The popular Russian-language game show "What? Where? When?” has been stumping experts and viewers alike since the mid-1970s. With its reliance on quick thinking, insight and reasoning, the game pits viewers who submit questions against a team of experts, with the submitting viewer winning a monetary prize if the experts cannot answer a question. Almost 5,000 miles away, US state and federal legislators and government agencies are asking the same questions regarding the regulation of crypto assets, but it is far from clear who will walk away with the prize.

The “What?” is the effort underway in the US Congress to clarify when the Securities and Exchange Commission (“SEC”) has jurisdiction over a particular token or cryptocurrency (collectively, “crypto assets”) and when the Commodity Futures Trading Commission (“CFTC”) has jurisdiction. The crux of the determination lies in whether a crypto asset meets the criteria utilized by the SEC for a “security” based on a host of factors, including whether the crypto asset qualifies as an “investment contract”¹. In the Howey case, the Supreme Court held that an offer of a land sales and service contract was an "investment contract" and therefore a “security” under the US securities laws as it satisfied each prong of a four-pronged test which that court established (the “Howey Test”)². Specifically, the Supreme Court formulated the criteria underlying an “investment contract” as follows:

An investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise. The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others. If that test be satisfied, it is immaterial whether the enterprise is speculative or non-speculative or whether there is a sale of property with or without intrinsic value³.

Accordingly, the Howey four-prong test to be used in determining whether an “investment contract” exists is: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit and (4) to be derived from the efforts of others. If the crypto asset meets the Howey test of an “investment contract”, then it is a “security” and subject to regulation by the SEC as such. The determination of whether a crypto asset is an “investment contract” lies primarily in whether it satisfies the "expectation of profit to be derived from the efforts of others” prongs under the Howey Test, since the “investment of money” and “common enterprise” tests are easily met. For example, if the success of a crypto asset depends on the ongoing participation of its backers, the purchaser of the crypto asset is likely relying on the "efforts of others" (i.e., here, the backers) in order to realize a profit. As a result, the SEC, with the help of the CFTC and Congress, is seeking to achieve some clarity in determining when a crypto asset satisfies the definition of “security” under the US securities laws and when the characterization might change based on whether the crypto asset becomes more decentralized and fungible and less dependent on the actions of its backers for any profits.

The CFTC has jurisdiction over commodities and the vast majority of swaps and futures. Although most swaps and futures on crypto assets would fall squarely within the CFTC’s jurisdiction⁴, it is still unclear which crypto assets would meet the definition of “commodity” under the US Commodity Exchange Act and related regulations, with the exception of Bitcoin and Ethereum⁵, which are viewed by both the CFTC and SEC as “commodities”. In the Coinflip matter,⁶ the CFTC confirmed its jurisdiction over “virtual currency”, which it defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, but does not have legal tender status in any jurisdiction.” Implicit in the definition is the element of fungibility in terms of the use of the “virtual currency”, even though virtual currencies leave a unique trace on the blockchain in a way that truly fungible commodities do not. Recent developments, in particular SEC Chairman Gary Gensler’s comments at the Aspen Security Forum on August 3, 2021, have sparked discussion among industry participants as to whether SEC initiatives in the crypto space will reverse existing regulatory interpretations or merely expand on current positions⁷.

In addition, both the US Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) and State Regulators have jurisdiction under money transmission laws and regulations. Generally, while not all state laws have specifically defined “virtual” currency or crypto assets, virtual currency may be seen as a form of “monetary value” which would make the receipt and transmission of virtual currency licensable activity in those jurisdictions. Two states in particular, New York and Louisiana, have enacted a specific license type for virtual currency transactions. New York’s definition of licensable activity under its existing license includes not only receipt and transmission of virtual currency, but also maintaining custody of virtual currency for others, buying and selling virtual currency or performing exchange services as a customer business, or administering or issuing a virtual currency. Louisiana’s definition of licensable activity under its relatively new license is similarly broad, including not only the exchange, transfer or storage of virtual currency (whether directly or through an agreement with a virtual currency control services vendor) but also the holding of electronic precious metals or electronic certificates representing interests in precious metals, exchanging digital representations of value used in gaming platforms for either virtual currency offered by or on behalf of the same publisher or legal tender outside the online game platform offered by or on behalf of the same publisher. Note that while the Louisiana law was effective August 1, 2020, it is our understanding that the regulator intends to draft the required rules under the applicable law prior to taking any applications for necessary licensure.

The “Where?” hinges on the outcome of the joint regulatory framework currently under discussion not only in Congress but also among government agencies such as the Internal Revenue Service ("IRS"), FinCEN, the Office of the Comptroller of the Currency, Federal Reserve Board and Federal Deposit Insurance Corporation and state regulatory agencies. Once these agencies can provide clarification on whether and when a crypto asset is a security, commodity, currency (the current FinCEN position and that of some state regulators) or property (the IRS’s view), the hope in the marketplace is that there will be less jurisdictional overlap and more certainty as to where the regulation of crypto assets will be parked. Given the complex and evolutionary nature of some crypto assets, it is likely that rules, guidance, or interpretations adopted in the near term will face challenges as the crypto assets currently in the marketplace change and as new crypto assets are introduced, thereby hampering certainty in terms of which agencies have oversight over particular crypto assets. In addition, the global legal environment for crypto assets will likely require harmonization or at least coordination of rules among the United States and other regulators in order to mitigate the risk of regulatory arbitrage.

The answer to the question of “When?” may be the easiest one to predict: a joint regulatory framework is not likely to happen in the near future. Although efforts are underway as described above, the United States may ultimately adopt a wait-and-see approach based on the outcome of regulations elsewhere. Even if the United States moves forward with a joint regulatory framework for crypto assets, it isn’t clear where crypto assets will fall in the line of priorities for each regulator or agency asserting jurisdiction over these products. Nor is it certain how the competing groups will resolve the age-old friction of turf: which organization or organizations will walk away with the largest share of supervision of, and enforcement of violations of, the laws and regulations relating to, crypto assets. In addition, state regulatory agencies are separately deciding what oversight is necessary for crypto assets, adding an additional layer of regulatory oversight.

Unlike in the “What? Where” When?” of Russian fame, the path of crypto assets regulation in the United States is likely to defy both knowledge and logic, despite the efforts of government and regulatory actors. It remains to be seen who, if anyone, emerges as the clear prizewinner in the near future.

¹ In Section 2(a)(1) of the Securities Act of 1933, a “security” is defined as including, among other things, an “investment contract”.

² Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293 (1946).

³ Ibid.

⁴ Security-based swaps and certain security-based futures and options fall under the jurisdiction of the SEC. By way of example, if the underlying reference asset on a swap is deemed to be a single “security”, the SEC would have jurisdiction over the swap, as it would be treated as a “security-based swap” under both the US securities and commodities laws and regulations. Accordingly, since certain initial digital coin (ICO) offerings have been determined by the SEC to meet the definition of “security” under the Howey Test, a swap on a single ICO would be a security-based swap and therefore fall under the jurisdiction of the SEC. However, because swaps on more than a single security are “swaps”, a swap on more than one digital coin would be a swap subject to CFTC jurisdiction.

⁵ See In the Matter of Coinflip, Inc. d/b/a Derivabit, and Francisco Riordan, Sept, 17, 2015 (https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfcoinfliprorder09172015.pdf). See also https://www.coindesk.com/cftc-chairman-confirms-ether-cryptocurrency-is-a-commodity). 

⁶ In the Matter of Coinflip, Inc. d/b/a Derivabit, and Francisco Riordan, Sept. 17, 2015, supra note 4.

⁷ See https://www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021-08-03.