Can the SEC Regulate Bitcoin?
Defining the Term “Security” Under Federal Law
In simplistic terms, a “security” is an investment in a business that is intended to generate a return for the investor. Shares of stock in a corporation are a familiar example. But, there are several other types of securities as well. These are defined in Section 2(a) of the Securities Act and Section 3(a)(10) of the Exchange Act.
Each of these laws includes provisions that define the term “security” by providing a list of assets that qualify. Examples include:
- Bonds
- Debentures
- Financial instruments
- Investment contracts
- Notes
- Pooled investment trusts
- Stock
As you can see, “cryptocurrency” is not on the list. In fact, the list of assets that the SEC considers securities does not include any assets in the crypto space. So, how does the SEC assert authority over the cryptocurrency market?
The SEC has used the broad definition of the term “investment contract” to claim that the sale of cryptocurrencies constitutes a regulated securities offering. In particular, it has relied on the definition of the term “investment contract” established by the U.S. Supreme Court in SEC v. W.J. Howey (1946).
Under Howey, the definition of an “investment contract” is an investment of money in a common enterprise with the expectation of profits to be derived from the efforts of others. As you can see, this definition is also extremely broad. So, in order to determine whether the sale of a particular cryptocurrency constitutes a regulated securities offering, the courts must examine the specific facts at hand.
When it comes to the SEC’s efforts to regulate Bitcoin specifically, two federal courts have recently reached the same conclusion. If you are selling Bitcoin, facilitating Bitcoin transactions, or providing information about Bitcoin, these decisions provide a strong defense to any enforcement action the SEC may take against your business.
The U.S. Courts of Appeals for the Second and Seventh Circuits Both Conclude that Bitcoin is Not a Security
While the SEC has a strong argument for regulating cryptocurrencies using the definition of the term “investment contract” from Howey in many instances, it has hit a wall when it comes to Bitcoin. In March 2024, the U.S. Court of Appeals for the Second Circuit and the U.S. Court of Appeals for the Seventh Circuit both concluded that the SEC cannot regulate Bitcoin, as it is not an “investment contract.”
In SEC v. Coinbase, Inc. in the Southern District of New York, the court concluded that the SEC failed to allege that Coinbase’s staking program involved an investment of money in a “common enterprise.” The court determined that this was a fatal flaw in the SEC’s case, and it dismissed the SEC’s action. The court based its decision on the narrow definition of the term “common enterprise,” holding that “to qualify as a common enterprise, each investor must receive an interest that is factually and legally identical to that of each other investor.” The court also rejected the SEC’s claim that the defendants’ investment contracts included “the expectation of profits from [the] efforts of others.”
The court in Coinbase Inc. also rejected the SEC’s claim that Bitcoin was effectively a security based on the investors’ expectation of profit. The court noted that the record in the case showed that roughly half of Coinbase’s investors had no expectation of profit. It also rejected the SEC’s argument that investors’ “expectation of profit” did not need to be premised on the efforts of the company behind the investment contract:
Here, the SEC asserts that Howey’s “efforts of others” prong is satisfied because . . .the Trading Platform “incentivizes them to work to remain listed so that their prices will rise and so that they can be traded without legal registration.” The SEC also asserts that “the value of the . . . tokens themselves is tied to the success or failure of the business, so the buyers have a reasonable expectation of profit from the efforts of the companies that issued them.”
However, nowhere in its complaint does the SEC allege that an investor’s expectation of profit is based on the efforts of the issuer of the token. . . . Rather, it alleges only that there is an expectation of profit based on the efforts of third parties.
The Seventh Circuit reached the same conclusion in Balestra v. ATBCOIN LLC, finding that the SEC failed to allege a “common enterprise.” In Balestra, the court also rejected the SEC’s argument that it did not need to establish an expectation of profit from the “efforts of others.”
What About SEC v. Ripple Labs?
As discussed above, the court reached a different conclusion in the SEC’s enforcement action against Ripple Labs. There, the court held that the sales of Ripple’s XRP tokens constituted securities offerings that fall within the SEC’s enforcement jurisdiction.
But, Ripple Labs is distinguishable from Coinbase and Balestra on several fronts. Notably, Ripple Labs involved a new cryptocurrency offering rather than the sale of an existing cryptocurrency. In Ripple Labs, the court held that Ripple’s initial coin offering (ICO) of XRP tokens constituted an investment contract because investors were purchasing a new cryptocurrency from an established company. As such, the court found that these investors’ expectation of profit was based on the efforts of others—specifically, Ripple Labs itself.
Put simply, the key difference between Ripple Labs and Coinbase and Balestra is that in Ripple Labs the SEC was seeking to regulate an ICO, while in Coinbase and Balestra the SEC was seeking to regulate the sale of an existing cryptocurrency (Bitcoin). The court’s decision in Ripple Labs appears to be limited to ICOs—which the SEC has long been able to regulate. The SEC’s decisions in Coinbase and Balestra, by contrast, are more recent, and they reach the same conclusion that the SEC does not have the authority to regulate Bitcoin.
What About the SEC’s Regulation of ETF Offerings Based on Bitcoin?
The SEC is currently considering whether to approve the first-ever spot Bitcoin ETF. It has previously approved ETFs based on Bitcoin underlying futures contracts, but it has not yet approved an ETF based on Bitcoin itself.
If the SEC approves a spot Bitcoin ETF, does this mean that Bitcoin is a security? No. What this means is that the ETF is a security. This is an important distinction. An ETF is a product that is tradable on the public markets, and ETFs are regulated as securities under the Securities Act and Exchange Act. However, the ETF’s underlying asset (in this case, Bitcoin) is not necessarily a security in and of itself. The ETF is simply an investment vehicle that allows investors to gain exposure to Bitcoin’s price movements.
Schedule a Complimentary Consultation with a Senior Bitcoin SEC Attorney at Spodek Law Group
If your business is facing scrutiny from the SEC based on its involvement with Bitcoin, we encourage you to schedule a complimentary consultation at Spodek Law Group. We represent United States-based and foreign businesses in SEC matters nationwide and worldwide. To speak with a senior Bitcoin SEC attorney in confidence, call 212-300-5196 or tell us how we can reach you online today.
