Lack of National Crypto Regulation Leaves Issues to Courts: Litigation Will Likely Classify Digital Assets in Absence of SEC Action


Coinbase Global won the dismissal of a federal class action complaint on Feb. 1, leaving a hazy status quo for the cryptocurrency industry in place absent action by the Securities and Exchange Commission or Congress on regulation.

The cryptocurrency exchange was accused by customers of operating as an unregistered securities exchange or broker-dealer in a lawsuit filed in the Southern District of New York in 2021.

But U.S. District Judge Paul Engelmayer in Manhattan rejected the claim that Coinbase Global defendants are direct sellers and had violated the Exchange Act.

“The dismissal does allow crypto exchanges to, by and large, continue business as usual for better or for worse, so it does put the burden on the exchanges, which is still questionable,” said Alex Murray, a professor at the Lundquist College of Business at the University of Oregon.

Underwood et al v Coinbase Global is currently on appeal.

“There is a lack of regulation,” Mr. Murray told PacerMonitor News. “It’s not even clear if the SEC can regulate the cryptocurrency market.”

In the absence of SEC digital asset rules, cryptocurrency and blockchain businesses are advised to adopt strong Bank Secrecy Act (BSA), Anti-Money Laundering (AML) and Office of Foreign Assets Control (OFAC) compliance programs.

“They should report suspicious or fraudulent transactions that are identified, comply with OFAC sanctions requirements, and coordinate or register as necessary with the requisite federal and state regulatory agencies as required by the laws, regulations and guidance,” said James Vivenzio, senior counsel at Perkins Coie law firm and former BSA/AML policy director at the Office of the Comptroller of the Currency with the U.S. Department of Treasury.

That’s because under the SEC’s current regulation-by-enforcement approach, digital currencies have yet to be classified as either commodities or securities.

“I am not a fan of establishing policy through enforcement,” Mr. Vivenzio told PacerMonitor News. “I think it’s much more effective for policy to go through the regulatory notice and comment process so there is consideration from all stakeholders.”

In SEC v Ripple Labs, also filed in the Southern District of New York, the SEC alleges that defendants gained some $1.38 billion by selling a digital asset called XRP without registering the offer and sale.

The court has not yet issued a final opinion.

“It’s an important case,” Mr. Murray said in an interview. “It will have very clear ramifications on how far the SEC’s jurisdiction can go in determining whether cryptocurrency is a digital currency or a security. That also comes down to whether a centralized exchange is necessary if these are just currency transactions.”

Since crypto exchange FTX filed for bankruptcy last year, more pressure has been placed on the SEC to act by industry insiders and members of U.S. Congress.

FTX was once valued at $32 billion, but its founder, Sam Bankman-Fried, resigned after he was accused of fraud.

“The collapse of FTX was an earthquake,” said Dr. Bina Ramamurthy, author of Blockchain in Action and director of the Blockchain ThinkLab at SUNY Buffalo. “The SEC must become a little bit technically savvy rather than just waiting on the courts to decide and then going by the precedent because I don’t know how knowledgeable the courts are. The common people don’t know much about blockchain and cryptocurrency.”

U.S. House Financial Services Committee Chair Patrick McHenry (R-NC) blamed the SEC’s regulation-by-enforcement approach for driving innovation overseas and endangering American competitiveness at a recent hearing called Oversight of the Securities and Exchange Commission.

“You’re punishing digital asset firms for allegedly not adhering to the law when they don’t know it will apply to them,” Congressman McHenry told SEC Chair Gary Gensler at the April 18 hearing. “It’s nonsensical.”

In the void left by inaction, Texas has become a leading crypto- and blockchain-friendly location with its eagerness to protect crypto and blockchain businesses with state regulation.

State Rep. Giovanni Capriglione (R-Tarrant County) crafted House Bill 1666 that, if approved by the Texas legislature, would require proof of reserves and prohibit cryptocurrency exchanges from combining consumer funds with corporate assets.

The downside is the fear that the industry will be politicized since the Lone Star state is largely controlled by conservatives.

“It’s concerning because I do think blockchain is something that needs bipartisan support to have a regulatory environment that is fostering crypto innovation nationwide,” Mr. Murray alleged. “It’s a very friendly state in terms of tax code and tax law but there’s a culture shock. It’s good for the company but not necessarily the workers.”

In lieu of relocating to Texas or waiting on the SEC to put its foot down, Dr. Ramamurthy would like to see the blockchain industry create its own generalized cryptocurrency exploratory commission to act as a nationwide regulatory board even though it could become bureaucratic over time.

“They can come up with something non-denominational and what it will decide, we do not know whether we’ll like it or not,” she said. “There would be a lot of lobbying with it but at least establishing a commission to explore what’s going on will put some focus into all these SEC definitions.”

Until then, Mr. Murray is an advocate for bolstering Science Technology Engineering and Math (STEM) studies in schools and universities as a way to retain blockchain innovation on American soil.

“There are efforts to increase [STEM] studies,” he said. “I don’t think they are as widespread or as concerted as they could be. There are courses offered at several institutions. I’ve integrated it into some of my own classes, so it is happening, but I think a wholesale effort has yet to be realized.”

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