As interest in cryptocurrencies (“crypto”) continues to rise, businesses and investors are left wondering what regulations they must follow. While crypto may contain the word “currency” in its name, it is unclear whether it truly is a currency. There has been a lot of debate over which category it belongs to for regulatory purposes.1 Is it a currency or a security? The SEC has yet to provide guidance on this rapidly developing market.
Simply put, a currency is a store of value, unit of account, and medium of exchange, while a security is a tradable financial asset that has monetary value.2 The Securities Act of 1933 (“the ‘33 Act”) provides a list of what qualifies as a security, and crypto is not included. However, the list contains investment contracts, which is the category the SEC has openly debated whether cryptocurrencies belong.3 The Supreme Court in Howey stated an investment contract exists when “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”4
The determination of which category crypto belongs in is essential for investors as it implicates which governing body has the authority to regulate the market. If crypto is categorized as a currency, the SEC lacks jurisdiction. If it is considered a security, it falls squarely in the SEC’s jurisdiction and becomes subject to the agency’s strict reporting and trading regulations.
The SEC is not the only government agency that has failed to provide clear guidance on what category crypto belongs in. The IRS still refers businesses to its 2014 Notice where it opined on the topic.5 The 2014 Notice stated it is “aware that ‘virtual currency’” exists and referred to “Bitcoin” as a convertible virtual currency because it has an equivalent value in real currency. However, in the same notice, it stated that virtual currency could be held as a capital asset like stocks and bonds.
Something that tends to complicate the classification of crypto even more is the fact that it seems a specific cryptocurrency’s classification may change over time. This happened in the case of the token ether, the primary token for Ethereum.8 The then SEC Chairman decided it no longer met the Howey test and declared it not a security. Then SEC Chairman Clayton also stated that Bitcoin was not a security due to its decentralized nature.10
Even though the SEC has stated Bitcoin and ether are not securities, the question remains on what the status is of the numerous other cryptos. A recent action brought by the SEC against Ripple Labs, Inc. (“Ripple”) in the U.S. District Court for the Southern District of New York could significantly impact how crypto is regulated and categorized. The SEC argues that XRP, Ripple’s cryptocurrency, is an investment contract under the Howey test, and therefore by not registering it, Ripple sold XRP as an unregistered security.11 While the parties have entered into settlement discussions, it is still a case to watch for potential regulatory impacts on cryptos.
While it is still unclear whether cryptos are securities or currency for regulatory purposes, one thing is clear: the market is only continuing to grow, and the SEC and other government agencies are taking notice of the unregulated area. Common sense, sound legal advice, and diligence will help any business or investor navigate this market despite the uncertainty surrounding crypto.
1. SEC Reckons With Crypto’s Currency And Security Conundrum, PYMNTS (Apr. 20, 2021).
2. Public Statement, Bill Hinman, Dir. Of Div. of Corp. Fin., SEC; Valerie Szczepanik, Senior Advisor for Digital Assets & Innovation, SEC, Statement on “Framework for ‘Investment Contract’ Analysis of Digital Assets” (Apr. 13, 2019).
3. Public Statement, Chair Gary Gensler, SEC, Remarks Before the Aspen Security Forum (Aug. 3, 2021).
4. SEC v. W. J. Howey Co., 328 U.S. 293, 298–99 (1946).
5. I.R.S. Notice 2014-21, 2014-16 I.R.B. 938 (Apr. 14, 2014).
8. David Borsack & Cole Schotz, Cryptocurrencies And The Security And Exchange Commission, JDSUPPRA (Aug. 4, 2021).
9. Aaron Hankin, SEC’s Jay Clayton says Ether isn’t a security, reiterating the regulator’s stance, MarketWatch (Mar. 12, 2019).
10. Is Crypto A Commodity or Security?, SoFi (Apr. 27, 2021).
11. Press Release, SEC, SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering (Dec. 22, 2020).