The SEC explains how it's viewing a crypto security: State of Crypto

Joint SEC-CFTC interpretive guidance outlines how the agencies will determine whether a cryptocurrency is a security.

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The U.S. Securities and Exchange Commission and Commodity Futures Trading Commission published interpretive guidance explaining how they might define what is or isn't a security in crypto; the CFTC also issued a no-action letter for a non-custodial wallet provider to facilitate derivatives and prediction markets transactions; Arizona is filing criminal charges against a prediction market provider; and by the way we kind-of-sort-of have hints of movement on market structure legislation.

What a week, huh?

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Digital securities

The narrative

The U.S. Securities and Exchange Commission published interpretive guidance this week — joined by the Commodity Futures Trading Commission — laying out how it approached the question of what in crypto it will deem a security.

Why it matters

What is, and isn't, a security has long bedeviled the industry. We had efforts at somewhat defining this from the SEC in the past — Bill Hinman's "When Howey met Gary (plastics)" speech, for example — but this week's interpretative guidance is one of the most specific efforts to define this for the industry.

Breaking it down

The SEC laid out several categories it saw in the crypto space, with one of these categories being digital securities. These are cryptocurrencies that meet the definition of a security under any other context, but happen to be tokenized, the guidance said. For example, if a crypto asset meets the prongs of the Howey Test, it's a security.

This is the category of tokens the SEC will oversee.

Other categories include payment stablecoins, digital tools, digital collectibles and digital commodities, which are generally not securities unless the issuers or operators take actions that might meet securities regulations, such as fractionalizing the tokens in question.

"We establish a straightforward taxonomy of crypto assets — most of which are not securities — and clarify how the Supreme Court’s Howey test applies when a crypto asset is part of an investment contract," SEC Chair Paul Atkins and Commissioners Hester Peirce and Mark Uyeda wrote in an oped for CoinDesk.

The CFTC said it would sign on to the guidance and administer it under the Commodities Exchange Act.

"Market participants — from innovators and issuers to individual investors — should review this interpretation to better understand the regulatory jurisdiction between the SEC and CFTC," the CFTC said in a press release. "The interpretation will be published on CFTC.gov and in the Federal Register."

Congressman Troy Downing (R-Mont.) called the guidance "very positive," but said Congress still needed to pass market structure legislation as a future administration could undo the interpretative guidance.

"Just having another two or three years of this and then having ambiguity out there doesn't make most people comfortable on doing any kind of big investment," he told CoinDesk. "But it's a great start because this is exactly what the industry wants, and it allows some people to move forward."

Chris LaVigne, a partner at the law firm Withers, said the guidance "predictably concludes that most crypto assets and many common crypto activities are not securities," though the agency kept some discretion to being an enforcement action in this area.

"The guidance moves the securities inquiry away from the asset or activity itself (which are mostly deemed digital commodities not within the purview of the SEC) and re-centers the analysis on the transactions and representations in which these assets or activities arise or are marketed," he said. "By doing so, the SEC did not completely eliminate uncertainty or its enforcement role, because it concludes that a crypto asset that is not a security can nonetheless be sold as part of an investment contract if it is marketed with promises of profit derived from the issuer’s essential managerial efforts."

A crypto that was marketed as a security may eventually be deemed something else "once those promises are fulfilled or no longer operative," he said. This might affect securities more broadly than just crypto assets.

It's less clear what may constitute a commodity under the guidance.

Jason Gottlieb, a partner at Morrison Cohen, said the Commodity Exchange Act defines commodities as a list of products (excluding onions and motion picture box office receipts), services and other issues "in which contracts for future delivery are presently or in the future dealt in."

This legal definition diverges from the definition seemingly being used in the guidance. The CFTC's approach to crypto over the past decade has evolved since some early lawsuits, where it claimed jurisdiction over bitcoin BTC$68,720.94, leading it to seemingly have jurisdiction over non-security cryptocurrencies. But this definition needs to be codified by market structure legislation, he told CoinDesk.

"People need to understand that jurisdiction is still uncertain. The SEC is clearly saying 'we don't have jurisdiction if the token does not meet these criteria,'" he said. "Just because the SEC does not have jurisdiction does not mean the CFTC does."

Gottlieb said he was part of a case before the Seventh Circuit Court of Appeals seeking to gain clarity on this question, but market structure legislation would be needed to cleanly grant the CFTC jurisdiction over all non-security cryptocurrencies.

