3. Two Landmark U.S. Crypto Lawsuits
The Ripple case and the Terraform case are two landmark cases in the U.S. crypto industry that cannot be overlooked. In both cases, the courts defined the legal attributes of crypto assets from different perspectives, sparking a strong reaction within the crypto industry. The main points of contention in both cases are highly similar to those in the current case, as they both address the classification and regulation of crypto assets. These cases are of significant reference value for predicting the direction of the current case’s ruling.
3.1 Ripple Case
3.1.1 Basic Case Facts
Ripple Labs is the holder of Ripple and its native cryptocurrency token XRP, founded in 2012, and is one of the earliest pioneers in the blockchain field. XRP is designed as a bridge tool to facilitate financial transactions, with its customer base primarily consisting of financial institutions.
In December 2020, the SEC filed a lawsuit against Ripple Labs, its CEO Brad Garlinghouse, and co-founder Chris Larsen, accusing them of illegally issuing securities by selling XRP, with total funds raised exceeding $1.3 billion. The SEC argued that XRP is essentially an investment contract, akin to stocks or bonds, and therefore should strictly adhere to securities laws, including registering with the SEC and providing adequate disclosures to investors. However, Ripple defended itself by claiming that XRP is a digital currency, more similar to Bitcoin or Ethereum. Additionally, XRP does not meet the criteria of the Howey Test and should not be classified as a security.
The SEC’s lawsuit created a huge wave in the crypto industry, as it marked the first time the SEC filed a lawsuit against a widely circulated mainstream cryptocurrency, symbolizing the broader conflict between digital asset innovation and regulation.
3.1.2 Results
In July 2023, the court ruled that XRP (and all cryptocurrencies) is not a security when sold to the public on exchanges, but is considered a security when sold to institutional investors. This ruling triggered a strong market reaction, causing XRP’s price to rise by 70%.
In August 2024, a final ruling was made. Regarding whether XRP should be classified as a “security,” the court distinguished between sales scenarios. On the one hand, institutional direct sales were found to meet the criteria of the Howey Test. The court ruled that institutions purchasing XRP directly from Ripple, with the expectation that the value of XRP would increase for profit, constitutes typical investment contract behavior and qualifies as securities issuance. On the other hand, XRP sold programmatically on the open market did not meet the criteria for a security. The court emphasized that open market buyers did not know who the seller was and had no expectation of profits from Ripple, meaning this kind of transaction did not meet the investment contract standard, thus was not considered a securities transaction. The court ultimately imposed a civil fine of about $125 million on Ripple, far below the SEC’s initial request of nearly $2 billion, but higher than Ripple’s intended cap of $10 million.
In terms of results, both Ripple and the SEC achieved partial victories. Ripple avoided the massive fine requested by the SEC, while the SEC did not leave empty-handed. However, it is clear that the SEC’s expectations were significantly thwarted, leading the SEC to file a Notice of Appeal in October 2024, seeking to overturn part of the district court’s ruling in the Federal Second Circuit Court of Appeals. According to the Federal Second Circuit Court’s response, the SEC must submit its appeal brief by January 15, 2025. Therefore, the final outcome of the case remains subject to potential changes.
3.1.3 Subsequent Impact
The Ripple case has had a significant impact in several ways. First, it clarified the importance of the method of transaction in the classification of crypto assets. In the Ripple case, the court ruled that selling XRP to the public on the secondary market does not constitute a securities transaction, indicating that the manner in which crypto assets are sold or traded can affect their classification.
Second, this case has limited the SEC’s ability to expand its regulatory reach over crypto assets. Unless the SEC succeeds in its appeal, the ruling in this case will be binding in the U.S., where precedent law applies, and will prevent the SEC from classifying a wide range of crypto assets as securities under its regulatory scope.
Overall, the Ripple case marks a significant victory for the crypto industry in the battle against strong regulatory measures. This ruling not only boosted the confidence of crypto practitioners and improved market sentiment, but it could also serve as an important turning point in future regulatory landscapes.
