Is crypto a security, bro?

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Ethan Wu (0:36)

Pushkin.

The US crypto crackdown is in full swing. The US Securities and Exchange Commission is suing the two most important crypto exchanges, Coinbase and Binance, alleging that they're running unregistered securities exchanges. This is a big deal. A lot of different global regulators are grappling with what to do with crypto. Gary Gensler, head of the SEC, has been quite aggressive in saying, we don't need more digital currency, and it's time for these crypto companies to come into compliance. But there's a question underlying this entire SEC crackdown on crypto, which is, are cryptocurrencies securities? Do these assets even fall under the SEC's purview? To begin with, we recently wrote about this in the Unhedged newsletter, and today we'll discuss.

This is the Unhedged podcast, the new markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in New York, joined by my boss, Robert Armstrong, who has granted me diplomatic immunity to call his views wrong.

Robert Armstrong (1:34)

I think boss is a strong word, Ethan. All writers are equal in the Unhedged universe, even if some of us are slightly more equal than others.

Ethan Wu (1:42)

I wish I bought into that. I really do.

We have taken different sides, like I referred to in the newsletter on this issue. Rob, what's your side?

Robert Armstrong (1:51)

My side is that your side is wrong.

Ethan Wu (1:53)

Okay, well, that's also my side.

Robert Armstrong (1:55)

My side is that cryptocurrencies are not investment securities, and they should not be regulated by financial regulators in the United States or anywhere else.

Ethan Wu (2:07)

Okay. My side is that cryptocurrencies are plausibly securities. Specifically, they look a lot like stocks.

And I think they would slot in, not perfectly, not without any friction, but they would slot into the SEC's broader securities regulation framework.

So these are the sides, but we should introduce how these decisions are made. In this discussion, you can't avoid the Howey Test. This is what the Supreme Court in 1946 said should sort of be the standard for defining what counts as an investment contract, what counts as a security. And there are some other ways to do it, but this is the primary one. It's the one relevant here. And the Howey Test was based on this lawsuit over a Florida land deal, and orange groves are oranges securities. And it stipulates...

Robert Armstrong (2:52)

They definitely are, by the way.

Ethan Wu (2:53)

Sure.

Robert Armstrong (2:54)

Not cryptocurrencies, but citrus.

Ethan Wu (2:56)

Citrus. It's security. Does that make orange juice a derivative?

That is the question.

Robert Armstrong (3:01)

Yes.

Ethan Wu (3:02)

The Howey Test is three legs.

One leg is a person has to invest. Second is it has to be a common enterprise. The third is it has to be with the expectation of profits based on the efforts of others.

Robert Armstrong (3:14)

All right. So let's walk through those. Certainly, there is the expectation of profits with Bitcoin, Bitcoin or cryptocurrency generally. People aren't out there hoping for losses.

So we check that box very nicely. And we're a third of the way there.

Ethan Wu (3:29)

Well, someone's investing. And I think that's clear enough.

Robert Armstrong (3:32)

Yeah, somebody's putting money into this thing. So that's happening.

Ethan Wu (3:35)

Then there's common enterprise.

Robert Armstrong (3:37)

Well, I guess that we can check that box too, right? There's hella nerds in mother's basements working together to make this ecosystem spin round and round.

It's a decentralized enterprise, but you could argue it's an enterprise, sure.

Ethan Wu (3:54)

Yeah. Armstrong, it seems like you've conceded the argument that I am right and now I will become the boss and I will be more equal than others.

Robert Armstrong (4:01)

The problem with the Howey Test is not that cryptocurrencies meet it, it's that everything meets it.

Anytime anybody puts up a little money and hopes to turn into a little bit more money, suddenly this becomes a security and the appropriate regulator becomes the SEC. This is just wrong. Sports betting apps should not be regulated by the SEC. Exchanges or websites or conventions or wherever people trade trading cards should not be regulated by the SEC. And it seems to me perfectly clear that cryptocurrency is much closer to one of these things than what we know as securities, bonds, stocks, whatever else. Specifically because bonds, stocks, even the bad ones, they have a reasonably legitimate argument that they are backed by productive commercial enterprise, economic activity, right? Whereas that is not true of cryptocurrency. I think one of the things that we have to keep in mind in this discussion is that as a economic innovation, cryptocurrency has fallen flat on its face.