SEC Crypto Regulation 2024: Historical Context, Updates, and Insights

In recent years, the world of crypto and blockchain technology has witnessed several high-profile projects facing legal and financial struggles. This has led to significant losses for investors and raised important concerns about the stability and safety of the crypto market. Major projects like FTX and BlockFi have declared bankruptcy, further diminishing trust in the sector.

These events have triggered a significant shift in how regulatory bodies approach cryptocurrencies, with the SEC leading the charge in establishing a more robust regulatory framework.

This article will delve into the specifics of the SEC crypto regulation, exploring the historical context of their decisions and examining its updates and their implications for investors, projects, and the broader crypto ecosystem.

What is SEC and what does it have to do with crypto?

The Securities and Exchange Commission (SEC) is a federal agency in the United States responsible for enforcing federal securities laws and regulating the securities industry, the nation’s stock and options exchanges, and other related activities and organizations.

The jurisdiction of the SEC over securities is broad and encompasses the issuance, sale, and trading of securities to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.

Securities are defined under U.S. law by the Securities Act of 1933 and the Securities Exchange Act of 1934. The definition includes traditional instruments such as stocks, bonds, and notes but can also apply to other investment contracts if they meet certain criteria.

The Supreme Court’s decision in SEC v. W.J. Howey Co. (1946) provided a test (known as the Howey Test) to determine whether an instrument qualifies as an “investment contract” and thus a security under U.S. law. According to the Howey Test, an investment contract exists if there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.

Crypto: to regulate or not to regulate?

The debate over whether certain cryptocurrencies qualify as securities primarily revolves around this definition and the application of the Howey Test. Many cryptocurrencies operate on decentralized networks using blockchain technology developments, raising questions about how traditional regulatory frameworks apply to these new types of assets.

Cryptocurrencies as commodities vs. securities

Some cryptocurrencies, like Bitcoin, are often considered commodities rather than securities because they do not represent an investment in a single enterprise and do not provide owners with a claim on future profits.

However, other crypto assets, especially those offered through Initial Coin Offerings (ICOs) or token sales, may be considered securities if they meet the criteria established by the Howey Test.

In July 2017, the SEC issued the “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO” (the DAO Report). This report outlined the SEC’s position that the majority of tokens distributed through ICOs are classified as securities. It cautioned issuers and others involved in the market to adhere to the federal securities laws when offering and selling these tokens.

SEC’s position

As mentioned above, the SEC believes many ICOs and token sales involve the offer and sale of securities and thus fall under its regulatory purview. The agency has taken enforcement actions against several projects that it deemed to have issued securities without proper registration or exemption.

However, the SEC has also stated that not all cryptocurrencies are securities and that the determination requires a facts-and-circumstances analysis.

The SEC itself admits the necessity of evolving alongside the markets it regulates:

“The SEC must also continue to enhance its expertise in, and devote increased resources to, product markets beyond equities — including crypto assets, derivatives, and fixed income — and maintain a nimble and flexible approach to address market changes expeditiously.”

This statement shows that the agency recognizes the necessity of continuously adapting and providing enough resources to properly manage a wide range of financial instruments, especially the fast-growing area of cryptocurrencies.

Historical context of SEC’s involvement in crypto

The SEC’s involvement in cryptocurrency regulation has grown dramatically since its first case in 2013. Starting with just one case that year, the numbers have steadily increased, reaching 28 cases by 2023.

Let’s take a look at the progression of these cases over the years to understand the trajectory of SEC’s regulatory actions in the crypto space.

July 23, 2013: Shavers and BTCST

The SEC charged Trendon T. Shavers and his company, Bitcoin Savings and Trust (BTCST), with operating a Ponzi scheme involving Bitcoin.

Shavers, using aliases, raised over 700,000 Bitcoin (worth over $4.5 million at the time) by promising investors up to 7% weekly interest from Bitcoin arbitrage activities. However, the SEC revealed that BTCST was a sham, with Shavers using new investors’ Bitcoin to pay previous investors and for personal expenses.