3.2 Terraform Case
3.2.1 Case Summary
Terraform Labs is a platform providing blockchain technology and crypto assets. Its founder, Do Kwon, attracted investors in the secondary market by designing and selling various crypto assets, including the native stablecoin UST and the token LUNA. The UST coin was pegged to the US dollar, and its stability algorithmically depended on the support of its sister token, LUNA. However, Terraform’s stability mechanism encountered serious problems in practice. In May 2021, UST de-pegged, but Terraform temporarily restored the peg through secret arrangements with third-party companies. In 2022, UST once again fell below 1 USD, and without external intervention, its value rapidly collapsed, leading to the loss of value in LUNA as well. This crash triggered a market value loss of over 40 billion USD, which also affected other crypto assets, including Bitcoin, and further impacted the entire crypto market, leading to bankruptcies in several companies in 2022.
In February 2023, the U.S. Securities and Exchange Commission (SEC) charged Terraform Labs and its founder, Do Kwon, with unregistered securities fraud involving billions of dollars. The SEC argued that Terraform attracted investors through misleading statements and fraudulent actions, violating the registration and anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.
In June 2024, the U.S. District Court approved a $4.5 billion settlement agreement between Terraform Labs and the SEC. According to the agreement, Terraform was required to pay nearly $3.6 billion in illegal earnings, $420 million in civil fines, and about $467 million in pre-judgment interest. Do Kwon, alongside Terraform, was required to pay $110 million in illegal earnings and $14.3 million in pre-judgment interest, while Do Kwon alone must pay a $80 million civil fine. However, since Terraform filed for bankruptcy in January 2024, these fines may not be fully paid and may be processed as unsecured debts in the bankruptcy liquidation.
3.2.2 Ruling
The core of the Terraform case ruling was the legal classification of UST and LUNA. The court found that purchasers of these crypto assets reasonably expected the tokens to generate profits and viewed them as a profitable investment, fulfilling the definition of an investment contract under the Howey Test. The court further ruled that all related crypto assets created by Terraform, including UST and LUNA, met the definition of an investment contract under the Securities Act of 1933 and should be classified as securities.
Notably, the court responded to Terraform’s defense based on the Major Questions Doctrine, which requires that “in special circumstances, an agency claiming authority to regulate a significant portion of the U.S. economy must point to clear congressional authorization for that power.” The court noted that (1) there is almost no comparability between Terraform Labs and cases involving major industries like tobacco and energy, and (2) the SEC’s regulation of certain crypto assets as securities did not constitute a transformative expansion of its regulatory power.
Additionally, similar to the arguments raised by 18 states against the SEC, Terraform claimed that the SEC violated the Administrative Procedure Act. The court rejected this argument, stating that the SEC’s decision to classify Terraform’s digital assets as investment contracts was not based on new policy, but was an enforcement of prior policy. The court also confirmed that the SEC’s charges sufficiently accused Terraform of offering and selling tokens like LUNA as an illegal public offering of unregistered securities and making false or misleading statements during the issuance process to benefit from them.
3.2.3 Subsequent Impact
The Terraform case ruling supported the SEC’s regulatory stance, drawing widespread attention within the crypto asset industry. Specifically:
l Classification of Crypto Assets: The Terraform case reasserted the method for determining the legal status of crypto assets. It showed that crypto assets traded in secondary markets could be classified as securities if they pass the Howey Test, particularly when investors have a reasonable expectation of profit from the efforts of the issuer.
l Strengthened SEC’s Regulatory Authority: The Terraform ruling has been cited by the SEC in lawsuits against other crypto exchanges, such as Binance and Coinbase, potentially driving the SEC towards broader regulation of the digital asset market.
l Warning to the Crypto Industry: The ruling also serves as a warning to industry participants about the legal risks involved in the design and marketing of crypto assets.
3.3 Summary
Although both the Terraform and Ripple cases center on the classification of crypto assets, the rulings in these cases show significant differences. In the Ripple case, the court ruled that the secondary market sale of XRP does not constitute a securities transaction, while the Terraform case ruled that UST and LUNA fit the definition of an investment contract.
This difference increases the legal uncertainty in the digital asset space. The Ripple case highlights the importance of the method of transaction, suggesting that anonymous secondary market transactions may not meet the requirements for a “common enterprise” or “dependence on the efforts of others” under the Howey Test. In contrast, the Terraform case places more emphasis on the investors’ expectation of profit and the actions of the issuer, meaning that even in secondary market transactions, the issuer’s efforts can still lead to a classification of securities. This legal distinction adds uncertainty to the digital asset industry.
