In June 2023, the U.S. Securities and Exchange Commission (SEC) initiated legal action against two of the largest and most influential crypto asset exchanges in the world, Binance and Coinbase. This past January marked a turning point in the lawsuits, with hearings held for both within the span of a week. The outcome of these hearings could be game-changers for not only Coinbase and Binance but also the entire cryptocurrency industry, as they could set important precedents for how digital assets are regulated in the future.
The Key Legal Issue: Are Cryptocurrencies Securities?
On June 5, 2023, the SEC sued Binance in U.S. District Court for the District of Columbia, alleging that the company had unlawfully operated as an unregistered securities exchange, broker, and clearing agency, among other charges. The very next day, SEC continued its enforcement blitz and filed another lawsuit against Coinbase in U.S. District Court for the Southern District of New York, levying similar allegations.
While the specific charges against Binance and Coinbase differ, the crux of both cases is whether the SEC has the legal authority to regulate cryptocurrencies. This hinges on the application of the Howey test, a legal standard established by the 1946 Supreme Court ruling in SEC v. W.J. Howey Co., to cryptocurrencies. In the case, the Supreme Court held that a transaction qualifies as a security if (1) money is invested; (2) there is an expectation of profits from the investment; (3) there is a common enterprise; and (4) success of the investment relies on the effort of others.[1] If cryptocurrencies are classified as securities under this test, the SEC would have jurisdiction over them. SEC Chair Gary Gensler has even claimed that most cryptocurrencies should be classified as such, with Bitcoin being a notable exception. Crypto industry supporters have argued otherwise, criticizing the SEC’s approach as an overreach of its authority.
The SEC v. Coinbase Hearing
The hearing in the Coinbase suit, held on January 17, 2024, tackled this contentious issue. Coinbase argued that the SEC does not have authority over them because the digital assets in question do not constitute securities under Howey. In a notable analogy, Coinbase likened buying cryptocurrencies to purchasing Beanie Babies, as opposed to stock in Beanie Babies Inc. It argued that cryptocurrency buyers, like those taking a chance on the collectible’s price rising, do not obtain a stake in a common enterprise or expect profits based on other’s work. Coinbase’s argument appeared to strike a chord with Judge Katherine Failla, who raised concerns over “the specter of collectibles being regulated by the SEC." The SEC countered that buying Beanie Babies—mere objects—is not the same as buying cryptocurrencies, which necessarily involves investing in the network enabling the digital asset.
The SEC v. Binance Hearing
Less than a week later, on January 22, 2024, lawyers for Binance and the SEC sparred over the same issue at a hearing before Judge Amy Berman Jackson. Binance argued that the assets it sells are not securities because security offerings always involve contracts, and Binance did not owe obligations to its customers following a sale. The SEC, however, responded that the Howey test is meant to be flexible and that Binance’s marketing and promotion of its tokens suggested to investors that they would be earning a profit as if investing in traditional securities. Judge Jackson pushed back against Binance’s narrow interpretation of Howey, noting the test’s breadth. But she also questioned the limits of the SEC’s broad interpretation that appeared to render all digital assets securities, asking “How are the issuers supposed to know when they cross the line?” Binance made a case that its promotional efforts were comparable to Topps advertising baseball cards, but the comparison to collectibles did not seem to resonate with Judge Jackson.
Looking Ahead: The Potential Outcomes
Neither Judge Failla nor Jackson has yet reached a decision regarding these hearings, but when the decisions do arrive, they will contribute to the growing number of cases addressing the question of whether cryptocurrencies are securities. The current landscape is divided, with a finding that the sales of Ripple’s XRP token were not offers of securities and a contrary ruling that SEC may continue its lawsuit against Terraform Labs for its failure to register digital currencies. A ruling in favor of Coinbase or Binance may bolster industry claims that SEC has overreached, potentially hindering the SEC’s ability to regulate the industry. Conversely, a ruling in favor of the SEC will strengthen its claim of authority over cryptocurrencies and could lead to increased enforcement action against the industry.
The forecast for these cases’ outcomes is also mixed, with one analyst estimating a 70% likelihood of Coinbase’s case being dismissed, while others expressed skepticism about a dismissal at such an early stage of litigation. For Binance, if Judge Jackson follows the reasoning in Ripple that secondary sales of assets on the public market are not securities offerings, a partial dismissal may be on the cards.
Beyond the Courtroom: The Wider Regulatory Scene
The SEC’s lawsuits against Coinbase and Binance are part of a broader and ongoing regulatory debate and uncertainty surrounding crypto assets. The SEC is not the only regulator that has shown interest in crypto assets. For instance, the U.S. Commodities Futures Trading Commission (CFTC) and other U.S. agencies reached a $4.3 billion settlement with Binance last November to resolve the anti-money laundering cases brought against the company.
Despite the increasing prominence of cryptocurrencies and the legal controversy surrounding them, one key player has been conspicuously silent: Congress. Congress has yet to pass new law on cryptocurrency, even as the industry continues to call for “regulatory clarity” through federal legislation. 2023 saw the introduction of notable bills such as the Lummis-Gillibrand Responsible Financial Innovation Act and the Digital Commodities Consumer Protection Act, both of which would place the CFTC in the driver’s seat of cryptocurrency regulation. However, with Congress not expected to reach definitive solutions in 2024, agencies and the judiciary may continue to shape the regulatory landscape for the near future.
[1] S.E.C. v. W.J. Howey Co., 328 U.S. 293, 299–300 (1946)