Establishing the legal status of cryptoassets as securities

In November 2024, a dispute over the nature of digital assets, particularly cryptocurrencies, intensified in the US – are they securities? Eighteen states have filed a lawsuit against the Securities and Exchange Commission (SEC). Those who filed the lawsuit believe that digital assets, especially when sold on a secondary market (e.g., a cryptoexchange), do not fall under the SEC's jurisdiction.

The SEC requires issuers of securities to register with the SEC, including disclosure and publication of a prospectus. Applying similar rules to cryptocurrencies harms states' efforts to develop the digital assets industry, which is governed by consumer protection laws and licensing requirements for money transmitting services (for example, in Florida and Kentucky).

It is important to note that the Securities Act has classified an investment contract as a security since as early as 1933. A 1946 court case resulted in the development of the Howey test, which defines 3 criteria for a security:

1) Investment of money in any form (e.g., purchase of a digital asset in exchange for fiat currency).

2) Existence of a common enterprise.

3) Expectation of profit as a result of the efforts of others (the issuer of digital assets).

The third criterion, the investor's expectation of profit as a result of the efforts of others, is important. An investor can expect a profit if he sells the asset at a profit as a result of an increase in its market value due to the issuer's management efforts rather than general economic growth or inflation. For example, the issuer can make these decisions: limit the supply of the asset; decide who gets additional tokens (assets) and on what terms; monopolize the validation and confirmation of transactions with the asset; and pay its managers with the asset. The purchase of a digital asset will rather have an investment character, when the possibility to immediately use it to pay for goods and services instead of fiat currency is limited.

The SEC believes that individuals involved in Initial Coin Offering (ICO), sale or distribution of a digital asset should assess whether the digital asset has the characteristics of an investment contract. This includes not only the form and terms of the investment in digital assets, but also the circumstances and way it is offered and sold, including in the secondary market (e.g., whether it is a private offering to a limited number of investors or a public offering to all). To resolve contentious issues, the SEC encourages contacting it on its website.

The SEC has repeatedly resorted to enforcement against cryptoassets providers such as Ripple, Binance, and Coinbase.

The example of a state whose efforts are hurt by the SEC's position is Oklahoma, where HB 3594, a law regulating digital assets, went into effect in November 2024. “Digital assets” include virtual currencies, cryptocurrencies, stablecoins, and non-fungible tokens (NFTs).

The law does not allow the government to prohibit or restrict the use of digital assets for the purchase of goods and services and selfcustody using self-hosted wallet or hardware wallet.

Payments with digital assets cannot be subject to additional taxes and fees compared to other means of payment. The law legalizes home digital asset mining subject to local noise requirements, as well as the business of mining in industrial zones with a prohibition to set special noise pollution standards for such businesses.

Interestingly, this law in no way excepts any person, entity, transaction or activity from the jurisdiction of the Oklahoma Department of Securities, i.e. the above dispute between the states and the SEC is not about whether digital assets are securities, but rather about the distribution of powers between the center and the regions.

Russia’s experience

In Russia, the Law on Digital Financial Assets (DFA) and Digital Currency prohibits the acceptance of digital currencies (cryptocurrencies) as means of payment. In Russia, there is no question of regulating digital currencies and DFAs as securities. A similar approach exists, for example, in France.

From the monitoring issue No. 11, November 2024. Download the full issue (PDF) · issue page at the Gaidar Institute