Demystifying the Lawsuits
Paving the way for clear regulatory frameworks for digital assets
Digital assets, with their complexity, novelty, and vast potential for disruption, present a unique conundrum for regulatory bodies worldwide. As the industry has evolved, regulators have struggled to keep pace, leaving a wake of ambiguity and confusion. The implications of this regulatory void have manifested most prominently in recent legal developments involving industry giants.
Several crypto industry leaders, such as Coinbase and Binance earlier this year, found themselves in the thick of legal entanglements due to allegations of dealing with unregistered securities. This development is a first in the crypto space, as regulators, specifically the US Securities and Exchange Commission (SEC), have typically opted for settlements over defining clear regulations.
The result is a state of affairs where pioneering companies are left to chart their own course, often culminating in legal skirmishes, as is the case with these industry titans.
Making Headlines: The Block.one Case
An early noteworthy example of the regulatory puzzle facing crypto companies was the case against Block.one in 2019. The company was taken to court by the SEC for launching an Initial Coin Offering (ICO) of an unregistered security, raising a staggering $4 billion.
Despite the magnitude of this violation, Block.one was only penalized $24 million, a mere fraction of their total raise. This outcome, while seemingly favorable for crypto, underscores the inadequacy of the current regulatory approach.
The Block.one case was one of several lawsuits filed by the SEC that made headlines.
SEC v. Ripple: A Milestone Victory for Crypto
In December 2020, the SEC filed a lawsuit against Ripple Labs, a US-based firm that provides crypto solutions to businesses. Ripple also owns the XRP Ledger public blockchain and its native cryptocurrency token, XRP.
The SEC filed a legal action against Ripple and its two senior officials at a US Southern District Court of New York. In the legal action, the SEC alleged that Ripple, its former CEO and Co-Founder, Christian Larsen, and current CEO, Bradley Garlinghouse, raised more than $1.3 billion while using an unregistered digital asset securities offering.
Following the lawsuit, major crypto exchanges like Coinbase suspended the trading of the XRP token.
The SEC alleged in its lawsuit that Ripple, Larsen, and Garlinghouse sold its XRP tokens to US investors and globally. In their argument, Ripple was supposed to have registered the sales and offer of the XRP tokens before selling them. In addition, Larsen and Garlinghouse designed the sales of the tokens that amounted to nearly $600 million.
Ripple, in part of its defense, argued that the XRP token is an entirely operational digital currency that has, over the years, achieved global adoption. Furthermore, Ripple stated that the XRP token has always traded alongside BTC and ETH, two digital currencies that the SEC doesn’t consider securities.
On July 13, 2023, Ripple received a partial win after Judge Analisa Torres ruled that the XRP coin wasn’t a security at the time it was sold to the general populace.
In the ruling, Judge Torres stated that Ripple’s sale of its XRP tokens on a public cryptocurrency exchange didn’t equate to offers of securities because the XRP buyers didn’t have any hope of earning rewards associated with the efforts Ripple made to sell its tokens. The ruling further asserted that the XRP sales were blind bids as there was no way to tell who between the crypto exchanges and Ripple received the funds used to purchase the tokens.
Notably, Judge Torres stated that in no way did the sale of the XRP tokens fulfill the Howey test that the SEC had used as part of its argument for the case. Thus, the sale of the XRP tokens on different crypto exchanges and as compensation to the staff or Ripple didn’t include the sale and offer of investment contracts.
Despite the victory for Ripple and the crypto community, the SEC also got a partial win as the court ruled that the sale of roughly $728.9 million XRP tokens to institutional investors and hedge funds amounted to the sale of unregistered securities.
When it came to Larsen and Garlinghouse’s involvement, Judge Torres stated that a jury would have to establish whether the two aided the company in violating the securities law as alleged by the SEC.
The digital asset market responded positively to the ruling. However, there were calls to the relevant financial regulators to establish laws and regulations around blockchain and cryptocurrencies in general.
Grayscale Wins ETF Lawsuit Against SEC
Grayscale made headlines last month when it won its case against the SEC.
Grayscale Investment is one of the largest crypto asset managers and manages the Grayscale Bitcoin Trust (GBTC). GBTC is a traditional finance product that gives institutional investors exposure to Bitcoin without them having to buy, manage, and own BTC. Grayscale launched the trust in 2013 and publicly reports its financials.
But why exactly did Grayscale sue the SEC?
