Written by Laura “LC” Cole and Aaron Krowne
The act of launching a blockchain token is not, intrinsically, problematic, but everything done in preparation for and in support of after said launch must be navigated thoughtfully with appropriate professional advisers. SEC and DOJ complaints from the past few years allege over thirty problematic tokens are securities. An overview of some of the main issues with these projects, in our view, were:
- Tokens launched as a blatant capital raise for the core development of their projects (sometimes without any securities exemption compliance, e.g. via Regulation D or S, or any document issuance);
- Token projects touting gains brazenly on social media and in chats;
- Token projects which launch before even the initial version of core features are developed;
- Token projects teasing future development of partnerships, burns/buybacks, additional secondary market listings, etc; and
- Token projects continuing to rely on founding/core team to continue development to deliver anticipated value, or which reserved too much power over governance/decentralization process, or which controlled an excessive amount (often more than half) of the token supply.
These are some high-level points the SEC and DOJ have regularly cited as being problematic or which are common to the implicated token projects.
In the 2022 Wahi[1] case, the SEC and DOJ brought companion “insider trading” actions against a Coinbase employee, his brother, and a friend, creating the first precedent for a U.S. federal action which attempted to label tokens as securities without directly bringing a full case against the token’s issuer or any associated parties of the issuer (or those involved with the issuance process) for violating securities laws. The complaint called out the ex-Coinbase employee for engaging in insider trading by using confidential information obtained from Coinbase on which tokens would be listed on the exchange in order to make purchases of those tokens in advance and benefit from expected price increases. In what many in the industry called an expansion of the SEC’s “regulation by enforcement” approach to crypto, the SEC alleged that $AMP (Flexa Network), $RLY (Rally Network), $DDX (DerivaDEX Protocol), $XYO (XY Labs), $RGT (Rari Capital), $LCX (Liechtenstein Cryptoassets Exchange), $POWR (Power Ledger), $DFX (DFX Finance), and $KROM (Kromatika Finance) tokens were unregistered securities. The DOJ, in a parallel action, added accusations against another four tokens.
The SEC’s arguments for why these tokens were alleged securities were based on the Howey[2] test, which emerged from Supreme Court case precedent in 1946 for determining whether certain transactions qualify as “investment contracts.” Under the Howey test, a transaction is an investment contract if it includes each of the following: (1) an investment of money; (2) a reasonable expectation of profits from the investment; (3) the investment of money is in a common enterprise; and (4) there is a profit which comes from the efforts of a promoter or third-party. For the purposes of its complaint, the SEC emphasized the “expectation of profits” and the “efforts of others” elements, especially referencing projects touting gains and with a core team holding too much control.
Ultimately, the SEC and DOJ reached a settlement with the two Wahi parties in 2023 and proceeded in 2024 to default judgment against the remaining party (who was apparently overseas and unresponsive), leaving us with no true litigated precedent as to the securities status of the complained-of tokens from the case. As a result, the settlement left the industry without clarity as to the regulatory status of the secondary sales of these digital assets, and by extension, those sharing similar attributes.
Shortly after the Wahi case, the SEC filed lawsuits against major exchanges, Binance[3] and Coinbase[4], alleging they were acting as (among others) unregistered brokers and securities exchanges who listed certain tokens which were unregistered securities.
The Coinbase and Binance complaints, together with the 2022 Wahi complaint alleged the following tokens were unregistered securities:
| AMP | RLY | DDX | XYO |
| RGT | LCX | POWR | DFX |
| KROM | ALCX | GALA | ENS |
| TRIBE | BNB | BUSD | SOL |
| ADA | MATIC | FIL | ATOM |
| SAND | MANA | ALGO | AXS |
| COTI | CHZ | FLOW | ICP |
| NEAR | VGX | DASH | NEXO |
This list of tokens is far-reaching because, firstly, it includes some major tokens (by market capitalization and various other measures), and secondly, many reasonable observers believe some of them have truly weak fundamental arguments for being securities. For example, $SOL, the native token to the Solana blockchain, is arguably not a security. The SEC presented (in our view) questionable rationale based heavily on Solana Labs’ use of private funding to build out the network and its Twitter statements announcing the token’s availability on U.S. exchanges as support for its claim that users are buying $SOL with the expectation of profit and not because it is needed to operate on the network. However, Solana’s ecosystem (considered a rival to Ethereum – which was noticeably not included in these complaints), is fairly evidently extensive, open-sourced, and relies materially on decentralized users and developers to engage and grow the network. The volume of builders and developers in the Solana ecosystem has reportedly grown significantly in recent years and the Solana Foundation apparently controls less than 40%[5] of the total supply of $SOL. Solana also reportedly is experiencing extensive third-party development activity at both a high volume and in a wide variety of areas, ranging from NFTs to smartphones to on-chain email.
While Binance reached a $4 billion settlement (including agreeing to injunctive actions) with DOJ, CFTC, FinCEN, and OFAC for separate violations, it remains embroiled in its suit with the SEC, as does Coinbase. Coinbase has remained steadfast and outspoken about the alleged lawfulness of its operations in the U.S. and that the tokens offered on its exchange are not securities. Moreover, in August 2023, Coinbase launched its own protocol, Base, claimed to be a “secure, a low-cost, developer-friendly Ethereum Layer-2, built with the idea of bringing new users to web3 and paired with its own token, $BASE.”
Due to its persistently failing to issue affirmative guidance regarding token classification and bringing mainly cases that aren’t likely to result in tokens’ security status being adjudicated on the merits (as in the foregoing collateral claim cases, as well as the fraud and gross misconduct cases that predominated before), the SEC has been accused of intentional stall tactics and perpetuating the grey area the sector finds itself in in the U.S. This has even resulted in some courts, as in the recent Debt Box case, accusing the SEC of “gross abuse of the power.”[6]
Even though industry participants are still looking to Congress, administrative agencies, and the courts for answers to these unresolved questions, they are pressing on and continuing to build through the fog. While token issuers face an increasing risk through “collateral” claims of tokens being securities like the ones above, the silver lining is that it appears increasingly likely that more of these claims will be litigated in full on the merits in the near future, which would then lead to a clearer dividing line between security and non-security tokens. In any case, venturers in the space should proceed cautiously with knowledgeable counsel. If you are thinking about launching a blockchain token or other digital asset, reach out today for a courtesy call with our team to discuss how we might navigate your launch in a thoughtful, legal risk-minimizing way.
[1] SEC v. Wahi et al., No. 2:22-cv-01009 (W.D. Wash. 2022).
[2] SEC v. W.J. Howey Co., 328 U.S. 293 (1946)
[3] SEC v. Binance Holdings Limited, Bam Trading Services Inc., Bam Management US Holdings Inc., and Changpeng Zhao, Civil Action No. 1:23-cv-01599 (D.D.C. 2023).
[4] SEC v. Coinbase, Inc. and Coinbase Global, Inc., No. 1:23-cv-04738 (S.D.N.Y. 2023).
[5] https://forkast.news/what-is-solana-ecosystem-behind-sols-rise/
[6] SEC v. Digital Licensing Inc. dba Debt Box, et al., No. 2:23-cv-00482-RJS-DBP (D. Utah 2024).