16 June 2020

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.

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