SEC Probe into Defining Crypto for Regulation

SEC crypto regulation

To bring cryptocurrency up to regulatory standards, the U.S. Securities and Exchange Commission has questioned Grayscale Investments’ analysis of trusts offered by the investment service.

Through filings, Grayscale suggested that three cryptocurrencies may be considered securities as federal law. 

Grayscale Investments LLC, a cryptocurrency asset management services provider and subsidiary of Digital Currency Group, has disclosed that it has been answering questions regarding the nature of the native currencies of three different blockchains with the U.S. Securities and Exchange Commission (SEC).

Grayscale pitches crypto trusts to investors looking to diversify their investment portfolio beyond stocks and bonds. Grayscale currently holds billions of dollars in assets in these trusts – with Bitcoin (BTC) and Ethereum (ETH) being the most popular amongst investors.

Being a leading investment services company, Grayscale was asked about its “securities law analysis” of Stellar (XLM), Zcash (ZEC), and Horizen (ZEN) by the SEC. Native tokens from these networks are also in Grayscale’s crypto trusts and are among the smaller trusts offered by the firm.

The SEC is known to be an aggressive regulator, and these questions can bring uncertainty to the prospect of Grayscale marketing their brokerage account-friendly crypto trusts. It also poses a danger to the decentralised nature of crypto, as the SEC is seeking to subject cryptocurrency tokens – which are used internationally – to U.S. securities law.

Defining cryptocurrencies as securities

The inquiries, discreetly made in filings between June and mid-August, were “responses” to the SEC’s Division of Corporate Finance and the Division of Enforcement, as the SEC has announced that it will double down on crypto asset enforcement.  

Earlier this year, the SEC seemed to have adopted the stance that cryptocurrencies should be considered securities. While the broad definition of cryptocurrency covers terms like “coin”,  “token,” “asset,” and “currency” to mean all the same thing, a more accurate form of categorisation is needed – function.

If a currency is considered a security, the SEC looks at whether the currency constitutes an “investment contract.” Currencies that are considered investment contracts must meet the criteria of the Howey Test, which requires that there must be (1) the investment of money, (2) in a common enterprise (3) a reasonable expectation of profits to be derived from the efforts of others.

“If somebody is raising money by selling a token and the buyer is anticipating profits based on the efforts of that group to sponsor the seller, that fits into something that’s a security,”  said SEC chair Gary Gensler on his vision for cryptocurrency regulation in August 2021.

While the SEC has not yet begun to formally direct crypto exchanges to register as security  exchanges, it also has not formally provided guidance to determine the security status of specific cryptocurrencies. 

However this year, the SEC has announced via a complaint that nine cryptocurrencies are considered as securities: Flexa’s AMP, rally (RLY), the Rari governance token (RGT), derivaDAO (DDX), XYO, LCX, powerledger (POWR), DFX finance (DFX) and kromatika (KROM). In the claim, the SEC stated that these tokens were illegally unregistered securities, which sent crypto lawyers into a scramble due to the uncertainty of the futures of these platforms.

As of writing, there is no legal brief or a judge ruling on the status of cryptocurrencies under U.S. federal law. However, the SEC’s inquiries into Grayscale may indicate that the enforcement entity is setting up groundwork for formal rulemaking.

Cryptocurrency has a reputation for being decentralised, which can pose both positive and negative outcomes for its users. While decentralisation offers anonymity, privacy, and transparency in theory, the prospect of regulation from enforcing entities tends to have a bad reputation amongst those keen on sticking with the original spirit of crypto.

However, as the crypto sector matures to accommodate for mass adoption, there is more demand for setting up a clear set of rules and regulations for the widespread use of cryptocurrencies.

In order to protect users now and in the future from malicious activity and bad actors – and to be further recognised as a legitimate form of currency in the eyes of the law, regulations for digital currencies and tokens have to be planned out.

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