This is the Big One
Paul Grewal and the Coinbase legal team win another major victory. The cryptocurrency exchange has advanced to the Second Circuit.
I started Brogan Law to provide top quality legal services to individuals and entities with legal questions related to cryptocurrency. Cryptocurrency law is still new, and our clients recognize the value of a nimble and energetic law firm that shares their startup mentality. To help my clients maintain a strong strategic posture, this newsletter discusses topics in law that are relevant to the cryptocurrency industry. While this letter touches on legal issues, nothing here is legal advice. For any inquiries email aaron@broganlaw.xyz.
On the heels of Coinbase’s successful FOIA campaign against the FDIC, the company got another big win this week. A judge in S.D.N.Y. just certified Coinbase’s interlocutory appeal on the question of whether secondary sales of cryptocurrency tokens are security transactions. The result will determine the immediate future of the cryptocurrency industry in the United States. Let me explain.
Securities Law and Cryptocurrency
So obviously the big question in the regulation of cryptocurrency in the United States has, for many years, been the definition of a security. On some level it is kind of silly that this one piece of analysis has come to dominate the space for so long—the relevant legal test from U.S. v. Howey has been basically stable since 1946—but the reason is simple.
Generally, the United States maintains a free market economy. Anyone can come here and buy more or less whatever they want. There are some tax implications, and if the things you want to buy happen to be a lot of agricultural-grade ammonium nitrate fertilizer or pseudoephedrine you might have to answer some questions at some point, but generally we’re free.
Transactions in securities, though, are highly regulated. These radical certificates are so dangerous that, as a default, you can’t sell them at all in the United States. If you do want to sell them, they either must be private and sold under an exception—almost always Regulation D, almost always using Rule 506(b)—or public and sold into the ornate apparatus of national security exchanges. These public securities require millions of dollars of banking and legal services to launch effectively, and then millions more dollars of annual reporting compliance filing 10-Q, 10-K and other disclosures.
Oh, and if you make an error in any of those disclosures, or even if some bad fact arises ex post that would have materially affected those disclosures had you known about it when you filed, then you have committed securities fraud and Bernstein Litowitz will sue you. And if you sell something that you think is not a security and the government disagrees? Well, you might just get an early-morning knock at the door and a court-date. Have fun!
If you have been reading this newsletter for a while, you know the benefits and issues with this regime. The benefit is that sales in public securities are generally very efficiently priced because there is a lot of information available about them, and it is very easy to trade them once their promoter pays the toll and they arrive on national exchanges. The downside is that public securities are too expensive for ordinary companies to use and private securities are highly illiquid, which makes it very difficult for approximately anyone to raise funds by selling them.
And crypto solved this, by (in many cases) having a lot of the salient features of securities but not being securities. In this way, the industry gets the benefit of a security-like financial product—facilitating fecund capital markets to fund compelling products, providing liquid secondary markets to allow third parties to trade on the relative merits of different projects—without the costs of a hundred-year old securities law regime: millions of dollars of compliance and dead-end secondary markets.
But the other side of the coin is that since these new markets are unregulated, they are volatile, and in both the ICO boom of 2017-2018 and the bubble-collapse of 2022 many retail investors lost large sums of money. This brought the SEC calling, and they started to say things like “hey—this cryptocurrency token has many of the features of an investment contract, stop selling it now!”
The cryptocurrency industry fought back, and reached a basic consensus that (i) cryptocurrency tokens sold into the United States for the purpose of fundraising a project are likely to be considered securities by a majority of federal courts, (ii) cryptocurrency tokens like BTC and ETH that are the product of large, meaningfully decentralized networks are generally not considered securities by the SEC, and (iii) stablecoins that do not promise any profit or provide exclusive access to staking or yield-earning applications are relatively unlikely to be considered securities by anyone.
There remains, however, a fourth category of cryptocurrency transaction for which there is no consensus as to legal status. This is sales of cryptocurrency tokens in secondary market transactions. You see, the Howey test does not delineate a status that attaches to the certificate1, rather it determines whether a specific transaction is an “investment contract”, which is a subset of securities. This means that a cryptocurrency token is not fundamentally a “crypto-asset security” as the SEC has sometimes called it, but could be a unit of a security transaction.
The Secondary Market Cases
In the early years of the SEC crypto cases, a number of courts either did not draw a distinction between primary and secondary sales, or found that secondary sales of cryptocurrency were securities. This approach came to a head in a series of four opinions across S.D.N.Y. and D.D.C. in 2023 and 2024.