The U.S. District Court for the Eastern District of Texas ruled against Shavers and BTCST, ordering them to pay over $38 million in disgorgement, $1.8 million in prejudgment interest, and $150,000 each in civil penalties, while also permanently barring them from future securities law violations.

June 17, 2015: Sand Hill Exchange

The SEC discovered that Sand Hill Exchange, a Silicon Valley-based company, was illegally offering security-based swaps to retail investors without adhering to regulatory requirements.

The company, founded by Gerrit Hall and Elaine Ou, initially aimed to create a platform for valuing private startups like a fantasy sports league but evolved into offering real-money contracts on pre-IPO company values. Despite claiming to seek regulatory approval, Sand Hill didn’t restrict its offerings to accredited investors, violating Dodd-Frank Act provisions.

The SEC intervened early and prevented investor losses. Sand Hill, Hall, and Ou ceased their activities following SEC inquiries and settled the charges without admitting or denying findings. They agreed to stop future violations, and Sand Hill paid a $20,000 penalty.

July 25, 2017: The DAO

This part of history is worth mentioning one more time to understand the context of today’s SEC crypto regulation and related decisions.

The SEC issued a report warning that digital asset transactions by “virtual” organizations, such as Initial Coin Offerings (ICOs) or Token Sales, must comply with federal securities laws. This came after an investigation into “The DAO,” an organization whose tokens were deemed securities, thus requiring registration of offers and sales unless exempt.

While the SEC chose not to bring charges against The DAO, it aims to caution the industry and market participants about their legal obligations.

The SEC also released an investor bulletin to educate on ICOs, highlighting the securities law’s disclosure requirements and warning against investment fraud.

February 20, 2019: Gladius Network LLC

This case stands out because Gladius Network LLC took the initiative to self-report to the SEC after conducting an unregistered ICO in late 2017, raising approximately $12.7 million to fund the development of a network for renting spare computer bandwidth.

The company launched its ICO after the SEC had already cautioned that these campaigns might be subject to securities laws. Gladius still did not seek registration or an exemption at that time.

Their straightforward action in 2018, disclosing the oversight and their willingness to rectify the issue by paying back investors and registering the tokens as securities, convinced the SEC not to impose any fines.

December 22, 2020: Ripple Labs

The SEC sued Ripple Labs Inc. and executives Christian Larsen and Bradley Garlinghouse for raising over $1.3 billion through unregistered XRP sales, alleging they bypassed necessary registration, depriving investors of critical information and protections.

Despite Ripple’s partial victory in July 2023, when a judge ruled that XRP sales on public exchanges were not unregistered securities offerings, the SEC still insisted that sales to sophisticated buyers violated the law.

However, in October 2023, the SEC dropped claims against Larsen and Garlinghouse, focusing on determining the appropriate penalty for Ripple’s actions.

August 9, 2021: Poloniex

The SEC charged Poloniex LLC for operating an unregistered online digital asset exchange, which facilitated the trading of digital assets, including those considered as securities, without proper registration. From July 2017 to November 2019, Poloniex’s platform acted as an “exchange” under securities laws, yet it failed to register as a national securities exchange or to operate under an exemption.

Without admitting or denying the SEC’s findings, Poloniex agreed to a cease-and-desist order and pay over $10 million, including disgorgement, prejudgment interest, and a civil penalty, to settle the charges.

February 14, 2022: BlockFi

The SEC crypto regulation took action against BlockFi Lending LLC for not registering its cryptocurrency lending product offerings and sales, setting a precedent for crypto lending platforms. BlockFi was also found in violation of the Investment Company Act of 1940 registration provisions.

