The line of demarcation of cryptos and traditional financial instruments has become a source of intense debate among market participants and regulators. The US Securities and Exchange Commission (SEC) has emerged as a central figure in this conversation, largely because of its role in regulating securities.

Recent decisions by the SEC have now firmly classified certain securities, which has significant implications for investors, exchanges and the wider industry.

SEC Perspective on Cryptos and Securities

Many digital signals have been declared securities by the SEC, which applies standards established under the Securities Act of 1933 and further interpreted by several landmark court decisions.

The central case, SEC v. WJ Howey Co., sets out the «Howey Test» criteria for determining whether a transaction qualifies as an investment contract, a type of security. This test checks whether a transaction involves an investment in a joint venture, expecting profits primarily from the efforts of others.

In applying these criteria to the cryptocurrency market, the SEC emphasized the likelihood that some tokens meet this definition, which requires compliance with established securities laws.

As a significant measure, several cryptocurrencies have recently been pinpointed as securities. This list of encrypted securities includes:

Filecoin’s inclusion was highly controversial, given its broad trading base on multiple US exchanges and its previous plans for a proposed trust with Grayscale Investments. Unexpected SEC decision result and winding down the trust proposal, allowing stakeholders to grapple with the implications.

«Grayscale does not believe that FIL is a security under the federal securities laws and intends to promptly respond to SEC staff with an explanation of the legal basis for Grayscale’s position,» the company said.

Understanding the Consequences of Trading Crypto Securities

Selling unregistered securities is generally a a violation of US law. This regulation requires securities to be registered with the SEC before they are sold to the public.

While there are exemptions to this rule—such as sales to accredited investors or private placements—the sale of unregistered securities can result in significant penalties, including fines and disgorgement of profits.

Given the SEC’s new classification, exchanges listing these tokens may face legal scrutiny. Some US exchanges already list more than a dozen cryptos that the SEC classifies as illegal for sale, which could prompt regulatory actions and subsequently affect their operations.

The landscape is certainly more complex for investors in these newly classified securities. The regulatory compliance required for securities trading means that investors must consider factors such as securities laws and regulations.

In addition, the marketability and liquidity of these guarantees could be affected, given their new legal status.

Investors may find trading opportunities for these tokens limited if exchanges delete them to avoid potential regulatory penalties. This, in turn, could reduce the liquidity of those properties, making it more challenging to buy or sell them on the market.

Crypto exchanges that list these securities face their own challenges. From a regulatory perspective, they risk sanctions and legal consequences if they continue to list these securities without the necessary registration and exemptions.

Mitigating the Risks: Legal Advice is vital

Given the legal complexities associated with the sale of unregistered securities and the specific exemptions that may be involved, professional legal advice is essential for all stakeholders in this space. Investors, project creators, and especially crypto exchanges must give themselves a new understanding of the regulatory environment to successfully navigate these changing dynamics.

Critics argue that the SEC’s recent enforcement actions and interpretive decisions could stifle innovation in the blockchain and crypto industry.

“Enforcement regulation does not work. It encourages companies to work offshore, which is what happened with FTX,” said Brian Armstrong, CEO of Coinbase.

Blockchain projects often raise funds through initial coin offerings (ICOs), which would be considered securities offerings under SEC interpretation. Therefore, these projects must comply with strict, often difficult and expensive regulatory requirements, which discourages smaller innovative projects.

The SEC’s approach may shift some activities to softer jurisdictions. However, given the global nature of crypto, US investors may still have an indirect impact.

For example, a project may block US investors from participating in an ICO to avoid exposure to US securities laws. This could limit the opportunities for US investors to participate in innovative blockchain projects.

Crypto Securities: Looking Ahead

The IS recent actions the SEC’s classification of certain cryptocurrencies as securities represents a significant change in the regulatory landscape. The outcome of these decisions is likely to have far-reaching consequences, not only for the digital tokens in question but also for the wider crypto industry.

The reclassification of these cryptos as securities could result in reduced liquidity, limited market access, and potential legal consequences for unregistered securities trading. This not only creates challenges for individual investors and exchanges but can also impact innovation within the industry.

The precise consequences of the SEC’s decisions will depend on a variety of factors. These include the legal strategies adopted by affected parties, potential changes to the regulatory environment, and the wider market response.

The interweaving of crypto and securities laws underscores the importance of understanding the regulatory landscape in which these digital assets operate. While recent SEC decisions have added additional complexity to the equation, they also highlight the need for regulatory clarity in this rapidly evolving area.

Through professional legal advice and a proactive approach, stakeholders can face the challenges of these developments and continue to participate in the dynamic crypto market.