Annual Review of Crypto Regulation: Headwinds Subside, Bright Future Ahead
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Annual Review of Crypto Regulation: Headwinds Subside, Bright Future Ahead
The "Sword of Damocles" hanging over the cryptocurrency industry appears to be gradually dissipating.
Navigating Web3 tides with focused insightsBy PanteraCapital
Translated by Felix, PANews
In 2022, regulatory actions caused domino after domino to fall across the crypto industry, triggering a cascade of collapses. This year, the final few dominos were toppled—with Binance being one of the last major players standing. Now, it appears all the dominos have fallen. Most significant developments are now positive news, and the blockchain industry has made meaningful and necessary progress. This article reviews some of the key regulatory events of 2023.
Resolved Enforcement Actions
NFTs
The U.S. SEC recently announced its first two enforcement actions under federal securities laws against NFT issuers: Impact Theory, a California-based media and entertainment company, and Stoner Cats 2, producers of an adult animated television series. These cases mark an expansion in the scope of entities the SEC is regulating. In both cases, the SEC alleged that the NFTs sold constituted unregistered securities. Following the charges, both companies agreed to settlements with the SEC, paying approximately $6.1 million (Impact Theory) and $1 million (Stoner Cats), respectively.
In both cases, the SEC focused on how the issuers marketed their NFTs—specifically, promoting the idea that investors would profit from the efforts of others. This expectation of profit derived from third-party efforts is a key criterion in the Howey Test used to evaluate whether digital assets qualify as securities.
These enforcement actions strongly suggest that the U.S. SEC may conduct further scrutiny of NFTs. Issuers selling such assets should carefully assess their product design, marketing, and promotional strategies.
Kraken
Another major settlement this year involved the exchange Kraken. Kraken agreed to pay $30 million to settle with the U.S. SEC over allegations that its staking service constituted an unregistered security, meeting the definition of an investment contract.
Similar to the SEC’s findings in the Impact Theory and Stoner Cats NFT enforcement actions, the SEC emphasized how Kraken promoted its staking service, advertising annual returns of up to 21%. Kraken also had unilateral discretion to change staking yields and commingled customer assets with its own.
Ooki DAO
Ooki was a case brought by the Commodity Futures Trading Commission (CFTC). The CFTC accused Ooki DAO—and any individual or entity holding tokens and voting for certain governance proposals—of violating the Commodity Exchange Act (CEA) by operating as an unregistered futures commission merchant (FCM), soliciting and accepting customer orders, accepting money or property as margin, and extending credit. A major hurdle in this case was determining how a decentralized protocol could be properly served. The CFTC argued that Ooki DAO was an entity that could be sued as an “unincorporated association under state law,” not merely a technology. The court ultimately agreed.
The judge entered a default judgment in favor of the CFTC, ruling that Ooki DAO operated as an illegal trading platform and unregistered FCM, and failed to implement an adequate KYC program. The DAO was ordered to pay approximately $640,000 in penalties and cease operations. While the fine may seem small compared to other settlements, the primary impact of this case is the court's recognition that a DAO can be treated as a legal entity. This raises concerns among token holders who participate in governance votes, as individual holders might also face liability in future enforcement actions.
Pending Enforcement Actions
Coinbase
A central regulatory theme over the past year has been the SEC’s enforcement actions against major exchanges in the crypto ecosystem, including its lawsuit against Coinbase.
The SEC alleges that Coinbase has been operating as an unregistered securities exchange, broker-dealer, and clearing agency. As in the Kraken case, the SEC claims Coinbase’s staking service constitutes an unregistered security. Coinbase subsequently filed a motion to dismiss the lawsuit, with a decision expected in January next year. If the court does not rule in Coinbase’s favor on the motion to dismiss, this legal battle is expected to continue for a prolonged period.
Notably, several months before the SEC filed its lawsuit, Coinbase sued the SEC under the Administrative Procedure Act (APA) to compel the SEC to respond to its prior petition for rulemaking on digital assets. Essentially, Coinbase is attempting to force the SEC through litigation to establish clear regulations explaining how securities laws apply to cryptocurrencies, via a formal notice-and-comment process that allows public participation.
In its complaint against Coinbase, the SEC must prove that the digital assets—or arrangements involving digital assets in staking—constitute investment contracts and therefore securities. Additionally, regarding the charges of operating an unregistered exchange, broker-dealer, and clearing agency, the SEC listed several digital assets it considers unregistered securities, including Solana, Polygon, NEAR, and MATIC.