Furthermore, the rulings could affect the SEC’s regulatory strategy, leading to shifts in its stance on crypto assets. In the Terraform case, the SEC’s position was affirmed, strengthening its authority over secondary market transactions of crypto assets. In the Ripple case, the court limited the SEC’s ability to extend its regulation over such transactions. This inconsistency reflects that the SEC’s regulatory strategy in the digital asset space may need to be adjusted case by case, with the possibility of more segmented oversight focusing on issuers’ actions.
Additionally, these rulings have sent mixed signals to the market, potentially leading to increased volatility. The Terraform case is seen as a victory for the SEC, reinforcing expectations of stricter regulation, which could suppress innovation in crypto assets. In contrast, the Ripple case is seen as a win for the crypto industry, boosting market sentiment and temporarily lifting the prices of digital assets.
Finally, these recurring judicial decisions may drive legislative clarification. The differences between the rulings in the Ripple and Terraform cases suggest that current securities laws are inadequate to address the complexities of digital assets. The outcomes of these cases could prompt further legislative efforts by the U.S. Congress to provide clearer rules for digital assets’ legal status and regulatory scope. Specialized legislation, such as the pending FIT21 in the Senate, may be a potential solution to the current regulatory ambiguities arising from differing judicial interpretations.
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4. Motivation and Chances of Success for the 18-State Lawsuit
4.1 Analysis of the Lawsuit Motivation
The 18 states’ joint lawsuit against the SEC’s regulation of the crypto industry as unconstitutional is essentially an attempt to limit the SEC’s regulatory expansion through judicial means, while also seeking to gain more autonomy for state powers within the constitutional framework. The motivations for filing the lawsuit are likely as follows:
l Forming a General Legal Precedent through Constitutional Ruling: In recent years, the SEC has expanded the scope of the Howey Test to impose securities regulation on a large number of digital assets, which has sparked widespread controversy both inside and outside the industry. By invoking the U.S. Constitution’s First and Tenth Amendments, the 18 states aim to challenge the SEC’s enforcement actions at the constitutional level, hoping for a ruling by the federal courts that could invalidate the SEC’s enforcement practices. If the U.S. Supreme Court ultimately supports the 18 states’ position, it would set a legal precedent with nationwide binding effect, providing legal guidance for similar disputes in the future and compelling the SEC to adjust its regulatory strategy.
l Restraining Administrative Power and Preventing Policy Continuation: Under the leadership of Gary Gensler, the SEC has adopted stringent policies toward crypto, including aggressive enforcement actions against crypto firms like Ripple and Terraform, as well as imposing large fines. This regulatory model has severely stifled industry development and infringed upon states’ rights. Through this lawsuit, the 18 states not only seek to curb the current SEC chairman’s stringent policies but also aim to establish legal boundaries for future administrations, preventing similar policies from continuing.
l Filling Legislative Gaps and Promoting Industry Development: Federal legislation in the U.S. regarding digital assets remains incomplete, with ongoing disputes about the legal status and regulation of digital assets. Through judicial rulings, the crypto industry hopes to establish legally binding precedents within the existing legal framework, offering clearer compliance pathways and creating a more favorable environment for innovation and development in the sector.
4.2 Favorable Conditions and Unfavorable Factors
In terms of favorable conditions, the 18 states chose to file the lawsuit after the Republican Party, represented by Trump, won the election, which has created several advantageous conditions while also facing numerous uncertainties.
Favorable Conditions :
l Trump Administration’s Policy Position : President-elect Trump has clearly expressed his support for the crypto industry and has announced plans to replace the SEC chairman. The new chairman nominated by Trump may adopt a more lenient regulatory policy, which could reduce the SEC’s antagonism in this case and make the court’s ruling more favorable to the crypto industry.
l Conservative Leaning of the U.S. Supreme Court : This case involves constitutional issues, and the U.S. Supreme Court has final authority on constitutional cases. Currently, the Court has a conservative majority, with justices such as Thomas and Alito, who tend to support states’ rights in matters concerning the balance of power between federal and state authority. This political leaning could provide the 18 states with more support for their claims that the SEC’s actions are unconstitutional. Furthermore, conservative justices are more likely to be receptive to arguments aimed at limiting the power of federal administrative agencies, thus improving the chances of success in the case.
l Broad Industry Support : There is widespread criticism of the SEC’s current regulatory policies both within the crypto industry and beyond. Many companies believe that stringent regulatory requirements stifle technological innovation and increase compliance costs, leading to a strong demand for breaking the current stringent regulatory model.
