation for the rest of the industry.

If a judge agrees with the SEC’s argument, many other similar tokens could be deemed securities — and the companies that trade them could be forced to be regulated as securities exchanges. When Ripple was sued by the SEC in late 2020, for example, Coinbase chose to suspend trading the token rather than risk drawing scrutiny from federal regulators. In this case, however, Coinbase says the nine tokens – seven of which trade on Coinbase — aren’t securities.

The case cuts to the heart of what’s long been a huge source of uncertainty in the crypto industry. The SEC has far-reaching legal authority over how stocks and other securities are traded, as well as who is allowed to buy and sell them. But the agency has thus far shied away from issuing a clear definition of what criteria are used to determine whether or not a token is a security. As a result, cryptocurrency firms, exchanges and traders have been operating for years in a legal fog.

SEC officials have previously made statements that align with the agency’s claims in the current case. The previous chairman, Jay Clayton, for example, said he felt that most ICOs looked like securities, and Gary Gensler, the current chair, has said that most tokens are likely securities.

But there are some notable new points of emphasis in the case against the former Coinbase employee. For one thing, the suit appears to distance the agency from a 2018 speech by then-SEC Director of the Division of Corporation Finance Bill Hinman, said Meghan Spillane, a partner at the law firm Goodwin Procter and an expert on litigation and digital assets.

Hinman’s speech was considered by many in the industry to be a regulatory guidepost, laying out ways that a token that was launched as a security could later be considered not a security. “If the network on which the token or coin is to function is sufficiently decentralized — where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts — the assets may not represent an investment contract,” Hinman said.

But Hinman’s views were never codified, and if the agency ever espoused them, it appears to have changed course. Several of the token projects named in the case have behaved in a way that Hinman suggested could be sufficient to avoid being considered a security: They changed over time by building governance features or a foundation that increases decentralization of the projects. Spillane said the SEC doesn’t appear to be considering any of that in the current case. “Basically the analysis is kind of frozen in time. And none of the allegations seem to account for how projects grow and develop over time,” she said.

It’s unclear why the SEC chose these nine tokens — AMP, RLY, DDX, XYO, RGT, LCX, POWR, DFX, KROM — as they are mostly small market capitalization projects. AMP is the largest at a $640 million market cap, while some of the others are not even over $100 million, indicating they may not have gained substantial traction. While the SEC said 25 tokens were involved in the insider trading case, it’s unclear whether the SEC did not consider the other 16 tokens securities or whether the agency just didn’t include them in the case.

The SEC’s approach in this case is also different from its action with Ripple, where the agency directly filed an enforcement action against the purveyor of the currency XRP.

Right now there aren’t clear rules on what is and isn’t a security, said David Pakman, managing partner at CoinFund, an early-stage crypto investment firm. “I think that the industry, which is largely filled with people with good intentions, struggles to pick a path that will allow people to launch tokens … The problem is there is no guide.”

Pakman noted that some projects have made an effort to keep a token from trading until it is fairly well developed, citing the FLOW token built by Dapper Labs, which his firm invested in.

The nine tokens cited in the Coinbase case are varied in their intended applications; some were meant to help facilitate digital payments, others for yield farming, energy trading, geolocation or helping creators promote their work. Some did an ICO in 2018, while others started selling tokens later on using different approaches. Some filed a Form D with the SEC to register the sale of securities, while some didn’t. Some had a DAO or foundation, while others didn’t. Some were started by incorporated companies; some were not. This raises questions about how many other tokens already trading could be implicated if the nine currently under scrutiny are legally deemed to be securities.

The SEC’s complaint did highlight a few specifics, such as the token not functioning when it was first sold, the heavy involvement of management in building it, management’s commitment to developing the token in the future, management’s token allocation and the availability of tokens on secondary markets.

These all appear to be an effort by the SEC to meet the Howey test, a basic way to determine whether something is a security: were people investing in a common enterprise with the expectation of profit from the effort of others?

For example, if a token isn’t functional when someone invests, that implies future profit when it launches. And management staying involved and committing to working on a project can also show future expectation of profits, while secondary trading can show the intent to profit (as opposed to the intent to use the token as a utility in and of itself).

Some in the industry see the SEC’s move as political — part of a struggle in Washington between the SEC and other agencies over regulation. “It feels like this question of what tokens are securities and what's not is caught up in a much bigger political question, as opposed to the pure legal argument,” Pakman said.

Caroline Pham, commissioner at the Commodity Futures Trading Commission, which could be jockeying with the SEC for regulatory control, criticized the SEC’s case, calling it “regulation by enforcement.”

The companies behind the nine protocols named in the case declined to comment or didn’t respond to requests for comment. The SEC declined to comment.

One crypto executive who has worked with Flexa, the company behind the AMP token, which is named in the case, believes AMP is a utility — it’s meant to provide collateral while crypto transactions settle — and shouldn’t be considered a security. “The idea that something like AMP would be considered a security was crazy,” said Josh Swihart, SVP of growth, product strategy and regulatory affairs at the Electric Coin Company, which invented the ZCASH token. “The token has a utility … to ensure that there's enough money in the system to make sure that somebody gets paid, that you can have finality on either side of the transaction. The token is this necessary element to allow that to happen in a decentralized fashion.”

Meanwhile, David Berkowitz, who used technology made by Rally Network to create his own personalized CMO “social token,” said he hadn’t heard from the company about what the case means for their tokens or the product. The RLY token, which is the governance token of the Rally Network, was named in the case. He and others have created their own individualized tokens using Rally.

While a number of pieces of cryptolegislation have been introduced in Congress, the SEC’s moves in court could become precedent until any legislation is passed or broader executive actions are made. That leaves the industry where it has been: reading the tea leaves on SEC speeches and enforcement actions, and then making moves that may or may not be later considered illegal.

