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In 1946 the SEC sued Howey & Co in court alleging securities fraud. Regulators argued the profit-sharing aspect of the arrangement made it an investment contract, which had to be registered with the SEC. The case made it all the way to the Supreme Court. The SEC won.
In its decision, the Supreme Court laid out its framework for classifying a security: A security exists when there is an "investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others"
Let's break this down into 4 parts: 1. An investment of money 2. A common enterprise 3. An expectation of profits 4. To be derived from the efforts of others This list is also known as the "Howey Test", and it is the lense through which the SEC views crypto.
Let's apply the Howey Test to crypto lending. 1. An investment of money - this clearly fits. Users give money to others in the form of cryptocurrency. 2. A common enterprise - also pretty clear. Here's the official SEC language supporting this:pic.twitter.com/daSrTCUe9v
3. An expectation of profits - Again, pretty convincing for SEC jurisdiction here. I lend my crypto to others because I expect a profit, otherwise why lend? 4. Derived from the efforts of others - this is where ambiguity & political games begin.
What makes a crypto profit "derived from the efforts of others"? Is it derived from the project's developers? The miners? The borrowers themselves?
In a June 2018 CNBC interview, SEC Chair Jay Clayton said Bitcoin was NOT a security. "Cryptocurrencies are replacements for sovereign currencies, replace the dollar, the euro, the yen with bitcoin. That type of currency is not a security."https://www.cnbc.com/amp/2018/06/06/sec-chairman-clayton-says-agency-wont-change-definition-of-a-security.html …
Okay, but what about other crypto assets? Stablecoins for example? Gary Gensler has been vocal in his opinion that stablecoins ARE securities. "These platforms are implicated by the securities laws and must work within our securities regime."https://www.nasdaq.com/articles/sec-chair-hints-some-stablecoins-are-securities-2021-07-21 …
Hold on a second there. Bitcoin is treated as a commodity today, putting it under CFTC jurisdiction. Why are stablecoins any different? The CFTC argues, nothing really:pic.twitter.com/oZUQetCeUP
The CFTC vs. SEC battle over jurisdiction is far from over, and will get more intense as new crypto use cases form. One such use case is lending, which is where Coinbase enters the equation.
Coinbase wants to launch a crypto lending feature. The SEC says "no, crypto lending is a security." CB disagrees. If CB does take the SEC to court (which I think is likely), it will force the agency to reveal more detailed specifics about why it argues this point.
My guess is the SEC will turn to the Howey Test and argue crypto lending profits are "derived from the efforts of others". This is where the entire legal battle lies, and I honestly don't know how it will be resolved. The CFTC will surely have something to say here as well.
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