To resolve these charges, BlockFi consented to pay a $50 million penalty, halt its unregistered lending product offers and sales, and seek compliance with the Investment Company Act within 60 days. Additionally, BlockFi’s parent company planned to register a new lending product under the Securities Act of 1933. At the same time, BlockFi agreed to pay another $50 million in fines to 32 states for similar violations.

December 13, 2022: FTX

The SEC charged Sam Bankman-Fried with defrauding FTX investors by misrepresenting the safety of the platform and secretly diverting customer funds to his hedge fund, Alameda Research. Despite raising over $1.8 billion, Bankman-Fried concealed the misuse of funds and FTX’s risky exposure.

A few months later, in February 2023, the SEC charged Nishad Singh, Samuel Bankman-Fried, and Gary Wang of FTX for fraud, alleging they diverted customer funds to Alameda Research, misleading investors about FTX’s safety and Alameda’s privileges. Despite clear indications of financial impropriety, the trio continued misappropriating funds, leading to FTX’s collapse, with Singh personally enriching himself.

On November 2, 2023, Sam Bankman-Fried faced conviction in New York for fraud, conspiracy, and money laundering. His defense argued for a reduced 63 to 78-month sentence, citing his autism and philanthropy, against a proposed 110-year term.

June 6, 2023: Coinbase

The SEC has charged Coinbase with operating without required registrations as a securities exchange, broker, and clearing agency, and for offering an unregistered staking service since 2019. According to the SEC, these actions allegedly deprived investors of necessary protections and oversight.

The SEC seeks penalties, disgorgement, and equitable relief, stressing the importance of compliance with securities laws for investor protection.

Here is what Brian Armstrong, co-founder & CEO at Coinbase, tweeted about the situation,

Regarding the SEC complaint against us today, we’re proud to represent the industry in court to finally get some clarity around crypto rules.

Remember:

1. The SEC reviewed our business and allowed us to become a public company in 2021.
2. There is no path to “come in and register” — we tried, repeatedly — so we don’t list securities. We reject the vast majority of assets we review.
3. The SEC and CFTC have made conflicting statements, and don’t even agree on what is a security and what is a commodity.
4. This is why the US congress is introducing new legislation to fix the situation, and the rest of the world is moving to put clear rules in place to support this technology.

In August 2023, Coinbase contended that the digital assets listed on its platform do not fall under the SEC’s jurisdiction, arguing that these assets are not “investment contracts” and, therefore, not securities. The company aimed to dismiss the lawsuit, claiming the SEC’s actions exceeded its regulatory bounds​​​​.

As of March 6, 2024, the SEC and Coinbase remain in anticipation of a crucial verdict on Coinbase’s request for a judgment on the pleadings. During a four-hour oral argument session in January 2024, presided over by U.S. District Judge Katherine Polk Failla in Manhattan, the determination of whether tokens qualify as digital assets was discussed. Despite the extensive debate, Judge Failla indicated that she had yet to reach a decision, as reported by Reuters.

This legal battle underscores the ongoing tension between the cryptocurrency industry and regulatory bodies over the classification and regulation of digital assets. The outcome could have significant implications for how cryptocurrencies are regulated and operated in the United States.

SEC crypto regulation: 2024 updates

In 2024, the SEC has already introduced several updates to its regulatory framework for crypto and DeFi sectors. Let’s take a closer look at them.

Green light to Bitcoin ETF

On January 10, 2024, a significant regulatory milestone was achieved when the SEC approved rule changes that will enable the establishment of Bitcoin ETFs in the United States. This pivotal decision paves the way for mainstream investors to partake in the Bitcoin market, which has been known for its high volatility and innovation.

The crypto community has warmly received this development, recognizing it as a monumental step forward in legitimizing cryptocurrency as an accessible investment option for the general public.

SEC’s new “dealer” definition impacting crypto

On February 6, 2024, the SEC crypto regulation adopted new rules. These mandate a broader spectrum of market participants to register with the SEC, affiliate with a self-regulatory body, and comply with existing securities laws and regulations.

