The SEC has declared another crypto as a “security” — after it is already dead.

Late Wednesday, the U.S. Securities and Exchange Commission filed a complaint arguing that FTT, the native token of collapsed crypto exchange FTX, was sold as an investment contract, and is a "security".

FTX's buy and burn practice was specifically mentioned in the complaint. “FTX’s ‘buy and burn’ program would purchase FTT, thus boosting demand, and then burn those purchased tokens in order to decrease the supply of FTT and increase its price”, said SEC.

What are the impacts on other cryptos and exchanges?

If FTT is ruled as a security by court, it will throw a shadow over many other platform tokens and crypto exchanges.

Crypto tokens adopting a similar “buy and burn” mechanism, such as BNB (Binance), OKB(OKEX), and KCS(KuCoin), could also be labeled as securities in this scenario. KuCoin released KCS Whitepaper in March 2022, revealing the 20 million KCS burn to accelerate the value growth of KCS. Binance introduced the BNB Auto-Burn program in 2021, aiming to maintain a stable value through burning its tokens. In May 2019, OKX initiated its OKB Buy-Back & Burn program, where 30% of the spot-market transaction fees were used to buy back tokens from the original pool— which were subsequently sent to a burning address.  

Crypto exchanges will face significant penalties for listing unregistered "securities". According to a report from Decrypt, major crypto exchanges would be exposed to immense legal liability, even at the risk of shutdown.

However, the prices for platform tokens don't appear to be moving on SEC’s stance. According to Cointime, FTT price hit a new all-time low following SEC’s charge, then climbed by 9.03% in the last 24 hours. At press time,  Huobi's HT is up 2.63% in the last 24 hours, Binance's BNB and KuCoin's KCS are up 0.21% and 0.03% respectively, and OKX’s OKB is down 3.79%.

What is a security, exactly?

“A digital token or crypto asset is a crypto asset security if it meets the definition of a security, which the Securities Act defines to include “investment contract,” i.e., if it constitutes an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others” — this is how SEC defines a security in its complaint

Under this definition, most cryptocurrencies are securities, Bitcoin and Ether may be the only exceptions. In 2018, SEC official William Hinman has indicated Bitcoin and Ethereum are not securities, as these assets have been sufficiently “decentralized.”

What other cryptos are considered securities by SEC?

SEC has been making its stance on crypto since 2017 during the ICO boom. In the Report of Investigation, SEC concluded tokens offered by “the DAO” were investment contracts, and therefore were securities

Other than FTT, a total of 13 tokens have been considered as securities by SEC, just in 2022.

July 2022: Nine cryptos listed on Coinbase

On 21st July 2022, SEC formally called nine cryptocurrencies listed on Coinbase as securities during an insider trading case in a 62-page complaint. The nine cryptos that were categorized as such are:

·       AMP: Flexa Network, incorporated in Delaware

·       RLY: Rally Network, based in San Francisco

·       DDX: DEX Labs, Delaware corporation

·       XYO: XY Labs, originally organized in Delaware

·       RGT: Rari Capital, incorporated in Delaware

·       LCX: Liechtenstein Cryptoassets Exchange, based in Liechtenstein

·       POWR: Power Ledger, corporation started in Australia

·       DFX: DFX Finance, an unincorporated business

·       KROM: Kromatika Finance, unincorporated business

SEC went through the nine cryptos one by one to illustrate how each should be defined under the Howey Test as securities. “Each of the nine companies invited people to invest on the promise that it would expend future efforts to improve the value of their investment,” the agency asserted in the document.

August 2022: Three native tokens from GrayScale

SEC has long been querying Grayscale on its security law assessment dealing with native tokens. According to a report, Grayscale initially admitted XLM(Stellar), ZEC(Zcash), and ZEN(Horizen) to be considered securities in August.

November 2022: LBRY token ruled a security in SEC case

Last month, a court ruling declared that LBRY’s native token LBC could be considered a security. “The language used here sets an extraordinarily dangerous precedent that makes every cryptocurrency in the US a security, including Ethereum,” LBRY wrote on Twitter in response to the ruling.

What if cryptos are securities?

If a crypto is labelled as “security”, then it must comply with SEC rules. Which means it must be registered with the SEC under federal laws and report to SEC, failure to do so may lead to significant penalties.

Crypto exchanges need to register with SEC

In September 2021, Gary Gensler said almost all crypto trading platforms should have to register with the SEC in testimony unless they qualify for an exemption.

An crypto issuer seeking to register the offer and sale of crypto assets as securities transactions “must furnish the required disclosure information to the SEC”, said David Hirsch, Chief of the Crypto Asset and Cyber Unit at SEC.

According to Investopedia, “If registered with the SEC, crypto exchanges would be forced to adopt technology systems to make their order books audit compliant. They would also face strict rules on order execution to prevent market manipulation.”

Otherwise, they are “operating outside of the law”

“It's a question of whether they're registered or they're operating outside of the law,” Gary Gensler famously said in March, claiming crypto exchanges that don’t cooperate with the SEC may be at risk of enforcement action.

Many crypto issuers have already been subject to SEC enforcement.  

In August 2021, SEC announced its first enforcement action on a DeFi lender and top executives, charging them for offering and selling over $30 million of digital tokens that should have been registered as securities. Two founders disgorged $12.8 million and paid $125,000 fines each.

Earlier this year, BlockFi was charged by SEC with failing to register the offers and sales of its retail crypto lending product as securities. BlockFi paid a fine of $100 million over charges, and agreed to register the product with SEC.

The same thing could happen to Ripple Labs. In 2020 the SEC sued Ripple Labs alleging Ripple violated securities laws by selling the XRP token without complying with registration and disclosure requirements for securities offerings. If XRP is declared a security, Ripple would have to pay for a fine, and could also have to give a share to each XRP holder —security investor in that case.