In October 2021, Grayscale submitted an application to the SEC as it looked to convert its GBTC into a Bitcoin ETF. Grayscale wasn’t the only asset management company to apply for a Bitcoin ETF, with other firms, such as Blackrock and Fidelity, following suit.
For Grayscale, however, this wasn’t its first attempt to apply for a Bitcoin ETF. The company applied in 2016, later dropping the application as it felt that there weren’t sufficient crypto regulations at the time.
Following this second submission, the SEC rejected the application stating that converting GBTC into a Bitcoin ETF would lead to market manipulation. While Grayscale’s application wasn’t the only one that was rejected, it was the only firm that proceeded to sue the SEC following the rejection.
In its lawsuit, Grayscale asserted that in no way should the regulatory requirements for a Bitcoin spot ETF differ from that of a Bitcoin future ETF and that the same laws that the SEC found applicable to a Bitcoin future ETF should apply to a Bitcoin spot ETF. On August 29, 2023, the US Court of Appeals for the District of Columbia ruled in favor of Grayscale.
The court’s ruling stated that the SEC didn’t provide Grayscale with sufficient reason for the rejection. The ruling made the SEC’s decision null and void.
Following the ruling, the Grayscale Bitcoin Trust witnessed a surge in its trading activities as the price soared from \$17.58 to \$20.56. Moreover, the price of Bitcoin also surged from nearly \$25,960 to approximately \$27,974.
The Call for Transparency and Regulatory Progress
It is becoming increasingly evident that the current “firefighting” approach to crypto regulation, wherein issues are addressed post facto, is neither sustainable nor conducive to the industry's growth.
What is required is a proactive and clear regulatory framework that can guide the industry's growth and safeguard investor interests.
In the absence of clear guidance from regulatory bodies, it falls on the legislative arm to provide clarity. To this end, there are bills currently under review in Congress that aim to clearly define the difference between securities and tokens, thereby bringing some much-needed clarity to the crypto space.
Blurred Lines: The Cryptocurrency Complexity
In conventional finance, distinctions between securities and non-securities are relatively straightforward. However, cryptocurrencies, by their very nature, blur these lines. The introduction of new token types and structures challenges traditional regulatory norms, creating complex gray areas where clear-cut classifications are elusive.
While there are some Bitcoiners who would prefer no institutional involvement in Bitcoin at all, a middle-of-the-road approach makes the most sense to adequately address those blurred lines of crypto regulation.
While Bitcoin should remain the people’s money, a scenario where it can successfully operate globally with no government or regulatory involvement is unrealistic at this point. Therefore, a compromise composed of clear, crypto-friendly regulations is the ideal outcome for the digital asset industry.
The Coinbase Dilemma: A Regulatory Maze
Companies like Coinbase are attempting to do it the correct way. They have been asking for a clear regulatory framework for years while bringing Bitcoin to millions of people. Unfortunately, Coinbase is yet to receive a clear framework on how crypto assets should be handled.
Coinbase, despite its best efforts to comply with regulations, finds itself trapped in a regulatory catch-22. Their attempts to seek clarity from regulatory bodies have been met with bureaucratic runarounds and unhelpful advice.
For example, they were advised to register their tokens, yet the registration process itself is ill-defined. Moreover, once registered, they can only issue tokens that are registered securities, which also requires regulatory approval – a process fraught with ambiguity and uncertainty. After years of asking for clear regulatory guidance without receiving it, the SEC sued Coinbase in June 2023 for allegedly selling unregistered securities, creating more unclarity and hurdles for crypto businesses in the US.
A Call for Regulatory Innovation: The Road Ahead
As it stands, the current regulatory environment is akin to a maze with no clear path forward. This ad hoc approach is untenable in the long term, given the transformative potential of blockchain technology and the digital asset industry at large.
As we move forward, it is essential that regulatory bodies respond to the rapid pace of technological innovation with equally dynamic regulatory innovation. The future of the burgeoning digital asset sector depends on the establishment of clear, fair, and concise rules that not only protect investors but also foster industry growth and innovation.
With nations like the UK, Dubai, Singapore, and Japan leading the way in the creation and adoption of clear regulatory frameworks for digital assets, the United States is poised to follow suit to ensure the space can continue to flourish. While there will be hurdles along the way, a thriving digital asset industry bolstered by an innovation-fostering regulatory framework will be the foundation for ongoing growth and development.
