Is a Crypto Token Itself a Security? SEC Can’t Make Up Its Mind

After years of legal prologue, the United States Securities and Exchange Commission’s (SEC) battle against large swathes of the crypto industry appears to finally be coming to a head.

In a federal court hearing last week regarding the merits of the agency’s lawsuit against Coinbase, and during one yesterday concerning its case against Binance, attorneys for the SEC attempted to explain why many tokens on both crypto exchanges should be considered illegally unregistered securities offerings. At multiple points in both hearings, presiding federal judges appeared unconvinced.

One emerging, particularly sticky point for jurists is how the SEC has defined crypto tokens in the context of securities law. Historically, the agency has gone after securities schemes, not individual products; for example, the agency has successfully sued entities that enriched passive shareholders by investing in whiskey and orange groves. The agency has never, though, sought to ban whiskey or oranges in their own right.

But in the last few months, attorneys for the federal regulator have swung between deeming the sale of crypto tokens in certain contexts illegal, and blanket labeling cryptocurrencies as securities in and of themselves. In front of one federal judge in the Coinbase hearing last week, SEC attorneys made the former argument; in front of another, in yesterday’s Binance hearing, they made the latter.

SEC at Binance oral: “The token itself represents the investment contract . . . the token represents the embodiment of an investment contract”.

Didn’t they say the opposite at CB oral?

— Scott Johnsson (@SGJohnsson) January 22, 2024

“I think the SEC has struggled to find a clear, consistent articulation of what they are deeming to be the security in any of these cases,” Kayvan Sadeghi, a securities litigator who specializes in blockchain-related cases, told Decrypt. “The courts are starting to realize that this inconsistency in the SEC’s articulation of its position itself suggests there’s a problem.”

Why did the SEC float one argument in one courtroom and a seemingly contradictory one days later, in front of a different judge, in a very similar case?

Sadeghi thinks the answer boils down to a simple truth: The SEC doesn’t know which reading of the law is true, or even which one will serve them best, because both arguments pose potentially huge liabilities.

“That’s the rock and the hard place of the SEC’s positions,” Sadeghi said. “Either position you take seemingly inevitably leads to one of these intractable problems.”

Take the argument made yesterday by the SEC’s attorneys, that many crypto tokens are in and of themselves securities, regardless of context. What happens if the company behind a token goes belly-up, or the entire team involved in making a coin valuable dies? Under a blanket definition, trading those tokens decades later would still be considered passive involvement in an illegal scheme—despite the fact that no such scheme exists.

So, it’s understandable why SEC attorneys would therefore make the argument they made last week, in the Coinbase hearing, that these matters come down to the context in which a crypto token is sold. But that reading is also plagued with problems, according to Lewis Cohen, an attorney specializing in crypto and securities regulation.

“Once you untether from ‘the token itself is a security’ argument, you have to articulate an alternative theory,” Cohen told Decrypt. “The judges are pushing back hard, because they can’t understand what that actual theory is. The SEC keeps vacillating on what that is… [they] can’t articulate a clear theory.”

SEC v. @Binance Update II

The hearing is concluded.

Some big picture takeaways:

-the judge seems skeptical of the idea that $BUSD stablecoin was offered as an investment contract.

-the judge seems receptive to the argument that Binance initially offered the $BNB token as an…

— MetaLawMan (@MetaLawMan) January 22, 2024

Drawing such a clear line—delineating what sorts of cryptocurrencies are illegal securities offerings, and which aren’t—is a task that has dogged the SEC for years. Time and again, crypto companies have asked for this sort of clarity about what sorts of cryptocurrencies the SEC would permit. Time and again, such requests have been rebuffed.

Implicitly, industry leaders have taken this unwillingness to signal the outright hostility of the SEC’s current leadership to a framework that would allow any cryptocurrency to legally proliferate in the United States.

Further, explicitly articulating any factual argument about why, say, Bitcoin is perfectly legal but Ethereum is not, would likely prove a daunting task that could put the SEC in a corner.

“They don’t have an explanation,” Cohen said of the agency’s approval of Bitcoin but disapproval of Ethereum, a similarly decentralized blockchain network with a native token that’s maintained by a team of core developers. “Because at the end of the day, there really is none.”

After years of enforcement actions settled out of court, or levied at entities with lesser resources, the SEC’s murky theories on crypto securities are now finally facing scrutiny in well-funded legal battles, Sadeghi said.

A final word on the matter won’t likely come, though, he believes, until the SEC’s lawsuits against heavyweights Coinbase, Binance, and Ripple Labs are decided—and then, all but certainly, appealed.

“Once these issues get to the Court of Appeals, that’s when things get more interesting, and will start to set some sort of binding precedent for other courts to follow,” the litigator said. “That’s where the real battles will be had.”

Edited by Andrew Hayward

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