SEC Enforcement will continue to treat most cryptocurrencies as securities in near-term
Early Consensus that Stablecoins that do not yield-farm may not be securities
In the Terraform Labs case, Judge Rakoff handed the SEC a victory by denying a motion to dismiss and rejecting the Ripple Labs ruling that retail cryptocurrency sales on a digital exchange are not sales of securities.[1]Terraform Labs expressly rejected the portion of the recent Ripple Labs decision holding that cryptocurrencies sold on an electronic exchange through a blind sale/bid process to retail investors were not securities under the Howey test. The Terraform Labs decision shows that different courts are likely to reach different conclusions as to whether cryptocurrency is a security, and the industry may not have clarity on the issue for several years – until the Supreme Court or Congress weighs in. But it also suggests that stablecoins that do not offer an investment yield are much less likely to be deemed securities.
In Terraform Labs, the Court denied in its entirety a motion to dismiss, which argued, among other things, that (i) Terraform’s crypto-based assets were not “investment contracts,” and (ii) the Major Questions Doctrine, the Due Process Clause, and the Administrative Procedure Act (“APA”) prevented the SEC from alleging that Terraform’s digital assets were “investment contracts.”
First, in the most notable part of the decision, the Terraform Labs court explicitly refused to apply the Howey test in the same manner as in the Ripple Labs decision. The Ripple Labs court held that sales of crypto assets to retail investors on exchanges were not securities subject to SEC regulation because those buyers lacked a reasonable expectation that their investments would earn a profit from the efforts of Ripple’s managerial team – whereas direct institutional purchasers from Ripple did have that expectation and thus such sales were sales of securities. But the Terraform Labs court disagreed, finding that sales to both retail and institutional investors were investment contracts subject to SEC regulation. Terraform Labs reasoned that “Howey makes no such distinction” between retail purchasers and institutional investors, and concluded that the nature of the purchase “has no impact on whether a reasonable individual would objectively view the defendants’ actions and statements as evincing a promise of profits based on their efforts.”
The key distinction between the two decisions is how the court viewed the promises made by the crypto-issuer’s managerial teams. Judge Rakoff in Terraform Labs focused on Terraform’s marketing campaign, which was aimed at both institutional and retail investors, and which stated that all holders of its crypto-assets would earn a profit from the efforts of the managerial team. In contrast, Judge Torres in Ripple Labs did not presume that retail investors would have seen or been aware of marketing representations that Ripple’s managerial efforts would cause investors to profit. Further, Ripple Labs did not find that Ripple engaged in a marketing campaign that targeted retail investors. Although both of these decisions could be harmonized by focusing on the specific marketing made to potential purchasers, the Terraform Labs ruling largely conflicts with Ripple Labs, which means there will not be legal clarity on this issue for some time.
Second, Terraform Labs agreed with Ripple Labs – at least conceptually – on the point that certain cryptocurrencies or digital tokens, such as stablecoins that did not offer an investment yield, would not be securities. Specifically, Judge Rakoff noted that a true stablecoin – a cryptocurrency designed to maintain a one-to-one peg with another asset – might not qualify as an investment contract because there would be no reasonable basis for expecting a stablecoin to “generate profits through a common enterprise.”[2] However, he found that Terraform’s “stablecoin” was an investment contract because it gave the owner the right to convert the coin to another token, LUNA, which could be staked or pooled to earn a profit of 20%. This implies that stablecoins that do not come with the right to convert to another coin and do not offer staking or pooling to generate yield – are much more likely not to be deemed securities.
Third, the court rejected Terraform’s and Kwon’s argument that the Major Question Doctrine prevented the SEC from regulating crypto assets. The Court reasoned that cryptocurrency was not as important as industries to which the Supreme Court has historically applied the Major Question Doctrine, such as energy and tobacco. The Court also noted that the SEC’s decision to require more “truthful marketing of certain crypto assets” was not a “transformative expansion in its regulatory authority,” and therefore did not warrant application of the Major Questions Doctrine. Separately, the Court found no violation of the Due Process Clause or the APA because the SEC had provided fair notice that it may bring litigation against people operating in the cryptocurrency industry through its actions, guidance, and litigation.
Sadis has a dedicated practice focused on Digital Assets and Blockchain Technology. We are available to discuss all digital asset and blockchain litigation matters, investments, or fund formation. If you have any questions about the Terraform Labs decision, this article, or any other digital assets issue, please contact Douglas Hirsch (dhirsch@sadis.com), Sam Lieberman (slieberman@sadis.com), Frank Restagno (frestagno@sadis.com) or Scott Ferrier (sferrier@sadis.com).
[1]SEC v. Terraform Labs Pte. Ltd. et al. (decided S.D.N.Y., Jul. 31, 2023),
[2] For example, PayPal recently launched a US Dollar Stablecoin, which, based on its description, would not be a security under Judge Rakoff’s analysis.
