Big Battles Loom in SEC’s War on Crypto

The SEC in 2024 will mark the seventh year of its campaign to regulate cryptocurrencies through enforcement, with no end in sight. The regulator is waging several major court battles that could determine whether rules written for Wall Street apply to digital assets.

But a winner is unlikely to emerge in 2024 and neither is certainty about who regulates crypto.

“When you do regulation by enforcement, this is how long it takes," said Jan Folena, a partner at Stradley Ronon who earlier tried major cases for the SEC. “There is no shortcutting it. You can’t go to the court and say, ‘We need an answer fast because nobody else is doing anything.’"

In the most closely watched case, Coinbase, the largest U.S. crypto exchange, will ask a federal judge in January to dismiss the SEC’s lawsuit alleging the company violates fundamental investor-protection laws. Courts typically don’t toss the SEC’s claims at an early stage, so the litigation is likely to last into 2025.

The SEC first warned it could police many cryptocurrency deals in 2017, when it issued a report outlining its legal authority under its then-Chairman Jay Clayton. The SEC under Clayton went after companies that sold digital coins for fundraising purposes.

Since then, multiple federal agencies have played a role in policing crypto trading. But the SEC has asserted the broadest claim over the $1.7 trillion market. Chair Gary Gensler, who succeeded Clayton in 2021, says almost all crypto products are securities, which his agency regulates.

Shortly after taking over, Gensler directed a new strategy for the agency’s struggle to police crypto. Instead of investigating hundreds of tiny startups that create digital coins, it would probe and pressure the handful of big exchanges that sell coins to the public. Thus the SEC’s lawsuits against Coinbase and two other platforms: Binance, the world’s biggest crypto trading platform, and Kraken, the second-largest exchange based in the U.S.

The failure of FTX, a major rival of Binance, in 2022 confirmed some of Gensler’s warnings about crypto as a “Wild West" and underscored how little crypto users knew about the inner workings of crypto exchanges. FTX founder Sam Bankman-Friedwas convicted in November of stealing billions of dollars from customers of the doomed crypto exchange.

Crypto firms cast FTX as an outlier and say digital assets are meaningfully different from stocks. Cryptocurrencies can fluctuate in value but don’t carry rights such as dividends or votes to elect a board of directors. The team that creates a crypto asset doesn’t promise to share “the profits, income or assets of the issuer’s business," according to Coinbase’s legal filings.

That means most cryptocurrencies are commodities rather than securities, according to Coinbase, which says the SEC’s case must be dismissed.

Coinbase and other crypto firms have spent millions lobbying Congress to create an alternative regulatory framework for digital assets. Some House Republicans are eager to give them that. But in the Senate, where key Democrats are skeptical and sometimes dismissive of crypto’s value, progressive lawmakers have backed Gensler’s approach.

The SEC faces other legal fights with crypto that could be resolved in 2024, including applications to launch exchange-traded funds that hold bitcoin.

The agency under Gensler and Clayton blocked the door to bitcoin ETFs based on concerns that crypto prices could be manipulated. An appeals court in August chided the SEC for its reasoning, raising expectations that it will approve some of them in early 2024.

The SEC says cryptocurrencies can be securities even if they don’t contractually promise a share of profits or management’s ongoing efforts to boost their value. Several recent court decisions have upheld that view of the law, the SEC says, including a continuing case in which the agency accused crypto entrepreneur Do Kwon of defrauding investors and manipulating cryptocurrencies that regulators argue are securities.

The agency has a “pretty unblemished record" of crypto enforcement, said Hilary Allen, a professor at American University College of Law. The SEC has indicated it might appeal the one major case in which a judge ruled against some of its claims.

The SEC has filed about 55 enforcement lawsuits over cryptocurrencies since Gensler took over, according to data from Cornerstone Research. But it is the cases against Coinbase, Binance and Kraken that will matter.

“If the SEC loses these cases, it won’t have the wind at its back in the same way it currently does," Allen said.

Those companies have enough money to hire top-flight legal talent and appeal if they lose. Coinbase is expected to fight all the way to the Supreme Court if it has to—a legal journey that would take years more to resolve.

But it might be worth it. Coinbase has a 70% chance of eventually beating the SEC’s claims, said Elliott Stein, a senior litigation analyst at Bloomberg Intelligence.

Coinbase’s outside attorneys include Steven Peikin, who led the SEC’s enforcement program for three years, and William Savitt, a litigator at Wachtell, Lipton, Rosen & Katz who argued Twitter’s case when Elon Musk tried to back out of buying the social-media company.

Binance is also seeking early dismissal of the SEC’s lawsuit and will argue for that outcome in January, two days after Coinbase does. But Binance, an offshore exchange, has more baggage than its U.S. rivals. It was criminally charged in November and admitted to violating laws that require financial companies to have anti-money-laundering controls. Founder Changpeng Zhaostepped down as CEO after pleading guilty and faces up to 18 months in prison. His sentencing is slated for February.

SEC lawyers recently told a federal court in Washington, D.C., that many of Binance’s and Zhao’s admissions support the SEC’s allegations. In its criminal case, for instance, Binance admitted that it illegally served millions of U.S. customers, a claim at the center of the SEC’s lawsuit.

Still, the SEC’s willingness to sue crypto projects doesn’t scare the industry as much as it used to, according to Stuart Alderoty, chief legal officer of Ripple Labs. Most of the SEC’s early enforcement actions yielded fines against smaller crypto firms, he said.

“The process is the punishment," Alderoty said. “It’s a very expensive process. And it forced them into settlements."

Ripple recently prevailed in a key part of its own lawsuit with the SEC. The SEC had alleged that Ripple and two of its officers broke the law by selling $1.4 billion of a cryptocurrency known as XRP. But U.S. District Judge Analisa Torres found that only some of the sales were securities offerings—the trades done on exchanges weren’t.

The outcome was a boon for Coinbase’s argument. The exchange says secondary-market trades are just like the sales that Torres exempted from the securities laws.

“Ripple’s significance was seismic," said Ashley Ebersole, a former SEC enforcement attorney who is now general counsel at 0x, a software provider to cryptocurrency developers.

If the agency eventually loses its major cases or if Coinbase and Binance score upset victories early in 2024, Gensler could pivot on his strategy and push for Congress to clarify the SEC’s jurisdiction over crypto.

But writing specialized rules for crypto would be a mistake, said Allen, the American University law professor. She sees that as rewarding an industry with a lighter-touch rule set that could potentially be exploited by other financial firms seeking to dodge strict SEC oversight.

“There is no riskless option for the SEC here," she said. “I see a lot to recommend the enforcement strategy because rule-making also carries a whole lot of risk."

Write to Dave Michaels at dave.michaels@wsj.com