Binance, Coinbase and the Future of Crypto Regulation - NerdWallet (2024)

U.S. regulators are in the midst of a crackdown on cryptocurrency that has created new uncertainty about the future of the market for digital assets.

And if the waters weren't muddy enough, a federal judge ruled in another SEC case in July 2023 that Ripple had not violated securities laws when it sold its XRP cryptocurrency to consumers. The court did say that some private sales had been securities contracts, however.

Taken together, the developments intensify lingering questions about just how existing laws governing investment and trading will apply to this relatively new asset class. The fallout from the latest flurry of litigation could have a lasting effect on how consumers are allowed to buy and sell crypto.

What's at stake with cryptocurrency regulation?

At the very basic level, the challenges by the SEC accuse the targeted companies of violating securities laws. That might sound technical, but in the United States, securities laws are essential for investors to understand why markets operate the way they do.

Crypto has so far operated in something of a regulatory gray area. It's not exactly like stock, or bonds, or real estate — or really any other financial product that existed at the start of the 21st century.

This uncertainty has a real effect on consumers.

Crypto is not covered by Federal Deposit Insurance Corp. policies that protect account holders against bank failures. It's also not covered by Securities Investor Protection Corporation (SIPC) insurance, which provides similar help to brokerage customers. Companies issuing cryptocurrency don't have to file financial reports like publicly traded companies do, which means that investors may not have the same insight into their cryptos' fundamentals as people who own stock do.

Have these regulatory gaps cost customers? Sure. Read up on the FTX collapse if you want to see some of the downsides in action.

The flip side of this is that crypto has been able to grow into a global asset class relatively unburdened by the strictures governing other products.

Crypto was born out of an ideological opposition to centralized financial control. And some proponents argue that the hands-off regulatory approach has led to innovation that would not be possible under the close watch of traditional financial authorities.

Is crypto a security?

The SEC actions against Binance and Coinbase turn on whether or not cryptocurrency is a security. But even beyond these lawsuits, the question is the subject of intense legal debate that could last for years.

The SEC has argued that some cryptocurrencies and products built using cryptocurrency are in fact securities. Among them are:

Wondering why the SEC might consider some crypto products to be securities? For starters, it might help to understand how government agencies in the U.S. define what is and is not a security — and why it matters.

So, what is a security?

Very sorry to do this, but we're going to have to get into some legalese in order to really explain this.

The Howey test

The question of whether something is a security or not depends on an evaluation known as the "Howey test"

This is based on a 1946 U.S. Supreme court decision that found that securities laws apply to an investment if it "involves an investment of money in a common enterprise with profits to come solely from the efforts of others. "

The SEC interprets this through a four-prong test that follows closely from the wording of the court decision.

In this reading, you may have invested in a security if the following things are true:

1.) You invested money in something.

2.) Other people have a stake in it, too.

3.) You're expecting to make money from the investment.

4.) Those expected profits would come from someone else's work.

There are arguments to be made on either side as to how the Howey test applies to crypto.

You might say that when you're buying crypto, you're investing in something built by another person or organization in anticipation that its value will rise.

Or you might argue that because crypto is "decentralized," every user plays some part — however small — in the operation of the blockchain network on which cryptocurrencies run.

However you come down on this, the ultimate decision will now be in the hands of regulators, courts and many, many (many) lawyers.

What's the future of cryptocurrency look like?

The future of cryptocurrency will be shaped one way or another by how regulations shake out.

The United States is only one of many jurisdictions wrestling over how to handle crypto, but given our nation's centrality to financial markets, there is a lot at stake in the Coinbase and Binance suits — along with whatever else is to follow.

Even days after the litigation was announced, the effects were being felt. Many of the cryptocurrencies named in the Coinbase suit experienced sharp drops in value, and other institutions began taking newly cautious approaches.

It might be hard to fathom why it would be bad for cryptocurrencies to be regulated like other investment products that are considered to be securities. After all, stocks trade freely on the market and there's no significant debate about whether they are subject to the SEC's regulation.

That said, cryptocurrencies have emerged as an asset class in absence of any kind of regulatory framework to oversee them. So a declaration that they are securities and should be regulated as such is not as simple as filling out a form. There's no form to fill out at this point.

Such a determination may leave the creators of a cryptocurrency project with few options for how to keep their product on the market.

For example, in February 2022, the SEC settled with the crypto exchange Kraken over allegations that its staking program was an unregistered security. As part of that settlement, Kraken paid $30 million and agreed to cease the program.

Are there other ways regulators may approach crypto?

The question over securities laws is scarcely the only source of regulatory uncertainty facing cryptocurrency.

In a 2022 report, the U.S. Treasury Department's Financial Stability Oversight Council laid out three major gaps between current regulations and cryptocurrency .

» Investing in crypto for the first time?

Author Andy Rosen owned Solana and Cardano at the time of publication.