What Is SEC and How Does It Classify Cryptocurrencies?

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 thus 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 major 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 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 also 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 as
Initial Coin Offerings (ICOs).

It happened so that while some ICOs were really 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 such fake projects which trapped the gullible
investors, the SEC decided to intervene in this and take some bold measures.

Over the last few years, the SEC has brought strict rules which notes that cryptocurrency
token issued through ICOs shall be treated as ‘securities’ and allowed only after the SEC’s
permission.

The SEC has also derived a special ‘Howey Test’ that helps investors identify beforehand
if the ICO is genuine or not.

How Does SEC Classify Cryptocurrencies

There’s has been long-going discussions and debates 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 any 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 it is NOT a security.

Another reason is that 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 shall be called 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 as a security.

The SEC Chairman Jay Clayton clarified that the legal status of cryptocurrencies can
change from the time of their inception to after a few years. “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,”
he said.

On the other hand, the fate of the world’s third-largest cryptocurrency Ripple (XRP) hangs
in uncertainty as a number of people have filed lawsuits against the company in the last
few years.

Apart from classifying cryptocurrencies as securities, the SEC is also majorly responsible
for monitoring other investment instruments like the Bitcoin ETF.