9 June 2020
With cryptocurrencies entering the mainstream financial market, the regulatory intervention of different government agencies has increased over the last few years.
With the U.S. being the mother of all financial markets and the most powerful economy, the regulatory actions of the country are most closely watched by the crypto market enthusiasts.
The Securities and Exchange Commission (SEC) is a U.S. body that oversees financial trading activities, especially securities transactions. It is primarily responsible for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry.
The formation of the SEC took place during the Great Depression of the 1930s through the formation of the Securities Exchange Act in 1934.
The primary job of the SEC is to monitor the activities of all players in the financial space and prevent any kind of fraud and intentional deception. The aim of the SEC is to boost confidence in the capital markets by providing investors with a conducive environment along with the assurance of fair trading practices.
SEC’s Role In Crypto Market
When it comes to monitoring the crypto markets, the primary role of the SEC remains the same. To understand its role in the crypto space, we first need to understand the need for SEC intervention in the crypto markets.
As we know, cryptocurrencies are completely decentralized and free from any regulatory intervention. Besides, the distributed ledger technology prevents any single-party dominance.
However, over the last few years, the crypto market was flooded with many new projects launching their own cryptocurrencies through the process of ICOs, popularly called Initial Coin Offerings (ICOs).
It happened so that while some ICOs were legit and played by the rulebook, many turned out to be a hoax, just promising big returns to investors without any concrete fundamentals.
When the markets got flooded with many fake projects, trapping gullible investors, the SEC decided to intervene in this and take some bold measures.
Over the last few years, the SEC has implemented strict rules, noting that cryptocurrency tokens issued through ICOs shall be treated as ‘securities’ and allowed only after the SEC’s has granted permission.
The SEC has also derived the ‘Howey Test’ that can help investors identify beforehand if the ICO is genuine or not.
How Does SEC Classify Cryptocurrencies
There have been many on-going discussions in the market about how the SEC sees cryptocurrencies and classifies whether or not it is a security. Jay Clayton, the presiding commissioner of the U.S. Securities and Exchange Commission (SEC), has been leading the charge for regulatory action.
Last year, Jay Clayton clarified his position on whether Bitcoin is a security or not. During his interview with the CNBC, Clayton said that cryptocurrencies like Bitcoin replace sovereign currency and, thus, are NOT a security.
Another reason for this is because Bitcoin has never sought public funds to create and develop its own technology. Moreover, it doesn’t even pass the Howey Test to be considered as a ‘security’. Basically, any cryptocurrency which seeks public funds to develop its own technology is a security.
Clarifying the definition of cryptocurrencies that classify as a ‘security’, Clayton said: “A token, a digital asset where I give you my money…[in exchange for] providing a return… That is a security, and we regulate that. We regulate the offering and trading of that security”.
Now, Ethereum (ETH)- the world’s second-largest cryptocurrency – raised its money through an ICO process in July 2013. However, the SEC has also kept it out of the definition of a ‘security’. The reason is that the SEC considers Ethereum to be too decentralized for it to be a security.
The SEC Chairman Jay Clayton clarified that the legal status of cryptocurrencies can change from the time due to changes in the platform. “A digital asset may be offered and sold initially as a security because it meets the definition of an investment contract, but that designation may change over time if the digital asset later is offered and sold in such a way that it will no longer meet that definition,” stated Clayton.
On the other hand, the fate of the world’s third-largest cryptocurrency Ripple (XRP) hangs in uncertainty as several people have filed lawsuits against the company in the last few years.
Apart from classifying cryptocurrencies as securities, the SEC is also responsible for monitoring other investment instruments like the Bitcoin ETF.