Correction: This story was updated on Aug. 8 to reflect that the SEC sued Ripple in late 2020, not 2021.

Fintech

Judge Zia Faruqui is trying to teach you crypto, one ‘SNL’ reference at a time

His decisions on major cryptocurrency cases have quoted "The Big Lebowski," "SNL," and "Dr. Strangelove." That’s because he wants you — yes, you — to read them.

The ways Zia Faruqui (right) has weighed on cases that have come before him can give lawyers clues as to what legal frameworks will pass muster.

Photo: Carolyn Van Houten/The Washington Post via Getty Images

“Cryptocurrency and related software analytics tools are ‘The wave of the future, Dude. One hundred percent electronic.’”

That’s not a quote from "The Big Lebowski" — at least, not directly. It’s a quote from a Washington, D.C., district court memorandum opinion on the role cryptocurrency analytics tools can play in government investigations. The author is Magistrate Judge Zia Faruqui.

Keep ReadingShow less
Veronica Irwin

Veronica Irwin (@vronirwin) is a San Francisco-based reporter at Protocol covering fintech. Previously she was at the San Francisco Examiner, covering tech from a hyper-local angle. Before that, her byline was featured in SF Weekly, The Nation, Techworker, Ms. Magazine and The Frisc.

Fintech

Is the FTX crash Gensler’s fault — or did it prove he’s right?

The SEC chair has been criticized for failing to offer regulatory clarity. But the crisis vindicates his approach to the controversial industry, others say.

Gensler and the SEC are facing a "can't-win situation."

Photo: Tom Williams/CQ-Roll Call, Inc via Getty Images

FTX’s controversial founder, Sam Bankman-Fried, has been tagged as the main culprit for the latest crypto meltdown. But crypto industry leaders are also pointing a finger at another surprising target: Gary Gensler.

The argument goes, the SEC, under Gensler’s leadership, has done such a terrible job in providing regulatory clarity to crypto companies in the U.S. that it forces companies such as FTX to set up shop in other countries known for loose regulations — which, in turn, encouraged SBF to do really bad things.

Keep ReadingShow less
Benjamin Pimentel

Benjamin Pimentel ( @benpimentel) covers crypto and fintech from San Francisco. He has reported on many of the biggest tech stories over the past 20 years for the San Francisco Chronicle, Dow Jones MarketWatch and Business Insider, from the dot-com crash, the rise of cloud computing, social networking and AI to the impact of the Great Recession and the COVID crisis on Silicon Valley and beyond. He can be reached at bpimentel@protocol.com or via Google Voice at (925) 307-9342.

Fintech

Circle CEO: FTX crash will spur faster crypto regulations

“If we do not hold crypto to a higher standard, we are going to continue to have these disasters,” Jeremy Allaire said.

"We need policy. We need regulation. We need intermediaries to follow the clear frameworks that are needed to address the different types of risks that exist," Circle CEO Jeremy Allaire said.

Photo: Bryan van der Beek/Bloomberg via Getty Images

Circle CEO Jeremy Allaire has found himself shocked twice in the past few months by rapid-fire change in his industry.

The luna-UST crash in May stupefied him in “how fast the death spiral happened and how violent of a value destruction it was.”

Keep ReadingShow less
Benjamin Pimentel

Benjamin Pimentel ( @benpimentel) covers crypto and fintech from San Francisco. He has reported on many of the biggest tech stories over the past 20 years for the San Francisco Chronicle, Dow Jones MarketWatch and Business Insider, from the dot-com crash, the rise of cloud computing, social networking and AI to the impact of the Great Recession and the COVID crisis on Silicon Valley and beyond. He can be reached at bpimentel@protocol.com or via Google Voice at (925) 307-9342.

Fintech

Here’s a timeline of FTX’s collapse

FTX is grasping at straws. Here’s how it got to this point.

In just a week, FTX has gone from the industry’s potential savior, leading rescues of failing firms, to needing a bailout itself.

Illustration: Christopher T. Fong/Protocol

Updated: Nov. 13, 12:52 p.m. EST

Following in the footsteps of Voyager and Three Arrows Capital, FTX is the latest example of crypto’s volatility: In just a week, it went from the industry’s potential savior, leading rescues of failing firms, to needing a bailout itself. Revelations that the powerful-seeming crypto exchange was far flimsier than it let on have led it to the verge of collapse.

Keep ReadingShow less
Nat Rubio-Licht

Nat Rubio-Licht is a Los Angeles-based news writer at Protocol. They graduated from Syracuse University with a degree in newspaper and online journalism in May 2020. Prior to joining the team, they worked at the Los Angeles Business Journal as a technology and aerospace reporter.

Fintech

The FTX fallout is spreading all over crypto

Solana got slammed, Crypto.com halted some stablecoin withdrawals, and bitcoin hit a two-year low.

The fallout from FTX comes after the bankruptcies of Three Arrows Capital, Celsius, Voyager, and others earlier this year following the collapse of the UST and luna cryptocurrencies.

Illustration: Christopher T. Fong/Protocol

The collapse of crypto exchange FTX has rippled across the crypto industry, but the ultimate effects have yet to be seen as the trading firm’s complex web of relationships continues to unravel.

One of the largest global crypto exchanges, FTX holds deposits for a number of large investors in the crypto industry.

Keep ReadingShow less
Tomio Geron

Tomio Geron ( @tomiogeron) is a San Francisco-based reporter covering fintech. He was previously a reporter and editor at The Wall Street Journal, covering venture capital and startups. He was also as a staff writer at Forbes covering social media and venture capital, and edited the Midas List of top tech investors. He can be reached at tgeron@protocol.com or tgeron@protonmail.com.

Latest Stories
Bulletins