As with many other SEC complaints, the SEC is not solely targeting intermediaries. Although the SEC did not sue Solana, NEAR, MATIC, or Polygon directly, naming them in the Coinbase complaint signals the SEC’s position that these digital assets are operating illegally as unregistered securities. Given this, a wave of enforcement actions is expected in 2024.
Ripple
Another major story driven by the U.S. SEC over the past year has been its ongoing litigation with Ripple Labs, in which the SEC claims Ripple’s token XRP is a security. In July, Judge Analisa Torres of the U.S. District Court for the Southern District of New York issued rulings on multiple motions in the case. In her analysis, Judge Torres reviewed and ruled on four distinct types of sales or issuances of Ripple’s native XRP token:
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Sales of XRP by Ripple through its wholly owned subsidiary to institutional buyers constituted investment contracts, as profits were expected based on the efforts of others.
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Programmatic sales of XRP by Ripple on cryptocurrency exchanges—conducted via trading algorithms—did not constitute investment contracts. Because these were “blind buy-sell transactions,” buyers could not know whether their payments went to Ripple or another seller. Therefore, buyers in programmatic sales did not expect profits from Ripple’s efforts, leading Judge Torres to conclude that XRP sold programmatically was not an investment contract under the Howey Test.
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Distributions of XRP by Ripple to employees as compensation, or to third parties funding the development of new applications for the XRP ledger, did not constitute investment contracts.
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Sales of XRP by Ripple’s CEO and Chief Legal Officer in their personal capacities on crypto exchanges were not investment contracts, for the same reason as programmatic sales. Since the buyers did not know the identity of the sellers, they did not base their purchases on expectations of profit from Ripple’s efforts, and thus these transactions were not investment contracts.
While the rulings on these transactions are complex, the primary takeaway for the industry is that Judge Torres clearly stated that XRP itself is not inherently a security. According to her ruling, the manner in which an asset is sold determines whether it qualifies as a security.
Overall, Judge Torres’ decision is widely seen as decisively positive for the industry, as the only ruling in favor of the SEC was limited to direct institutional sales by the issuer. However, although this ruling is undoubtedly a setback for the SEC’s enforcement agenda, the case remains on appeal and could still be overturned. Shortly after Judge Torres’ Ripple decision, another judge in the same district issued a conflicting ruling.
Judge Rakoff of the Southern District of New York (SDNY) denied a motion to dismiss an SEC lawsuit alleging that Terraform Labs and its CEO, Do Kwon, violated securities laws by issuing and selling multiple crypto assets. In his ruling, Judge Rakoff explicitly disagreed with Judge Torres’ distinction between purchasers in “primary products” and those buying crypto assets on exchanges as “blind” transactions.
Specifically, Judge Rakoff did not distinguish between primary and secondary sales, instead focusing again on the buyer’s expectation of profit.
Following these two contradictory rulings and subsequent motions and appeals, there is currently a split within the Southern District of New York on whether—and under what circumstances—exchange trading of crypto assets constitutes offers and sales of investment contracts. A definitive answer to this question could be crucial for market participants in the crypto space.
Compound
One notable case involves litigation against Compound Labs—but not initiated by a regulator. Compound Labs is a DeFi protocol that issues the governance token COMP. In December 2022, a class-action lawsuit was filed alleging that COMP is an unregistered security, and that Compound Labs and affiliated venture capital investors solicited plaintiffs to purchase COMP in violation of securities laws.
In September 2023, the court denied the defendants’ motion to dismiss. Though still in the early stages, this will be an important case to watch.
Bitcoin ETFs
Another topic dominating headlines and discussions is the pending applications for spot Bitcoin ETFs from several major institutions awaiting SEC approval.
For years, Grayscale has been fighting the U.S. SEC over its application to convert the Grayscale Bitcoin Trust (“GBTC”) into a regulated exchange-traded product listed on a securities exchange. In June 2022, the SEC rejected Grayscale’s application to launch a spot Bitcoin ETF. Grayscale then sued the SEC, arguing that the rejection was “arbitrary and capricious,” especially given the SEC’s prior approval of Bitcoin futures ETFs. Recently, a judge in the D.C. Circuit Court ruled that the SEC lacked sufficient justification to deny GBTC’s application, marking a partial victory for Grayscale. This means the SEC must now reconsider the application.
The SEC must make a decision within a specified timeframe. Specifically, a determination on GBTC is expected at any time between now and early January 2024, after which the SEC is likely to issue decisions on other applicants either simultaneously or shortly thereafter.
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