Unfavorable Factors :
l Judicial Uncertainty : The U.S. judicial system has yet to establish a unified standard for recognizing digital assets. In the Terraform case, the court rejected similar defenses based on the “Major Questions Doctrine” and the “Administrative Procedure Act,” which could negatively influence this case. Additionally, the differing views of state courts on the legal classification of digital assets could make it harder for the 18 states to succeed.
l High Time and Resource Costs : The lawsuit began in a local district court and may go through several appeal stages before reaching the U.S. Supreme Court. This lengthy legal process will consume significant time and resources, and the regulatory uncertainty during the proceedings may have short-term negative effects on the industry. Moreover, the 18 states will have to continuously respond to the SEC’s counterarguments, potentially facing considerable pressure on both policy and litigation resources.
l Slow Legislative Progress : As previously mentioned, although the House of Representatives passed the FIT21 bill to clarify the regulatory framework for digital assets, substantial progress has not been made in the Senate. Therefore, the passage of such legislation may still face obstacles. This legislative vacuum could lead the court to maintain the status quo rather than impose substantive restrictions on administrative powers.
Overall, considering the Republican Party’s control over both the executive and judicial branches, as well as the industry’s opposition to strict regulatory models, the 18 states have a reasonable chance of success in this lawsuit. A more favorable government stance toward the crypto industry could provide a positive shift in the case, and the conservative leaning of the U.S. Supreme Court may support their constitutional claims. However, the case faces challenges due to slow legislative progress and judicial discretion, especially regarding the ongoing debates about the legal classification of digital assets. Convincing the court to impose substantive restrictions on SEC policies will be the key to determining the outcome of the case.
5. Conclusion and Outlook
The lawsuit filed by the 18 states against the SEC represents a major legal and regulatory battle involving constitutional principles and the future of digital asset regulation. While the case presents certain chances of success, it must overcome multiple challenges in both the judicial and policy realms. Regardless of the final outcome, this case will have a profound impact on the legal and policy landscape of the U.S. crypto industry.
If the court ultimately rules that the SEC’s regulatory policies are unconstitutional , it would directly limit the SEC’s scope of regulation over digital assets, potentially shifting regulatory authority more towards the CFTC or state governments. This would create a more decentralized and diversified regulatory system. Such a change would help ease the current overly stringent regulatory style of the SEC, creating a more favorable environment for the crypto industry to thrive. It could also clarify the classification of crypto assets, reducing disputes over the application of the Howey Test, and enhancing compliance certainty. Furthermore, the case could play a crucial role in rebalancing the relationship between state and federal governments. State governments might devise regulatory policies better suited to local needs, fostering a competitive regulatory environment and reinforcing the U.S.’s leadership in the digital asset sector. Additionally, the reduction in regulatory pressure could significantly spur innovation in the industry. Companies would be able to experiment with new technologies and business models in a more relaxed environment, accelerating the widespread adoption of digital assets, particularly in areas like decentralized finance (DeFi) and cross-border payments.
However, the ruling of the case could also bring new risks and challenges. Changes in policy could cause market volatility, especially during the litigation process, as investors are highly sensitive to regulatory uncertainty. Moreover, if regulatory authority is devolved to state governments, policy differences between states could increase the compliance complexity for businesses operating across state lines. Additionally, international competitive pressure may increase, as regions like the European Union and Singapore have made significant progress in digital asset regulation. A fragmented regulatory framework in the U.S. could undermine its global competitiveness in the crypto market.
Overall, the lawsuit filed by the 18 states against the SEC is a pivotal milestone in the development of the U.S. crypto industry. The case provides an opportunity to push for a more favorable regulatory environment. Moving forward, the healthy development of the U.S. crypto industry will require a balance between regulation and innovation. With a reasonable judicial ruling, the U.S. has the chance to maintain its leadership in the global digital asset sector, driving innovation and growth.
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