The seminal case in this line was the July 13, 2023 Ripple summary judgement ruling that we have often discussed here. In that case, Judge Analisa Torres held that certain “programmatic sales” of the cryptocurrency token XRP, which were characterized by blind bid-ask matching, were not investment contracts because “[p]rogrammatic Buyers could not have known if their payments of money went to Ripple, or any other seller of XRP” and “the vast majority of individuals who purchased XRP from digital asset exchanges did not invest their money in Ripple at all.” While the court insisted that the ruling “[did] not address whether secondary market sales of XRP constitute offers and sales of investment contracts”, the implications were obvious to all. Under the Torres rule, secondary sales of cryptocurrency probably did not qualify as investment contracts.
This case was seen as heterodox at the time. It provided unexpected purchase for the cryptocurrency industry to advance similar legal arguments elsewhere, but was soon challenged.
Only a few weeks later, in the same courthouse in downtown Manhattan, S.D.N.Y. judge Jed Rakoff explicitly repudiated the Torres ruling in Terraform. Judge Rakoff refused to draw a distinction between primary and secondary cryptocurrency transactions, saying:
“It may also be mentioned that the Court declines to draw a distinction between these coins based on their manner of sale, such that coins sold directly to institutional investors are considered securities and those sold through secondary market transactions to retail investors are not. In doing so, the Court rejects the approach recently adopted by another judge of this District in a similar case, SEC v. Ripple Labs Inc… Howey makes no such distinction between purchasers. And it makes good sense that it did not. That a purchaser bought the coins directly from the defendants or, instead, in a secondary resale transaction has no impact on whether a reasonable individual would objectively view the defendants' actions and statements as evincing a promise of profits based on their efforts… [promotional statements] would presumably have reached individuals who purchased their crypto-assets on secondary markets -- and, indeed, motivated those purchases -- as much as it did institutional investors. Simply put, secondary-market purchasers had every bit as good a reason to believe that the defendants would take their capital contributions and use it to generate profits on their behalf.”
As quickly as the crypto industry won a victory in Ripple it was rebuffed in Terraform. What was left was an unstable equilibrium—the Torres and Rakoff rules were in explicit tension, and future courts could have gone either way.
The next ruling came in the SEC’s litigation against Coinbase, also in S.D.N.Y. On March 27, 2024 Judge Katherine Polk Failla chose to follow the Rakoff rule in the and adopted what is sometimes called the “ecosystem” theory:
“When a customer purchases a token on Coinbase’s platform, she is not just purchasing a token, which in and of itself is valueless; rather, she is buying into the token’s digital ecosystem, the growth of which is necessarily tied to value of the token. This is evidenced by, among others, the facts that (i) initial coin offerings are engineered to have resale value in the secondary markets and (ii) crypto-asset issuers continue to publicize their plans to expand and support the token’s blockchain long after its initial offering” (internal citations omitted)
As consensus began to form in S.D.N.Y., however, Judge Amy Berman Jackson in D.D.C. repudiated the reasoning in a June 28, 2024 Binance ruling. Judge Berman Jackson suggested the SEC was “talking out of both sides of its mouth” in its treatment of cryptocurrency tokens. Without ruling that secondary transactions were not investment contracts generally, Judge Berman Jackson dismissed the SEC’s argument that certain secondary sales were investment contracts because the “complaint [did] not include sufficient facts to support a plausible inference that any particular secondary sales satisfy the Howey test for an investment contract.” Importantly, Judge Berman Jackson explicitly sided with Judge Torres, saying:
“The Court is inclined to agree with the approach of the court in Ripple Labs, since the ‘it-is-what-it-is’ approach of the SEC appears to be inconsistent with the clear Supreme Court directives quoted in its pleadings, which hold that it is the economic reality of the particular transaction, based on the entire set of contracts, expectations, and understandings of the parties, that controls.”
Against this backdrop of genuine judicial disagreement, on April 12, 2024 Coinbase filed a motion requesting leave to appeal the March 27 ruling. Then on July 1, 2024 filed a notice of supplementary authority to include the Binance ruling. This week, on January 7, 2025, Judge Failla granted the motion to appeal.
The Coinbase Appeal
We’ve mentioned interlocutory appeals before, but, basically, requesting one amounts to telling a judge that you think they are wrong. You are politely asking them to go ask the judges of a higher court to check their math before the district court case proceeds. District judges have wide discretion to grant or deny petitions for interlocutory appeal, and their typical response is roughly “fuck off.”
