What Makes a Crypto Asset a Security in the United States?

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By Jody Godoy

(Reuters) Cryptocurrency companies that have resisted U.S. regulatory scrutiny, arguing that digital assets are not securities, won a court victory this week. On Thursday, Ripple Labs obtained a landmark ruling from a federal judge that said some of the company’s XRP token sales were not subject to securities laws.

WHAT DID JUDGE RIPPLE SAID?

U.S. District Judge Analisa Torres in New York found that certain sales of digital tokens by Ripple did not violate the law, as alleged by the U.S. Securities and Exchange Commission. The SEC sued Ripple for making an unregistered offering of $1.3 billion in XRP between 2013 and 2020.

Torres ruled that sales of Ripples on public exchanges to retail investors were not securities offerings under the law because the buyers had no reasonable expectation of profit from Ripples’ efforts.

These sales were blind bid/ask transactions, she said, in which buyers couldn’t tell whether their cash payouts were going to Ripple or any other XRP seller.

It was the biggest win for a cryptocurrency company in a case brought by the SEC. The regulator got a partial victory because Torres also ruled that Ripple violated securities laws when it sold XRP directly to sophisticated investors such as hedge funds.

WHAT DID THE SEC ALLEGATE?

The regulator has filed more than 100 lawsuits against crypto companies, claiming digital assets are securities.

The biggest deal was brought this year. The SEC said Coinbase, the largest US cryptocurrency platform, allowed users to trade at least 13 crypto assets that should have been registered as securities, including tokens such as Solana, Cardano and Polygon. Coinbase denied the allegation.

Industry players have insisted that most cryptocurrencies that operate on a shared database on a network of computers, known as a blockchain, do not meet the US legal definition of securities. . They say the SEC has been vague and inconsistent and has called for new regulations or laws.

WHAT IS SAFETY UNDER US LAW?

For the SEC, crypto assets are securities, citing a 1946 U.S. Supreme Court case involving investors in Florida orange groves owned by WJ Howey Co.

The court ruled that an investment of money in a joint venture whose profits come solely from the efforts of others is a kind of security called an investment contract.

The SEC had jurisdiction to seek to prevent Howey from selling fractional land interests to out-of-state investors with a contract to profit from the harvest, the court said.

Securities, unlike assets such as commodities, are strictly regulated and require detailed information to inform investors of potential risks.

WHAT DID THE OTHER JUDGES SAY?

Many SEC crypto-related cases have ended in settlements, with companies paying fines and agreeing to follow US law or exit the US market.

Prior to the Ripple decision, judges in the few cases decided by the courts agreed with the SEC that specific crypto assets were securities.

These rulings stated that claims by developers linking the value of their digital assets to efforts to develop or maintain the associated blockchain systems showed that investors’ profits depended on the efforts of others.

Courts have also ruled that investors in these assets are participating in a joint venture because the funds they spend are pooled by the token issuer and used to develop relevant systems.

WHAT ABOUT BITCOIN?

Bitcoin isn’t considered a security because its anonymous and open-source origins mean investors’ profits don’t depend on the efforts of developers or managers, said Carol Goforth, a law professor at the University of Arkansas.

Some blockchain projects have attempted to fund their operations in two steps, offering securities in accordance with SEC regulations and then giving or selling those investors cryptocurrency after building a functioning blockchain.

Goforth said the developers hoped this approach would remove the common corporate element, but she added that the SEC had never clarified what it would take to convert a secure to a non-secure.

(Reporting by Jody Godoy in New York and Tom Hals in Wilmington, Delaware; Editing by David Gregorio)

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