Many cryptocurrency questions begin with the topic of whether the digital assets constitute as securities under federal securities regulations. If that’s the case, they’re liable to a slew of federal securities laws. If not, they may still be subject to AML and other DOJ currency restrictions, as well as the Commodity Futures Trading Commission’s (CFTC) ability to pursue commodity market manipulation. Because there is no consistent regulation on the subject, regulators and courts have relied on the Howey test to decide whether the digital assets in question are investment contracts and so securities. This year’s court decisions may function as a stimulus for legislative action to provide more guidelines to the sector.
For example, whether the digital asset XRP is a security will determine the result of the SEC’s current litigation against Ripple Labs Inc. The SEC claims Ripple raised more than $1.3 billion in an unregistered XRP securities offering, despite Ripple’s claim that XRP is a fully functional currency. The parties’ key disagreements are anticipated to be resolved this year. The verdict may either strengthen the SEC’s position in the cryptocurrency market or provide the industry weapons to counter the SEC’s seemingly uninterrupted streak of victories in initial coin offering lawsuits.
Meanwhile, the SEC and a collection of state attorneys general recently reached a large settlement with a prominent crypto lending platform for interest-bearing crypto accounts, claiming that the accounts were unregistered securities and the organization was an unregistered investment firm. The Securities and Exchange Commission has also suggested regulatory modifications that seem to broaden the definition of “securities exchange” to include individuals who develop protocols for decentralized exchanges to support crypto trading.
Separately, a Connecticut jury recently ruled that a crypto mining operation’s different cryptocurrency-related items were not securities, despite the fact that the SEC had previously prosecuted and resolved securities fraud allegations against the company. Paycoin, a virtual currency, and “hashlets,” units of processing power ostensibly for crypto mining, were among the offerings. While the circumstances of the case were unusual, the jury’s civil decision in November 2021 serves as a reminder that a finder of fact may not always agree with the regulatory consensus that practically all crypto offers are securities.
The November 2021 Infrastructure Investment and Jobs Act, which shows Congress is taking moves toward official cryptocurrency regulation, has the ability to establish clearer definitions. For the purposes of tax reporting requirements for certain transactions, the law expands the definition of “cash” in the Internal Revenue Code to include “digital assets,” which are defined as “any digital representation of value recorded on a cryptographically secured distributed ledger or any similar technology.”
The Treasury Department suggested that NFTs (non-fungible tokens) could be considered “virtual assets” subject to regulation by FinCEN and other regulators under AML laws in a recent report, the Study of the Facilitation of Money Laundering and Terrorism Finance Through the Trade in Works of Art (treasury.gov). The Treasury said that whether or not NFTs qualify as virtual assets is determined by the NFT’s “nature and features.” NFTs that are “unique, rather than interchangeable,” and “used in practice as collectibles rather than payment or investment instruments” are not considered virtual assets, however NFTs or other digital assets that are “used for payment or investment purposes in reality” are. As a consequence, the issuers and other service providers of these latter NFTs might be deemed payment processors under the Bank Secrecy Act and associated anti-money laundering requirements.
The CFTC has also shown interest in creating laws and prosecuting crimes in the crypto area, with CFTC Chairman Rostin Behnam requesting Congress for expanded jurisdiction over cash cryptocurrency marketplaces. Behnam recently testified before the Senate Committee on Agriculture, Nutrition, and Forestry, arguing that underlying spot markets for digital asset commodities should be more transparent, and that the CFTC needs more tools to “bring the crypto market into the light,” including increased reporting, order visibility, and new rules around execution, custody, clearing, and settlement.
If Congress provides further regulatory guidelines in the crypto area, only time will tell.