What happened
The day has finally come -- the Securities & Exchange Commission (SEC) has formally made its case that a wide range of cryptocurrencies are, in fact, securities. This past week, the SEC launched two separate lawsuits against Binance and Coinbase, with varying allegations lobbed at the two largest centralized exchanges operating in the U.S.
In the SEC's lawsuit against Binance, Algorand and Filecoin were named as securities, while the SEC's lawsuit against Coinbase named NEAR Protocol as a security. The three tokens were down 18.6%, 17.9%, and 11.9%, respectively, over the past week (since last Friday's close).
So what
Regulatory headwinds in the crypto sector have been around for years. In late 2020, a high-profile lawsuit was launched by the SEC against top-10 crypto by market capitalization XRP. This case is still ongoing, and while many crypto proponents believe XRP's parent company Ripple can come ahead in its assertions that XRP isn't a security, the SEC appears to be front-running an ultimate decision in this case, going after a wide swath of tokens.
Whether the SEC will ultimately be successful in convincing the courts that all of these tokens qualify as securities (rather than commodities, which the SEC appears to concede Bitcoin and Ethereum qualify as) is unclear. Indeed, just because the SEC says certain crypto assets are securities doesn't make it so.
However, it's clear that investors are growing increasingly uncomfortable with the idea that these digital assets could be regulated in much the same way as stocks. If exchanges are forced to put onerous regulatory practices in place, many argue that innovation could be disrupted -- which is one of the key reasons many investors have diversified into this asset class.
Now what
The initial sell-off is one that might be expected, following news of this magnitude. This past week has seen some of the biggest regulatory bombs dropped on the crypto sector since its inception. Moving forward, it appears government agencies are no longer going to turn a blind eye to crypto and plan to actively regulate this sector.
Now, some crypto bulls may, paradoxically, look at this as a good thing. If some sort of consensus can be arrived at with respect to how crypto exchanges are expected to act, how initial coin offerings can take place, and guardrails for growth are put in, perhaps this is a sector that will grow in legitimacy, particularly among institutional investors. That's a fair point.
However, the risk that over-regulation could stifle innovation is one that investors appear to be more focused on right now. I'm not sure if these lawsuits will result in a positive or negative outcome for the crypto sector in the end. But this week, it appears investors are taking a more cautious approach, and that makes sense.
