The Rise of Cryptocurrency and the Race to Regulate It

If you invested $100 in Bitcoin in October 2010 how much do you think it would be worth eleven years later?  $1,000?  No.  $10,000?  Not even close.  $1,000,000?  Well, take that number and multiple it by forty-eight and you would have the returns on your $100 investment.[1]  But, if you decided to hold on your position for five more months then you would see your fortune get cut in half.[2]  Federal regulatory agencies, like the U.S. Securities and Exchange Commission (“SEC”), want to install safeguards and regulations to take the volatility and risk out of cryptocurrency trading.   

To understand why federal regulatory agencies want to institute new regulations, you first need to understand why cryptocurrencies do not fall under the same regulatory umbrella as traditional securities.  Cryptocurrencies are different because they are digital financial assets that are not backed by a bank, any physical asset of value, and ownership is guaranteed by cryptographic technology.[3]  Cryptocurrencies differ from a bank because the software catalogs and records every transaction back to its initial creation and leaves no capacity to counterfeit or falsify ownership.[4]  If a bank discovers a failing in their information system, and a breach of security, theft, or failure to carry out an instruction for transfer occurs, then the financial institution is legally responsible for compensating the owner of the asset.[5]  But there is one striking similarity between cryptocurrencies and traditional securities, and it is the key in the discussion of future regulations on cryptocurrencies.  That similarity between cryptocurrencies and traditional securities is the Howey test.[6]

The Howey test is how the United States Supreme Court defined an “investment contract” under the Securities Act of 1933.[7]  The Court defined an “investment contract” as “a contract, transaction or scheme whereby a person invest[s] his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”[8]  In 2020, the SEC sought to enjoin Telegram Group Inc. from engaging in a plan to distribute “Grams,” a new cryptocurrency, because the SEC believed it was an unregistered offering of securities.[9]  The New York Southern District Court held that the SEC showed a substantial likelihood of success in proving that the offering of cryptocurrencies fell under the Howey test.[10]  The Court agreed with the SEC and held that in the context of the scheme, the resale of Grams into the secondary public market would be an integral part of the sale of securities without a required registration statement.[11]  The New York Southern District Court’s application of the Howey test to the sale of cryptocurrencies is seen as a groundbreaking decision in cryptocurrency enforcement and opens the door for the SEC to intensify enforcement efforts in the cryptocurrency space.[12]

As the United States is opening the door to cryptocurrency enforcement, China slammed the door on all matters related to cryptocurrency.  Chinese regulators prohibited all cryptocurrency transaction amid concerns that speculative trading was “disturbing economic and financial order [and] breeding illegal and criminal activity.”[13]  China’s move to ban all cryptocurrency transactions has fueled some U.S. representatives to advocate that the United States should “leverage our free-market principles and unleash the American entrepreneurial spirit” with cryptocurrencies.[14]  The SEC Chair Gary Gensler views cryptocurrencies more similar with China’s view as a “highly speculative asset class” that is risky and volatile.[15]  The disparate views on regulations of cryptocurrency are valid as the technology surrounding cryptocurrency is as revolutionary as it is mysterious.  For the future of cryptocurrency regulations, it is unlikely that the United States will follow China’s decision to restrict all cryptocurrency transactions.  Federal Reserve Chairman Jerome Powell announced on September 30, 2021, that the United States has no plans to ban Bitcoin and cryptocurrencies.[16]  But with the recent judicial developments in the New York Southern District Court, it is likely that the SEC will adopt current securities laws and simply apply them to cryptocurrency transactions. 

[1] Carmen Reinicke, Bitcoin hits another record.  Here’s how much you’d have if you invested $100 in 2009, CNBC (Feb. 12, 2021, 8:03 AM), https://www.cnbc.com/2021/02/12/how-much-youd-have-today-if-you-invested-100-in-bitcoin-in-2009.html; See also YCHARTS, https://ycharts.com/indicators/bitcoin_price (last visited Oct. 5, 2021).

[2] Alain Sherter, Bitcoin crash wipes out nearly all the cryptocurrency’s gains for 2021, CBS News (Jun. 22, 2021, 4:11 PM), https://www.cbsnews.com/news/bitcoin-price-2021-gains/.

[3] Giancarlo Giudici, Alistair Milne & Dmitri Vinogradov, Cryptocurrencies: Market Analysis and Perspectives, J. Indus. & Bus. Econ., Sept. 11, 2019, at 2.

[4] Id. at 3.

[5] Id.

[6] Strategic Hub for Innovation and Financial Technology of the Securities and Exchange Commission, Framework for “Investment Contract” Analysis of Digital Asset, (April 3, 2019), https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets.

[7] SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[8] SEC v. Telegram Grp. Inc., 448 F. Supp. 3d 354, 365 (S.D.N.Y. 2020) (citing SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946).

[9] Telegram Group Inc., 448 F. Supp. 3d at 358.

[10] Id. at 359.

[11] Id.

[12] David I. Miller & Charlie Berk, SEC v. Telegram: A Groundbreaking Decision in Cryptocurrency Enforcement?, GreenbergTraurig (Apr. 01, 2021), https://www.gtlaw.com/en/insights/2020/4/sec-v-telegram--a-groundbreaking-decision-in-cryptocurrency-enforcement.

[13] Phelim Kine, China’s crypto ban fuels new U.S. wedge issue, Politico, (Sept. 30, 2021, 8:31 AM), https://www.politico.com/newsletters/politico-china-watcher/2021/09/30/chinas-crypto-ban-fuels-new-us-wedge-issue-494522 (the article cited the quote to a People’s Bank of China statement).

[14] Id. (the article cited a quote from U.S. Representative Andy Barr, ranking member on the House Financial Services subcommittee on National Security, International Development and Monetary Policy).

[15] Id.

[16] Alex McShane, Federal Reserve Cahir Jerome Powell: U.S. Has No Plans to Ban Bitcoin and Crypto, (Sept. 30, 2021, 2:49 PM), https://www.nasdaq.com/articles/federal-reserve-chair-jerome-powell%3A-u.s.-has-no-plans-to-ban-bitcoin-and-crypto-2021-09.