The world of cryptocurrency has been through a lot of difficulties in recent years. From the excitement of the crypto boom to the subsequent market crash and bankruptcy of many crypto companies, investors and regulators alike have been left with many questions about the future of this emerging industry. One organization that has been at the forefront of regulating the crypto sector is the United States Securities and Exchange Commission (SEC). With its mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, the SEC has become increasingly involved in regulating the cryptocurrency space. This Cryptopolitan guide inspects the SEC crypto regulations and their effects on the crypto and blockchain industry.
Recent Enforcement Actions of the SEC
The Securities and Exchange Commission (SEC) has been ramping up its efforts to crack down on unregistered securities in the cryptocurrency industry. Recent enforcement actions against Kraken and Paxos have put the spotlight on the regulatory challenges faced by the sector.
Kraken, a popular cryptocurrency exchange, was forced to shut down its staking service in the U.S. following a $30 million settlement with the SEC. The staking service involved investors locking up crypto tokens with a blockchain validator to receive new crypto once the validator used their tokens to validate data for the blockchain. The SEC considered this an investment contract because investors reasonably expected to receive money from Kraken in exchange for joining the staking pool.
The SEC alleged that Kraken did not make certain disclosures to investors, which led to the settlement and discontinuation of the service. This action by the SEC has raised concerns for other proof-of-stake projects like Ethereum, whose investors also use staking-as-a-service options.
In addition, the SEC has warned Paxos of its plans to sue them for issuing Binance USD (BUSD), a stablecoin pegged to the U.S. dollar. The SEC claims BUSD is unregistered security and that Paxos did not adequately warn investors of the risks involved in investing in the stablecoin or make proper financial disclosures. The warning has proven to be controversial, as experts debate whether investing in a stablecoin should be considered an investment contract. This has made the biggest exchange in the country, Coinbase, to actually delist the stablecoin from its platform.
SEC Priorities for 2023
The U.S. Securities and Exchange Commission (SEC) has recently included the regulation of emerging technologies and crypto assets as one of its 2023 priorities. This move signifies the SEC’s intent to focus more attention and resources on regulating the cryptocurrency industry, which has seen a surge in popularity in recent years.
As part of its priorities, the SEC intends to examine whether crypto companies meet standards of care when “making recommendations, referrals or providing investment advice.” This could have far-reaching implications for crypto firms, as they may be required to provide greater transparency and disclosure to investors.
The SEC’s increased focus on crypto regulation comes after a tumultuous year for the industry, which saw the bankruptcy of numerous crypto companies and a decline in the overall value of cryptocurrencies. The SEC’s regulatory efforts aim to protect investors and ensure fair competition for all market participants.
Existing Crypto Regulations
In November 2021, the Infrastructure Investment and Jobs Act included provisions that defined digital assets and brokers, placing similar requirements on crypto exchanges as stock brokerages. The Act requires centralized crypto exchanges to provide investors and the IRS with 1099 forms summarizing the activity of traders, which could help investors feel more comfortable investing in crypto assets.
The IRS considers virtual currencies as property, which means that crypto bought at one price and sold for a higher price can be subject to a capital gains tax. Similarly, losses resulting from crypto trading can be deducted as capital loss.
There is an interesting loophole resulting from this classification. While stocks and other securities are subject to a wash sale rule, which disallows the deduction of losses on the sale of securities that are repurchased quickly at a lowered price, this rule does not currently apply to crypto.
The SEC uses the Howey Test, outlined by the U.S. Supreme Court, to determine whether something is an “investment contract” and therefore a security. The Howey Test holds that security is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”
The application of this test to cryptocurrency remains up for debate. While the SEC considers some crypto assets as securities, others argue certain tokens should not be classified as securities.
Bitcoin is a notable exception to the SEC’s securities classification, as the agency does not consider it a security. The reason for this is that investors do not invest in Bitcoin with the reasonable expectation of profits. Bitcoin is seen more as a currency, similar to traditional fiat currencies.
