On Monday, the Securities and Exchange Commission decisively defeated the blockchain-based content sharing and publishing platform LBRY in a federal lawsuit. A court determined the company committed securities violations when it launched and sold its native token LBC.
Despite the ensuing anguish in crypto circles, LBRY’s loss on Monday was not a huge shock to legal experts. But seemingly minuscule nuances in the ruling’s language—the details that reveal how the crypto company lost its case—could have dramatic consequences for the regulatory fate of much of the crypto industry.
Experts familiar with the matter believe Monday’s verdict handed the SEC valuable ammunition that will arm it in what appears to be an escalating campaign to label all crypto tokens as securities and eventually pursue American-based crypto exchanges like Coinbase for securities violations.
The fact that a federal court found LBRY to be in violation of securities laws for selling huge amounts of a native token to fundraise for its platform is relatively unsurprising or precedent-setting, according to Lewis Cohen, an attorney specializing in crypto and securities regulation. (Cohen has previously represented Decrypt.)
“Despite all the hair pulling-out by crypto people, there’s a genuine issue in this case that has nothing to do with crypto in particular,” Cohen told Decrypt. “Somebody’s going around raising money, not complying with the SEC’s rules, and thinking that they can get away with it.”
But the court in Monday’s ruling did not merely find that LBRY violated securities laws when it sold LBC. It came close to stating explicitly that LBC itself was a security, regardless of the context of how it was sold.
“The undisputed evidence leaves no doubt that LBRY offered and sold LBC as a security,” US District Judge Paul Barbadoro wrote in Monday’s opinion. In other portions of the ruling, Barbadoro implied—though never stated explicitly—that LBC, regardless of how it was offered, could be considered a security in itself.
Though the distinction may appear semantic, that language is a huge victory for the SEC. By employing it, the judge displayed not just his deference to the SEC’s overall argument, but his total adoption of the agency’s view of the facts.
“The district court almost entirely deferred to the SEC,” Brian Frye, a University of Kentucky law professor, told Decrypt. “I mean, this opinion could have been plagiarized from the SEC’s brief for all that I know. He ruled for the SEC on literally everything with no caveats.”
The ruling’s language—if viewed by other courts to have determined LBC to be a security in all contexts— could mark a dramatic shift in the federal government’s decades-long approach to securities regulation.
Courts have routinely found certain assets—say shares in an orange grove, or whiskey—to have been sold as securities in a manner that didn’t label the underlying asset as inherently securitized. In other words, the SEC has successfully targeted entities in the past for selling whiskey in a securities scheme; that doesn’t mean that the agency was claiming—or that a court has ever found—that every bottle of whiskey in America is an unregistered security.
Cohen believes the SEC is trying to take that unprecedented step here with crypto, by labeling all crypto tokens as securities. And he thinks the LBRY ruling just got the SEC one step closer to that goal.
“What the LBRY decision does is provide a major step forward in the SEC’s quest to label all tokens as securities,” said Cohen. “And that is indeed a very, very significant thing.”
Why is it so significant? Because if the SEC can get courts to rule that crypto tokens are securities regardless of how they are sold, the federal regulator would be able not only to target projects that create tokens, or directly participate in securities “schemes,” it would also be able to go after any entity that sells these tokens in any context.
This would essentially give the SEC the green light to go after major exchanges and marketplaces—like Coinbase, Binance.US, Kraken, and FTX US—that peddle cryptocurrencies to millions of secondary buyers on a daily basis.
“There are so many of these token projects, and they are so time consuming to prosecute, that there's no practical way—the light bulb’s gone off—there’s no practical way that the SEC and state regulators can prosecute all of them,” said Cohen.
“So the SEC has changed gears. Instead of going after projects, they want to go after the marketplaces and intermediaries.”
Cohen believes that the LBRY ruling has given the SEC ammunition that it will now run with in other currently pending lawsuits against crypto companies, like its prominent suit against Ripple Labs regarding sales of the XRP token—a cryptocurrency that was developed by Ripple’s founders.
“The SEC seems uninterested in whether there is an ‘investment scheme,’” Cohen said of the SEC’s suit against Ripple. “They want to go all the way and say that the XRP tokens are the security.”
The more the SEC can get courts to see tokens as securities, the better position it will be in to successfully sue cryptocurrency exchanges and digital asset marketplaces for securities violations. If successful in those suits, the federal agency would likely shut down the majority of cryptocurrency trading in the United States.
“If they got their way, most US token marketplaces could not allow users to buy and sell ‘crypto-securities’ without registering as an exchange or getting an exemption,” said Cohen.
Thus far, such registered exchanges have been extremely reluctant to list tokenized assets.
The LBRY ruling may have therefore—despite its relatively straightforward facts—set in motion a series of escalating legal and regulatory events that could culminate in a final showdown between the SEC and major American cryptocurrency exchanges.
The result of that legal battle could permanently alter the fate of cryptocurrency trading; Wednesday’s bombshell news that the world’s largest crypto exchange Binance pulled out of a deal to acquire its potentially bankrupt competitor FTX only further escalates the stakes in an increasingly volatile crypto exchange landscape.
Frye, for his part, thinks the SEC does not need to employ such an elaborate plan to achieve dominion over crypto exchanges. He believes the agency could choose to regulate the likes of Coinbase and Binance whenever it wants to, and that in such an event, the courts would almost certainly not stand in its way.
“I would be very, very surprised if courts started stepping in here and saying, ‘You've overstepped, SEC, you're not allowed to do this,’” said Frye.
To the law professor, the only thing stopping the SEC is its own regulatory appetite.
“Nothing says the SEC can't decide it's going to regulate all of it,” said Frye. “There’s a practical, consequentialist type argument to say, ‘Gee, SEC, do you really want to do that?’” To that, the SEC will say, ‘We'll do whatever the fuck we want.'"