June 2023 saw the Securities and Exchange Commission (SEC) sue Coinbase , alleging breach of securities laws in ‘operating its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency’. The exchange was charged for unregistered sale and offering of its crypto asset staking program. Unsurprisingly, Coinbase filed a motion to dismiss the lawsuit in August.
In a 17 January 2024 hearing, US District Judge Katherine Polk Failla deliberated on these matters, focusing on the question of whether transactions in tokens traded on the platform involved an ‘investment contract’ and thus constituted securities. Despite diverging on this view, both parties agreed in court that the tokens themselves were not securities, echoing Judge Torres’ famous ruling in the Ripple case, that XRP token is not in and of itself a "contract, transaction[,] or scheme".
On the question of whether an investment contract was established, the lawyers for the SEC submitted that when users purchase a token, they are ‘investing into the network behind it’ in hopes of sharing the gains of the ecosystem, as when the network’s value rises, so does the token value. In making this point, they argued that the tokens are inseparable by nature from its ecosystem,
The token is the key that gets you into the ecosystem. The token is worthless without the ecosystem.
However, Coinbase argued that there were only secondary-market transactions with no contracts involved and for an ‘investment contract’ to be established, there needs to be a statement conveying ‘an enforceable promise’. They clarified that the purchasers were not signing contracts or entitled to the proceeds of a common enterprise in buying tokens over a secondary market such as Coinbase’s platform.
During the hearing, Justice Failla acknowledged SEC’s previous crypto cases, in particular SEC’s loss against Ripple Labs and the regulator’s win in the Terraform Labs case. However, she distinguished the present case from the Terraform’s case, stating that the case involves ‘quite different’ facts, as Terraform did not concern tokens being listed on a secondary exchange.
Ultimately, after 14 pages of questions and over 4 hours of deliberation, Justice Failla opted not to make a decision from the bench, with an eventual decision anticipated in the coming weeks. While her position is unclear yet, Justice Failla reflected hesitance during the hearing that the SEC was asking her to effectively
broaden the definition of what constitutes a security.
All eyes are on the outcome of this case, as it will be informative in clarifying the SEC’s jurisdiction over the crypto sector.
By T Masters and K Kim