The cases will likely clarify key questions over cryptocurrency regulation, an issue shrouded in legal and administrative ambiguity since its emergence: What oversight should regulators have over cryptocurrency? And should cryptocurrency be considered a security, akin to stocks or bonds? Or should it be categorized as a non-security, similar to tokens or currency?
The ‘security’ dispute.
The SEC oversees the buying and selling of securities, regulating brokers and clearinghouses, and requiring companies that issue securities to provide public disclosures. The SEC’s two-fold purpose is to protect investors from fraudulent practices and safeguard companies from exploitation.
The SEC’s general opinion of the cryptocurrency industry is that “if you are engaging in trading cryptocurrencies, or letting other people trade cryptocurrencies, you’re an unlicensed security firm,” Joey Politano, a former analyst at the Bureau of Labor Statistics and current independent economics writer, tells The Dispatch. “You should be like the New York Stock Exchange, but you’re not. And in that way, you’re misleading investors. That’s a crime.”
If cryptocurrency tokens traded on Binance and Coinbase are securities, as the SEC suggests, then the companies are essentially running an unlicensed securities exchange, a violation akin to selling shares of Disney stock on eBay.
“Everyone agrees that Coinbase is an exchange, where people trade cryptocurrencies,” Matt Stoller, director of research at the American Economic Liberties Project, explains to The Dispatch. The dispute arises over the interpretation of “security.” The SEC holds that people who use these exchanges are trading securities, while Coinbase firmly denies that cryptocurrencies are securities.
The question now goes to the courts, which will decide whether cryptocurrencies are securities or not.
Should cryptocurrency be considered a security?
The legal framework of what is considered a security was formed in SEC v. W. J. Howey Co., a 1946 Supreme Court case in which a Florida citrus grower sold acres of his orange groves only for them to be leased back to his company to be cultivated and sold. The Supreme Court ruled that the orange groves were securities and formulated a test to determine the qualifications for classifying a security: “whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.”
“I mean, it’s a security, right?” says Stoller, who shares the SEC’s view about cryptocurrency. “The people that issue cryptocurrencies are soliciting investment in a common enterprise. They are hoping to make money and it’s through the efforts of others.”
John Berlau, director of finance policy at the Competitive Enterprise Institute, is less convinced. He highlights that in Howey, buyers did not acquire a specific product like oranges but instead purchased acres of orange groves, essentially a portion of the company itself. Conversely, Berlau argues that cryptocurrency investors are purchasing tangible digital tokens, likening them to actual products, like oranges.
But in Stoller’s view, cryptocurrency is not an actual product. “It’s not technology. It’s just nothing. It’s people trading fake assets,” he says.
While the securities issue is likely to be at the forefront of both the Binance and Coinbase cases, the courts may not rely solely on the Howey test. Politano explains that even if the courts agree that cryptocurrency is a security, “there’s a possibility for nuance here, in that it’s not clear how to become a licensed cryptocurrency brokerage.” If the courts determine that Coinbase was acting as a securities brokerage, Politano says, it cannot continue operating as it had been, but the court may find a lack of significant wrongdoing.
“The SEC doesn’t know how to register a cryptocurrency exchange,” Berlau says.
“No exchange has been able to figure out, you know, how to register. I think a lot of them would do that,” he continues. “Robinhood and Fidelity sell crypto, but they do that as a subsidiary, not as a SEC registered broker dealer.” Those two companies are indeed registered with the SEC, but sell cryptocurrency through subsidiaries.
Berlau further stresses that it is impossible for Binance and Coinbase to determine which cryptocurrencies they are allowed to trade. The SEC identifies 13 cryptocurrency asset securities in their lawsuits against Binance and Coinbase, but clearly note that the list is “non-exhaustive.”
“In this case, the SEC had not said these were illegal securities, or they were unregistered securities, until the actual lawsuit,” explains Berlau. “The platform had no way of knowing that this would be a security until the SEC said it was. At the same time, you’ve got PayPal and others that are using Bitcoin.”
What is the difference between the Binance and Coinbase cases?
The SEC is accusing both companies of operating as an unregistered securities exchange. But regulators are also levying a fraud charge against Binance and CEO Changpeng Zhao, alleging Binance’s international company and its U.S. counterpart illegally transferred customer funds and assets to third parties, Sigma Chain and Merit Peak Limited, both of which are owned by Zhao.
Some have speculated that the fraud accusation against Binance implies that the Coinbase case will have a greater influence on the future of cryptocurrency law.
“The Coinbase case is really important because it does set the law around crypto,” explains Stoller. “The case against Binance is that Binance is essentially defrauding investors in different ways. And, you know, they’re commingling funds, they’re basically looking at Binance as a kind of FTX.”