For more than a decade, the pioneers of the cryptocurrency industry envisioned digital coins as an alternate branch of finance, a renegade sector that would operate outside the reach of big banks and government regulators.
But as digital currencies like Bitcoin and Ether became more mainstream, the crypto industry collided with a 1946 Supreme Court decision that created what is known as the Howey Test, a legal analysis that determines when a financial product becomes subject to the same strict rules as stocks and bonds.
In recent years, regulators have seized on that legal precedent to argue that cryptocurrencies are just another security, like shares of Apple or General Motors. The crypto industry has fought back, leaving it in a legal gray zone with an uncertain future in the United States.
Now the long-running dispute is edging closer to a resolution, as federal judges begin weighing in on a series of lawsuits by the nation’s top securities regulator against some of the largest crypto firms. This month, judges held hearings in two of the most consequential cases, which could dictate whether the multitrillion-dollar crypto industry can continue growing in the United States.
The legal battles are “an existential issue for crypto,” said Hilary Allen, a professor at American University who specializes in financial regulation.
The court fights intensified over the last 18 months, as the Securities and Exchange Commission brought enforcement lawsuits claiming that crypto companies were operating as unregulated securities businesses. In response, the industry argued that laws governing Wall Street trading shouldn’t apply to digital currencies. Both sides scored early court victories that left the matter unsettled.
But this month, federal judges held hearings in two cases that legal experts expect to be more decisive: the S.E.C.’s lawsuits against the crypto exchanges Coinbase and Binance, which explore the core issues in the broader legal battle. Preliminary rulings in those suits are expected in the coming weeks, setting the stage for litigation that could ultimately reach the Supreme Court.
“We built our legal strategy around” a possible Supreme Court showdown, said Paul Grewal, Coinbase’s chief legal officer. “These are issues that have potential implications for huge swaths of the economy.”
How the courts rule could determine whether the crypto industry can burrow deeper into the American financial system. If the S.E.C. prevails, crypto supporters say, it will stifle the growth of a new and dynamic technology, pushing start-ups to move offshore. The government has countered that robust oversight is necessary to end the rampant fraud that cost investors billions of dollars when the crypto market imploded in 2022.
“The history of the crypto markets shows that investors are at risk and are being hurt by these platforms’ utter disregard for regulatory requirements,” said Stephanie Allen, an S.E.C. spokeswoman.
Crypto’s origins date to 2008, when a developer known by the pseudonym Satoshi Nakamato created the software behind Bitcoin. Early advocates envisioned crypto as a decentralized alternative to traditional finance, a communal project run by a wide network of people scattered across the world.
But as the industry matured, companies resembling traditional finance firms started developing cryptocurrencies and marketing them aggressively. Enthusiasts bought the digital coins in the hope that they would surge in value. The government viewed the emerging sector as an unregulated version of Wall Street, rife with fraud and manipulation. Last year, the S.E.C. filed 46 crypto-related enforcement actions, according to Cornerstone Research, a consulting firm.
The S.E.C.’s blueprint for crypto is guided by a 1946 Supreme Court case involving investments in Florida orange groves. The case led to the creation of the Howey Test, a legal standard for determining what makes something a security if it isn’t a stock or bond.
Under the framework, a financial product becomes a security when it offers the chance to invest in a “common enterprise” with the expectation of profiting from other people’s efforts. Examples of securities under the Howey Test include some insurance products and even contracts for the sale of chinchillas.
A classification as a security comes with a wide range of legal requirements: Companies that offer securities must provide detailed disclosures and comply with complex investor-protection procedures that can be expensive to carry out.
In public remarks, Gary Gensler, the S.E.C. chair, has argued that most digital currencies qualify as securities under the Howey Test, because people invest in crypto hoping that the companies that issue the currencies will drive prices up. Only Bitcoin, he has said, is outside the S.E.C.’s reach, since no central group or individual oversees it.
Under the S.E.C.’s rule-making authority, Mr. Gensler had the option to develop new regulations for the crypto industry. But he has instead argued that the industry should be governed by existing laws and established court rulings to protect investors from fraud.
The crypto industry has called that approach overly broad, countering that there needs to be a formal contract between the seller of a digital coin and an investor for the arrangement to constitute a securities transaction.
“Gensler’s approach has been to put a square peg into a round hole,” said Teresa Goody Guillén, a partner with BakerHostetler and a former litigation counsel with the S.E.C. “There has to be a regulatory regime in place for these novel assets beyond just saying they are all securities.”
Mr. Gensler’s strategy faced an early test in the S.E.C.’s lawsuit against the digital currency issuer Ripple. In July, a federal judge in New York, Analisa Torres, ruled that Ripple’s cryptocurrency did not qualify as a security — at least when it was bought and sold on public exchanges by amateur investors. Judge Torres found that these investors did not expect to profit from Ripple’s actions as a business.
The ruling was celebrated in the crypto world. But the enthusiasm was tempered a few weeks later when a judge in another case endorsed the S.E.C.’s view that a different set of cryptocurrencies qualified as securities and rejected much of Judge Torres’s reasoning.
That split has raised the stakes for the judges overseeing the S.E.C. lawsuits against Coinbase and Binance, which serve as marketplaces for dozens of digital currencies. In those cases, the S.E.C. has argued that at least 20 cryptocurrencies qualified as securities, offering an opening for the judges to issue broad rulings that could apply across the universe of digital assets.
A hearing last week in the Coinbase case in federal court in Manhattan lasted five hours, with more than 500 people tuning in via phone; about 250 people tuned into the Binance hearing on Monday in Washington. Both hearings revolved around the applicability of the Howey Test to digital currencies.
Lawyers for Coinbase have argued that the S.E.C. is trying to stretch the intent of the Howey Test to cover crypto investments. Without a clear contractual agreement between the buyer of a digital coin and its issuer, the lawyers have said, a cryptocurrency is no different from any other “collectible” that might rise in value over time, like baseball cards or Beanie Babies dolls.
At the hearing, Judge Katherine Polk Failla appeared to endorse some of Coinbase’s concerns about S.E.C. overreach, saying the commission may be “sweeping too broadly.”
“We’re all just afraid that you have so little limitation on your standard” that some lawyers will argue that Beanie Babies are unregistered securities, she told a commission lawyer.
In the Binance case, Judge Amy Berman Jackson in Washington seemed more skeptical of the comparison between digital coins and collectible toys. But she expressed concern about the S.E.C.’s strategy and pressed the government lawyers to explain the boundaries of their argument.
Those hearings came a a few days after a major victory for the crypto industry, when the S.E.C. approved a new Bitcoin investment product for trading on Wall Street. Mr. Gensler had fought to block its introduction until a court ruled against the S.E.C. in August, effectively forcing the agency’s hand.
“That was an extraordinary thing that gave people cause for hope,” said Mr. Grewal of Coinbase. “There’s a real optimism in the industry now.”