The status of that legislation also remains up in the air. Senator Cynthia Lummis (R-Wyo.), speaking at the DC Blockchain summit earlier this week, said she anticipated a markup may happen in the final weeks of April. The issue of stablecoin yield may be resolved with an agreement that stablecoin issuers and their partner firms would not describe their products using bank terminology, though she cautioned that she hadn't seen any specific language yet.

The flip side, several individuals told me, is that the Clarity Act might require the SEC to go back to the drawing board on how it's defining securities in crypto. But this falls under the category of bridges that can be crossed when they're reached.

Senator Tim Scott (R-S.C.), the chair of the Senate Banking Committee, said lawmakers are also close to agreements on issues like ethics and quorums on the regulatory agencies — some of the outstanding areas of disagreement on the bill.

Downing said he saw an April time frame as doable for advancing market structure legislation. The closer lawmakers get to the end of the year, however, the less likely it would be that anything could be passed, he said, pointing to the midterm election. "But I don't think it's impossible."

Senator Kirsten Gillibrand (D-N.Y.) said on stage at the DC summit that she was "optimistic" there would be a markup soon, which would then lead to the Banking and Agriculture Committee's bills combining.

The combined bill would need to incorporate areas of bipartisan agreement, she said.

"One of the issues that I think is very important that people should be aware of is the Senate wants an ethics provision," she said. "I think the House would have had even more support on the Democratic side if they had retained their ethics provisions in their bill. It's very important that members of Congress do not get rich off of this industry, because they have access to non-public information, because they have positions of power and authority."

Downing said the market structure bill needed to address consumer protections and money laundering, without being so restrictive that companies would be scared to do anything.

"Nobody wants bad actors in their space and nobody wants that reputation of bad actors using this as a tool to do bad things," he said. "... If you bring those [provisions] in too narrow, nobody's going to do anything innovative."

He said he understood why banks might be concerned about the yield issues.

"Community lenders, community banks are worried about depositors all exiting the market, in which case you're not doing mortgages on small farms in Montana, right?" he said.

Late Friday, Senators Angela Alsobrooks and Thom Tillis told Politico they had reached an agreement on the yield issue, though the details had not been shared with the banking or crypto industries as of press time.

Prediction markets

Kalshi was just ordered to cease offering most of its prediction markets in the state of Nevada for at least two weeks, pending a hearing on April 3.

The order came after an appeals court refused to grant an administrative motion that could have blocked the state court's action. Earlier in the week, the state of Arizona filed criminal charges against Kalshi, alleging some of its election and other contracts violate state law.

In Nevada, a judge ruled that Kalshi can't offer sports, election or entertainment-related event contracts at least temporarily.

According to the order by Judge Jason Woodbury, the record in Nevada's case against Kalshi so far suggests that it offers products defined by state law, making its conduct subject to Nevada's gaming regulators.

"The question of federal preemption in this regard is nuanced and rapidly evolving," the judge wrote. "At the moment, the balance of convincing legal authority weighs against federal preemption in this context."

The Arizona action goes further, alleging misdemeanor violations on small bets placed on professional football and college basketball games, upcoming elections and on whether bills become law and whether public figures will show up to sporting events.

"Arizona law prohibits operating an unlicensed wagering business, and separately bans betting on elections outright," Arizona Attorney General Kris Mayes' office said in a press release.

Kalshi co-founder Tarek Mansour called the charges a "total overstep" that "have nothing to do with gambling or the merits."

There's a broader growing backlash to prediction markets. Senator Catherine Cortez-Masto, who represents Nevada, wrote an opinion piece saying prediction markets "blatantly violate state and tribal laws and regulations."

"To ensure responsible gaming, casinos, sportsbooks and online gaming sites have to follow minimum age requirements, participate in integrity monitoring and support critical consumer protections, like programs that help people with gambling addictions," she said. "Yet, this past year, emboldened by limp and overly permissive federal regulators like the Commodity Futures Trading Commission (CFTC), so-called 'prediction markets' have transformed themselves into illegal sportsbooks, offering their users illicit sports wagers."

This week

This week

• There are no hearings or public meetings scheduled (at least pertaining to crypto).

If you’ve got thoughts or questions on what I should discuss next week or any other feedback you’d like to share, feel free to email me at [email protected] or find me on Bluesky @nikhileshde.bsky.social.

You can also join the group conversation on Telegram.

See ya’ll next week!

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