The Infamous Ripple Lawsuit
The SEC’s lawsuit against Ripple Labs has been one of the most controversial and closely watched cases in the cryptocurrency industry. The SEC sued Ripple Labs in 2020 for selling its XRP token without registering it as a security, which raised a debate about whether XRP should be considered a security. The outcome of the case could have far-reaching consequences for the crypto industry.
Central to the legal debate is whether XRP should be considered a security. If the court sides with the SEC, crypto exchanges will face more scrutiny from regulatory agencies and will probably have to register as securities if they continue selling within the US. However, if the court rules in favor of Ripple Labs, it could set a precedent for other crypto assets to be classified differently from securities.
The case has implications beyond the classification of XRP as a security. It could set the tone for how the SEC regulates the cryptocurrency industry in the future. The outcome of the Ripple lawsuit could be a turning point for the industry, shaping how regulators view cryptocurrencies and how companies operating in the industry conduct their business.
The latest in the lawsuit is an admission by the SEC’s expert that variations in the prices of Bitcoin (BTC) and Ethereum (ETH) have been responsible for as much as 90% of XRP’s price fluctuations since the middle of 2018. Meanwhile, there is ongoing conjecture over when the summary judgment will be issued. At first, several legal experts predicted that the issue would be decided in the first quarter of 2023.
The Ripple lawsuit has already led to some changes in the cryptocurrency industry. Many exchanges have suspended or delisted XRP trading in response to the lawsuit. Some companies have even moved their operations outside of the U.S. to avoid dealing with the SEC’s regulatory framework.
Criticisms of SEC’s Approach
The SEC’s crackdown on the crypto industry has not been without its critics. Among them is SEC Commissioner Hester Peirce, who has dissented from some of the SEC’s recent enforcement actions. Peirce has argued that the SEC’s approach to regulating emerging industries such as crypto is not efficient or fair, and that enforcement actions are not a suitable way to establish what the law is in such an industry.
Peirce’s dissent highlights a broader sentiment among some in the crypto industry that the SEC’s securities regulations are too inflexible and not built to accommodate the unique characteristics of cryptocurrency. Many have argued that the SEC’s approach fails to take into account the differences between crypto and traditional securities and that a one-size-fits-all regulatory approach is not appropriate.
Some critics have also questioned the SEC’s willingness to use enforcement actions to establish its regulatory authority over the crypto industry. The SEC’s recent actions against Kraken and Paxos have prompted concerns among some that the agency is taking an overly aggressive approach to regulating the industry.
Despite these criticisms, the SEC maintains its actions are necessary to protect investors and ensure that the crypto industry operates in a fair and transparent manner. As the crypto industry continues to evolve and grow, it remains to be seen how the SEC will respond to new challenges and developments.
Challenges in Regulating Cryptocurrency
Regulating cryptocurrencies presents a unique set of challenges, as the technology is still relatively new, constantly evolving, and often operates in a decentralized and globalized manner. The difficulty in determining the SEC’s domain over crypto and the controversy surrounding the classification of stablecoins are just a few of the issues at the forefront of regulatory discussions.
One of the major challenges in regulating cryptocurrencies is determining the SEC’s domain over the industry. There is often a fine line between what is considered security and what is not.
Another issue that arises in regulating cryptocurrencies is the controversy surrounding the classification of stablecoins.
Stablecoins are a type of cryptocurrency that is pegged to an external asset, such as the U.S. dollar. Last, there are questions about the disclosure requirements and standard of care for crypto issuers.
The SEC’s 2023 priorities include examining whether crypto companies meet standards of care when “making recommendations, referrals or providing investment advice.” This priority highlights the need for clearer guidance on disclosure requirements for crypto issuers and what level of standard of care they should be held to.
The recent developments in SEC crypto regulations show the agency’s growing attention to the cryptocurrency industry. The SEC’s enforcement actions against Kraken and Paxos, as well as the ongoing Ripple lawsuit, reflect its efforts to bring greater accountability and transparency to the market. The Securities and Exchange Commission (SEC) is becoming more involved in the cryptocurrency business, as seen by recent steps taken by the agency. However, the future of cryptocurrency laws in the United States is still unclear. It is quite probable that the SEC will play a vital role in determining the evolution of the market and guaranteeing its continuous growth and success as it continues to advance.