Recent instability in the crypto sector will only intensify the debate in the United States over whether digital assets are securities subject to Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) jurisdiction.
Key players (including the SEC) argue that not all digital assets are securities—and that more federal guidance is needed for the United States to develop a globally competitive digital asset ecosystem.
Other jurisdictions have or are working on an approach to digital asset regulation that allows for various token classifications given the range of characteristics that digital assets can have.

Following the fall of FTX, the global spotlight on digital asset regulation has intensified. The key question—particularly in the United States—is whether and when digital assets should be subject to securities regulation. This debate is complicated by the variety of digital asset uses. As an example, a modified ERC-20 token standard on the Ethereum blockchain has been used to tokenize company shares with the ability to automate dividend payments, while the ERC-721 token standard has been used to create Non-Fungible Tokens (NFTs). These token use cases present entirely different functionalities and can be modified even further. How varied use cases are best regulated lies at the heart of the digital assets legal debate.

Under U.S. federal securities laws, a digital asset is deemed a “security” subject to the Securities Act of 1933 and the Securities Exchange Act of 1934 if the asset is an “investment contract” under the four-part test established by the U.S. Supreme Court in SEC v. W.J. Howey Co. (1946) (Howey Test). A regulated investment contract exists when there is: (1) an investment of money; (2) in a common enterprise; (3) with an expectation of profit; (4) relying on the efforts of others.

The Securities and Exchange Commission (SEC) first applied the Howey Test to digital assets in 2017. Munchee Inc. announced an ICO to raise about $15 million to improve its iPhone application, taking the position that the ICO did not require SEC registration because its tokens would be “utility tokens,” i.e., a token designed with a particular use (in this instance solely for use within the Munchee app). The SEC rejected this position, finding in December 2017 that Munchee tokens were investment contracts subject to regulation because their value appreciation created an expectation of profit by investors. The SEC foreshadowed this position several months before the Munchee enforcement action (in July 2017) when it issued a Report of Investigation (the DAO report) in which it provided guidance regarding the applicability of the federal securities laws to digital assets.

In 2019, the SEC further explained its view of the applicability of the Howey analysis to digital assets in the Framework for Investment Contract Analysis of Digital Assets (2019 Framework). Among other topics, the 2019 Framework focuses at length on how the SEC determines whether a purchaser has a reasonable expectation of profits derived from the efforts of others. The 2019 Framework indicates that in applying Howey, the SEC will seek to determine whether (a) the purchaser reasonably expects to rely on the efforts of a promoter, sponsor, or other relevant third parties; (b) these third-party efforts are significant and managerial rather than ministerial; and (c) the purchaser reasonably expects profits, e.g., capital appreciation, resulting from the development of the initial investment or business enterprise, or a participation in earnings resulting from the use of purchasers’ funds, not mere price appreciation resulting solely from the supply and demand for the underlying asset. The 2019 Framework provides that secondary sales or offers of digital assets are subject to the same analysis as an initial sale, plus additional considerations relating to the ongoing efforts of others.

While the 2019 Framework lists many non-dispositive factors the SEC may consider in determining whether a digital asset is a security, SEC Chairman Gary Gensler stated in April 2022 that he believes almost all digital assets are securities. “The fact is,” he said in published remarks, “most crypto tokens involve a group of entrepreneurs raising money from the public in anticipation of profits—the hallmark of an investment contract or a security under our jurisdiction.” Conversely, former SEC Director of Corporation Finance Bill Hinman stated in June 2018 that Bitcoin and Ether are not securities due to their decentralized nature and the absence of a central third party. These contrasting views are now being put to the test in the U.S. District Court for the Southern District of New York. In October 2022, the court ordered the disclosure of internal SEC correspondence and documents produced in connection with Director Bill Hinman’s speech (Hinman Documents), which many eagerly anticipate reviewing. The SEC has since asked the court to seal the Hinman Documents, among other matters.

Some stakeholders are acting consistent with Gary Gensler’s broad view of when digital assets are securities. Among other recent developments, Nexo announced they will be phasing out services in the United States and withdrew their earn products (which enable investors to earn interest on certain digital assets) from eight U.S. states on December 5, 2022. Meanwhile, investors are suing Gemini for failing to register their interest-earning program as a security.

Not all stakeholders agree that the SEC’s broad position on digital assets is correct. In July 2022, digital asset exchange Coinbase submitted a petition to the SEC requesting a clearer set of rules to govern the regulation of digital assets—claiming in part that traditional equities-focused securities regulation is not a good fit for blockchain-based technology. The U.S. Commodity Futures Trading Commission (CFTC) is also contesting the SEC’s jurisdiction over digital assets. The CFTC regulates leveraged retail commodity transactions, derivatives and futures contracts, among other products. It has taken the position that Bitcoin and Ether are commodities subject to CFTC jurisdiction and that fund managers investing in digital asset futures contracts, or that use leverage or margin to invest in digital assets, must register with the CFTC.

In the U.S. Senate, Senators Cynthia Lummis (R-Wyoming) and Kirsten Gillibrand (D-New York) are crafting bipartisan legislation that would create a broad regulatory framework for digital assets and give the CFTC the bulk of the responsibility for oversight. Senator Debbie Stabenow (D-Michigan) has introduced another bill that would grant the CFTC broad jurisdiction over digital assets and trading platforms. In the U.S. House of Representatives, a bipartisan group has introduced legislation that would allow for the regulation of digital commodity exchanges by the CFTC and establishes conditions for the sale of digital commodities and the registration of exchanges, among other requirements. These bills overlap but do not fully align. Moreover, they are just three of over fifty bills and resolutions introduced so far in Congress that relate to the regulation of digital assets.

Outside of the United States, several countries have taken important steps towards regulatory frameworks that recognize and account for the variety of digital asset uses. For example, in the UK, the Financial Conduct Authority published Guidance on Cryptoassets in 2019, which divides digital tokens into regulated and unregulated tokens. Regulated tokens, including (i) “Security Tokens” and (ii) “E-Money Tokens,” provide rights and obligations similar to those provided by “Specified Investments” under the Financial Services and Markets Act 2000 (FSMA), including ownership rights, repayment or entitlement to a share in future profits. Unregulated tokens include all other types of tokens, including utility or exchange tokens. The UK parliament is also debating the Financial Markets and Services Bill, which will provide regulators with greater oversight of the UK digital assets market and explicitly bring digital assets within the FSMA.

Switzerland adopted the Decentralized Ledger Technology Act in 2021, which provides a legal basis for securities to be based on blockchains. Meanwhile, the EU is in the process of introducing the Market in Crypto Assets regulations (MiCA), which would capture and regulate all digital assets not already caught by existing legislation. Other countries working to establish their own digital assets regulatory framework include Australia, Brazil, Dubai, Hong Kong and Singapore.

The United States has not yet adopted a comprehensive regulatory and enforcement framework for digital assets. Participation in U.S. digital asset markets must therefore be predicated on a careful consideration of whether implicated transactions will be regulated as a security, a commodity or not at all. International regulatory approaches greatly differ, requiring further consideration and analysis when engaging in multijurisdictional transactions with digital assets.

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