Faculty of law blogs / UNIVERSITY OF OXFORD

Crypto Skeptics’ Supreme Risk: The Danger of Relying on Courts to Decide Crypto’s Fate


Todd Phillips
Assistant Professor, Georgia State University J. Mack Robinson College of Business


Time to read

4 Minutes

The nature of most cryptoassets is contested under United States law. The industry asserts that the vast majority are commodities because of their issuers’ decentralized nature, whereas critics argue that most are securities. The former are subject to limited oversight by the Commodity Futures Trading Commission (CFTC), whereas the latter are heavily regulated by the Securities and Exchange Commission (SEC). There is little overlap between the perspectives, and Congress has been unable to enact legislation clarifying crypto’s regulatory status.

With the divide between perspectives so large, the task of clarifying the regulatory regime has been given to the courts. Under Supreme Court precedent, assets are considered securities if they meet the Howey test, and courts have thus far—with one notable exception, SEC v. Ripple Labs—agreed with plaintiffs that their  cryptoassets are securities. Accordingly, those skeptical of cryptoassets as investment opportunities appear content to let the courts proceed, without the need for legislation at all.

In a new brief for the Roosevelt Institute, I argue that this course of action—relying on the Supreme Court to be the final arbiter of which regulatory regime cryptoassets are subject to—is problematic. Not only does waiting for the Court to decide mean that crypto-markets will continue their unregulated operations and speculators and investors may be harmed in the interim, but there is a significant risk that today’s Supreme Court will read its precedent in ways that diverge from prior interpretations, opening the floodgates to regulatory arbitrage away from the securities laws.

Whether a cryptoasset is a security depends on whether it is an 'investment contract' under the federal securities laws. The Supreme Court first defined the term in 1946 in SEC v. W.J. Howey Co. Based on the term’s historic usage, the Court articulated a four-part test for determining whether an investment contract is a security:

‘[A]n investment contract is . . . [1] a contract, transaction or scheme [2] whereby a person invests his money in a common enterprise and [3] is led to expect profits [4] solely from the efforts of the promoter or a third party.’

Using the Howey test, federal courts have determined many times that sales of cryptoassets constitute investment contracts. Of course, the facts around any particular token must meet the Howey test to be deemed a security, but it is easy to show how most cryptoassets likely meet all prongs.

Despite the Howey Test’s long-standing tenure, crypto advocates and some scholars have begun arguing that it does not accurately describe the investment contracts that Congress intended the federal securities laws to cover. Rather, this camp argues, Howey requires an ongoing legal relationship between securities issuers and investors and, because ownership of cryptoassets does not establish that relationship, the assets themselves are not securities subject to the securities laws. This argument is not unconvincing—the term is “investment contract” after all. Crypto skeptics are hoping that this Supreme Court will ignore the arguments about history and Congressional intent to hold that cryptoassets should nevertheless be considered securities.

But will it? Today’s Supreme Court is the most conservative in decades and has been described as the ‘YOLO Court’ for the speed at which it is handing down precedent—and life—changing decisions. In case after case, the Roberts Court has either overruled prior decisions or read precedent in a novel light to move American law to the right. The Court’s conservative-leaning decisions run the gamut in terms of policy areas, from abortion rights to affirmative action in education to religious accommodations.

Perhaps the Court will leave Howey intact; it has not been as aggressive in pursuing conservative changes to the securities law as it has in other areas, and has largely taken cases only to resolving circuit splits. But taking the Howey test to this Court is nevertheless a high-risk strategy given that severe consequences may follow. Because a reformed Howey test would require an ongoing contractual relationship, contracts that disclaim issuers’ or promoters’ ongoing responsibilities related to the investments—even when an ongoing responsibility is implied—would be considered commodity sales.

Such a result would leave a hole in the heart of the securities laws. The absurdity can be seen in the SEC’s lawsuit against the company Ripple Labs, in which the judge bought these arguments. Ripple sold XRP tokens directly to institutional purchasers and to the general public through exchanges, all the while promoting its tokens as investment opportunities and explaining how it worked to increase their value. The court held that the sales to institutional purchasers were securities while those to the general public were not, on the grounds that institutional purchasers invested directly in Ripple Labs, with the understanding that the firm would use their capital to increase the value of XRP tokens. On the contrary, investors who purchased tokens through exchanges could not have known whether they were purchasing tokens from Ripple, which would use the money for investment purposes, or from someone else, who would not. The result is that sophisticated investors received securities laws’ protection while those who needed it the most were left to fend for themselves.

The consequences of such a decision on investor protection and capital formation could be significant if the securities laws, ultimately, become optional for asset sales to the vast majority of people. If issuing cryptoassets becomes a way for issuers (at least, those that are in control of endeavors while claiming to be decentralized) to raise capital without providing appropriate disclosures, the securities laws’ benefits for companies, investors, and capital markets could disappear—not just for entities that run applications on blockchains, but for other, traditional issuers as well. For example, companies could transition themselves into DAOs, thereby retaining an organizational structure while avoiding the securities laws (and perhaps the corporate laws as well). Although there is evidence that the securities laws provide benefits to some companies, those benefits do not necessarily transfer to all issuers, such as the penny stock issuers most likely to be replaced by DAOs. Furthermore, existing incentives may be completely upended if the securities laws effectively become optional.

There are actions Congress can take to avoid this outcome. Legislators could codify an expansive view of what is a security, as well as enact a strong regulatory regime for cryptoassets that are commodities to elucidate the differences between crypto-securities and commodities.

Nevertheless, the risk of relying on the Supreme Court to determine crypto’s fate is fraught—for both cryptoassets and the securities markets.

The author’s full brief can be accessed here.


Todd Phillips is an Assistant Professor of Legal Studies at Georgia State University and a fellow with the Roosevelt Institute.


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