Since bitcoin’s birth in 2009, cryptocurrency has been the black sheep of the digital asset world, showing the first promises of a decentralized financial system, while also being a vital tool for bad actors and under-the-table transactions.
For U.S. regulators, like the Securities and Exchange Commission (SEC), the blockchain-backed currency has long been a vexing alternative to the traditional dollar. On the one hand, its qualities have been too distinct to pass the legal tests required for the agency to have jurisdiction over it. But on the other, crypto users have increasingly been trading in ways that the SEC deems worthy of regulation.
On July 13, the tug-of-war showed hints of a possible winner.
The crypto industry scored a landmark victory in The Securities and Exchange Commission v. Ripple Labs in the U.S. District Court in the Southern District of New York, when the judge ruled that Ripple Labs did not violate federal securities law by selling its token, XRP, on a public exchange.
While the ruling did hold that Ripple violated the law by selling directly to sophisticated investors, the decision in favor of the digital asset company is likely to provide ammunition to other crypto providers in litigation with the SEC.
While the parties await final judgment, the ruling clarifies that the XRP token is not a security, and therefore doesn’t fall under SEC jurisdiction. Below are some key developments that paved the way to this major ruling:
SEC’s Shifting Enforcement Strategy
As digital assets have evolved over the last decade and half, so have regulators’ strategies to oversee them. At a symposium in June, Yuliya Guseva, vice dean and professor of law at Rutgers Law School and head of the Blockchain and Fintech Program of the Rutgers Center for Corporate Law and Governance, discussed the SEC’s shift from targeting initial coin offerings (ICOs) to trading platforms, like Ripple.
“So what is the SEC doing? It is firing its guns against all gatekeepers in the traditional conventional securities market space, securities exchanges or potential alternative trading systems (ATS), clearing agencies, and the Depository Trust and Clearing Corporation (DTCC),” she said.
Dorothy DeWitt, former chief finance counsel to New York Sen. Kirsten Gillibrand, added that a part of the reasoning behind the SEC’s move is that rulemaking in the space takes a significant amount of time, whereas enforcement by sanctions can often be a quicker alternative to regulation.
So long as there isn’t a pushback against sanctions, and companies continue to settle, it is unlikely that the agency will have to necessarily prove that the current regulations suffice when it comes to regulating the crypto market.
‘Coin Center vs. the U.S. Treasury Department’
The SEC is far from the only federal department seeking to regulate cryptocurrency. Starting November 2021, the Biden administration stressed its commitment to “cracking down” on cryptocurrency exchanges.
As a part of that initiative, the U.S. Treasury Department and the Internal Revenue Service (IRS) rolled out new reporting requirements for the digital asset as part of the $1.2 trillion Infrastructure Investment and Jobs Act. The provision, which goes into effect in 2024, would require taxpayers who receive more than $10,000 in cryptocurrency to report it to the IRS.
The crypto industry was not happy with the amendment to the tax code, leading to Coin Center, a nonprofit that focuses on policy related to cryptocurrency filing a lawsuit against the IRS and the U.S. Department of Treasury in June 2022. Since then, several digital asset providers have shown Coin Center their support in the litigation—claiming that since the asset is not a security, the agencies don’t have jurisdiction to regulate, and that their attempts to do so are tantamount to financial surveillance.
For Tom Bossert, president of Trinity Cyber and former Homeland Security adviser, the amendment came as an important indicator that several federal agencies were beginning to view cryptocurrency trading as more and more similar to cash transactions—and therefore applicable to the rules that securities fall under.
On July 13, however, the Coin Center lawsuit was dismissed by a Kentucky judge, who called it “premature.” However, the nonprofit plans to appeal.
NFTs vs. the Department of Justice
While cryptocurrency and nonfungible tokens (NFTs) are two distinct digital assets, both underpinned by blockchain technology, the enforcement of one often sets a precedent in the enforcement of the other, especially when it comes to the “securities question,” said Sarah Heaton Concannon, a partner and co-chair of Quinn Emanuel Urquhart & Sullivan’s SEC enforcement defense practice.
One such example of “sending a message” to the crypto industry by going after NFTs was in United States of America v. Chastain in the U.S. District Court of the Southern District of New York in June 2024, a first-of-its-kind indictment from the Department of Justice against the product manager for NFT marketplace OpenSea, Nathaniel Chastain, for insider trading. For attorneys, what stood out was that the DOJ never referred to an NFT as a security in the indictment, however, went about litigating it as such, with bail set to $100,000.
Concannon said that the bail was unusually high despite the modest profit that Chastain made, of $34,000, by way of transactions the agency views as insider trading. For her, it’s a sign that the DOJ was using Chastain as a warning signal to all digital assets—whether they passed the Howey Test or not.
In fact, “the indictment is notable for essentially dodging the thorny question entirely because it’s framed in a kind of classically insider trading language,” Concannon said. She added: “But because they brought it under wire fraud as opposed to a securities fraud statute, they don’t have to answer whether NFTs are securities.”
SEC Goes After Celebrity Crypto Endorsements
In March, the SEC brought another round of enforcement actions against celebrities like Lindsay Lohan and Akon for endorsing cryptocurrency without divulging that they were being compensated for advertisement—just months after Kim Kardashian faced a similar order. To be sure, such a disclosure is a prerequisite for a security.
However, the agency, in spite of its chairperson being vocal about cryptocurrency qualifying as a security, had not yet attempted any rulemaking that would clarify its view on the digital asset on paper.
Attorneys told Legaltech News that such rulemaking is unlikely to come down, and that enforcement actions like the ones Lohan is facing are just as unlikely to slow down. In fact, without rulemaking, the agency is able to enforce more freely, but there may be pushback against its actions.
“In litigation, the SEC must first prove that the crypto asset at issue is a security,” Concannon said. “Otherwise, there can be no violation of the securities laws. So in my opinion, more defendants need to put the SEC to its proof and push back on the unsupported and indefensible position that ‘virtually everything’ in this space is a security.”
For her, the Ripple Labs decision was a vital hint at whether entities dealing with SEC sanctions like these stand a chance against the agency.