This move, primarily detailed in a 247-page document, aims to extend regulatory oversight over the cryptocurrency and DeFi sectors by redefining terms such as “dealer” and “government securities dealer” and clarifying what constitutes engaging “as a part of a regular business” under the Securities Exchange Act of 1934.

These regulations target entities that significantly contribute to market liquidity. To fall under these new rules, entities must manage or control assets worth at least $50 million.

The reaction to this update wasn’t very positive. The DeFi Education Fund criticizes the SEC’s new rules as misguided, highlighting a lack of viable compliance paths for DeFi participants and calling the approach impractical and innovation-stifling.

Marisa Coppel, Head of Legal at Blockchain Association, reflects disappointment over the SEC’s disregard for industry feedback, arguing that the revised definition of “dealer” sets unrealistic standards for DeFi projects and lacks clarity.

SEC in “enforcement-only mode”

SEC Commissioner Hester Peirce stated at ETHDenver on February 29, 2024, that the U.S. investment regulator’s current stance towards the cryptocurrency sector is “enforcement-only mode” and mostly follows the court-forward approach. She also remarked on the effort to avoid legal action, saying, “What reflects is the fact that you all are using part of your brainpower.” In her opinion, with clearer regulations, the industry could instead concentrate on innovation.

It is true that the SEC has been cautious with setting up new, specific rules for cryptocurrencies. To address violations, the commission mostly applies and interpret existing security laws, such as:

• Securities Act of 1933
• Securities Exchange Act of 1934
• Investment Company Act of 1940
• Investment Advisers Act of 1940
• Sarbanes-Oxley Act of 2002
• Dodd-Frank Wall Street Reform and Consumer Protection Act

So, basically, the question at the heart of the SEC’s crypto regulation is whether or not crypto can be classified as securities. The commission has not yet provided a definitive classification for all cryptocurrencies.

Impact of SEC crypto regulation updates on the market and investors

The updates to SEC crypto regulations in 2024 are expected to significantly affect both the cryptocurrency market and its investors. By approving the establishment of Bitcoin ETFs in the U.S., the SEC has opened the door for broader investment in cryptocurrencies, potentially stabilizing and increasing market confidence in these assets.

However, the SEC’s expanded definition of “dealer” has sparked concern among DeFi participants and the wider crypto community. This redefinition could place considerable regulatory burdens on entities within the crypto space, potentially slowing down innovation and complicating compliance efforts.

In the end, achieving the right regulatory balance is essential. Regulations in general serve to safeguard investors from fraudulent schemes and ensure market integrity. For example, by enforcing Know Your Customer (KYC) and Anti-Money Laundering (AML) guidelines, authorities can prevent the misuse of crypto platforms for illicit activities.

Such measures are generally welcomed because they enhance the safety and attractiveness of cryptocurrencies as an investment option, potentially drawing more participants and bolstering market robustness.

However, there’s a risk that excessive regulation could undermine the foundational principle of crypto: decentralization. Cryptocurrencies were designed to operate without central oversight, but if compliance with complex regulations becomes feasible only for large, well-resourced companies, the crypto ecosystem could lean towards centralization.

Now, regulators are faced with the complex challenge of crafting laws that would preserve the beneficial attributes of cryptocurrencies — their capacity for innovation and decentralization — while also mitigating potential risks.

Conclusion

The landscape of SEC crypto regulation in 2024 has continued to evolve. As the SEC introduces new guidelines and clarifications, it is vital for stakeholders in the blockchain and crypto spaces to stay informed and compliant.

Navigating these ever-changing waters can be quite a challenge for both newcomers and seasoned players in the field. This is where our blockchain consulting services come into play. Our services range from strategic planning and compliance consulting to technical solutions and market analysis, all tailored to your unique needs and objectives.

Contact us today to explore how we can help you leverage the latest in cryptocurrency regulation, ensuring your business not only remains compliant but also thrives in this dynamic environment.