Image: ApeCoin

The U.S. Securities and Exchange Commission (“SEC”) appears to be looking to increase its oversight in the $2 trillion cryptocurrency market, with Chairman Gary Gensler stating this week that crypto platforms are playing roles that are “similar to those of a traditional regulated exchange,” and with “most crypto tokens [amounting to] investment contracts under the Howey Test,” as “many entrepreneurs are raising money from the public by selling crypto tokens.” As such, he stated in a speech for the Penn Law Capital Markets Association Annual Conference at the University of Pennsylvania that “investors should be protected in the same way” by “getting the platforms themselves registered and regulated much like exchanges.” 

Echoing his predecessor Jay Clayton, the former Chairman of the SEC, Gensler stated that most of the crypto token being offered up likely fall within the realm of securities in accordance with the Supreme Court’s 1946 Howey Test, which “says that an investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Even before the before the creation of the Howey test, in the first several years of federal securities laws in the U.S., Gensler stated that “some entrepreneurs were notified that they had to register their offerings” on the basis that the purported sale of the property – from whiskey warehouse receipts to live silver foxes – “was merely camouflage and not the substance of the transaction.”

New Tech, Same Protections?

In his talk this week, Chairman Gensler noted that “there is nothing new about people raising money to fund their projects, [and] crypto may offer new ways for entrepreneurs to raise capital and for investors to trade.” Nonetheless, “We still need investor and market protection,” he asserted, as “any token that is a security must play by the same market-integrity rulebook as other securities.” In other words: “There is no reason to treat the crypto market differently just because different technology is used,” per Gensler. “We should be technology-neutral.”

The SEC Chairman’s speech comes almost a month after President Joe Biden signed an executive order, in which he called on various U.S. government agencies to examine and develop policy recommendations for digital assets, including cryptocurrencies, in light of explosive growth in recent years. It also follows from early efforts by the Department of Justice to crackdown on digital asset fraud. The DOJ arrested two individuals in February for an alleged conspiracy to launder cryptocurrency that was stolen during the 2016 hack of Bitfinex, a virtual currency exchange, presently valued at approximately $4.5 billion. More recently, the DOJ – which created a new National Cryptocurrency Enforcement Team and appointed Eun Young Choi as its first director – charged two different individuals with conspiracy to commit wire fraud and conspiracy to commit money laundering, in connection with a million-dollar scheme to defraud purchasers of NFTs advertised as “Frosties.” 

The SEC’s growing focus on “platforms, stablecoins, and crypto tokens,” in particular, also comes as major acquisitions begin to unfold in the NFT space, such as Yuga Labs’ headline-making deal with Larva Labs to acquire the Cryptopunks and Meebits collections, and as new tokens, such as ApeCoin, are launched. First revealed in March, ApeCoin serves as the “primary token” for Yuga’s Bored Ape Yacht Club ecosystem, as well as “future Yuga products and services,” the Miami-based company stated last month. (While ApeCoin is closely tied to Yuga’s Bored Ape ecosystem, the coin was released and is governed by ApeCoin DAO.)

ApeCoin, which ApeCoin DAO insists is not a security and not run by Yuga Labs, is “a good example of how innovation in the NFT and cryptocurrency space continues to outpace regulatory guidance,” according to Mintz attorneys Edmund Daley, Cory Flashner, and Frank Gerratana. “This can pose significant issues for the innovators launching these projects and the exchanges offering them for sale.”

(More recently, Meta is said to be “readying plans to introduce virtual tokens and cryptocurrencies to its family of apps with an aim to use such virtual tokens for rewarding creators and lending and other financial services,” per Reuters. Meta’s cryptocurrencies “are intended for the metaverse and may not be based on blockchain.”)

It is not yet clear how the SEC will view/treat things like ApeCoin. However, reflecting on the headline-making $APE “utility token” that is currently trading on Coinbase and other exchanges, Daley, Flashner, and Gerratana state, “We know that if a regulatory body or court were to scrutinize the coin, it would likely begin by applying the well-known Howey Test to determine if the cryptocurrency is an investment contract, and therefore, a security.” Setting aside the “challenges of applying a seventy-six year-old test to a crypto offering that was issued [in March 2022], that analysis would look to determine whether the purchase of ApeCoin constitutes: an (1) investment of money, (2) in a common enterprise, and (3) with profits to be derived solely from the efforts of others.”

“Similar to the concerns facing many other cryptocurrencies and other digital assets, how the SEC views the cryptocurrency offering could determine whether that cryptocurrency comes within SEC oversight,” they note, stating that “this is particularly true for ApeCoin if the SEC were to conclude that the profits owners of the coin were expected to enjoy were derived solely on the efforts and success of the BYAC, despite the fact that the coin itself is issued by the Ape DAO.”

Ultimately, how the SEC views crypto projects like ApeCoin “will have a broader impact on the cryptocurrency exchanges that are listing the coin,” per Daley, Flashner, and Gerratana, making these issues – and a host of others – critical for crypto creators, platforms, and buyers to evaluate in this “rapidly involving environment.”