So it is very unusual that Coinbase convinced Judge Failla to certify interlocutory appeal here. Judge Failla’s order notes that “The significance of a crypto-asset's digital ecosystem to the Howey analysis, particularly as a point of contrast with collectibles or other commodities, is a difficult issue of first impression for the Second Circuit.” And she continues that:
“Without doubting its original conclusion that the challenged crypto-asset transactions can be distinguished from commodities or collectibles because crypto-assets lack inherent value absent the digital ecosystem, the Court nonetheless finds that Coinbase raises more than a ‘‘simple disagreement on the issue' and an attempt to relitigate it’ by questioning whether the Court must draw such a distinction. There is indeed substantial ground to dispute how Howey is applied to cryptoassets and the role of the surrounding digital ecosystem in that analysis.” (internal citations omitted)
From an inside baseball perspective, what is probably actually going on is more than Judge Failla doubting her previous ruling. The Ripple case reached a final disposition on August 7, 2024, and this meant that the SEC could finally appeal the Torres rule to the Second Circuit. That appeal was opened on October 4, 2024. The disposition of that appeal will likely be dispositive to at least some issues in the Coinbase case, and judges hate spending time and resources litigating issues that might resolve independently. From an incentive perspective, it makes complete sense for the court to throw up its hands and send the case to the Second Circuit to be decided alongside (or consolidated with under FRAP 3(b)(2)) Ripple.
Now, the Second Circuit has to agree to hear this thing, which I honestly have no idea whether they will be amenable to because I have never had a court certify an interlocutory appeal in one of my cases before. My guess is they’ll hear it because it's important, because they’re already getting Ripple, and because there is a genuine question here.
And assuming they do, this is the big one. District court judges are generally highly sophisticated people but there are a lot of them, and they say all kinds of different things all over the country. District court rulings are interpretations of the law, but not themselves precedential—they are not law. The circuit courts, on the other hand, are the big leagues. The decisions of circuit courts are precedential law.2 It is safe to say that the Second Circuit’s decision on this issue would reverberate across the nation, even the world.
What's the Most You Ever Lost on a Coin Toss?
Here is what is at stake. If the Second Circuit decides that secondary market transactions are not securities, then the large bulk of cryptocurrency transactions move outside of the SEC’s remit. That means that the project that these various cryptocurrency exchanges have been pioneering for all these years will finally and definitely be legal. There will be no more calls to come-in-and-register followed up with subpoenas.
This will not legalize ICO’s, but there are various other methods of distributing tokens that, in the medium term, can permit them to circulate legally in the United States secondary market. Obviously, it would be better if primary sales of cryptocurrency were legal in the United States but, peculiarly, if you had to choose only between primary and secondary markets, you would probably prefer secondaries. The ability of an asset to trade freely is just a lot more important to its social value than the first transaction in the chain.
And if the Second Circuit goes the other way and rules that secondary market transactions are investment contracts, well then by my reading this whole enterprise in unregistered securities becomes very illegal.3 However, Coinbase can still appeal to the Supreme Court and this is quite a significant matter economically, so they might just take it.
Even if they don’t take it now, there are cases pending elsewhere that could lead to a circuit split4, most notably the joint complaint in E.D. Kentucky by several state attorneys general and the Defi Education Fund that we covered back in November. If E.D. Kentucky and the Sixth Circuit come out the other way, then there will be a circuit split and the Supreme Court is going to hear this question. Nobody knows what the Supreme Court will do, but this issue is charged politically and right-coded and they tend to, uh, prefer that side of the aisle.5
Now you might be saying, does this really still matter? We know the Trump administration is going to come in and probably be a lot gentler with the cryptocurrency industry than the Biden administration was. But that doesn’t take away any of the gravity of this legal moment. Just like you can’t trust a toddler with a knife, you can’t trust a regulatory agency with an off-button. Times change, administrations change, but I’d like to still be here.
While there have been numerous proposals for the Trump controlled administrative state to lock in pro-crypto regulation—I particularly liked GMU professor J.W. Verrett’s inventive RCP proposal for regulatory contracts—nothing from the executive is as strong as law. That’s what Coinbase is making here, so stay tuned.
Crypto.com Sports
This letter has already gone way long, so we can’t give this issue the space it deserves, but I wrote a piece this week in TheStreet about Crypto.com’s new “Crypto.com Sports” sports-based prediction market products. Suffice to say, I think these are really interesting, possibly revolutionary, and have some very idiosyncratic legal consequences.6 Check it out here, and as updates come in we’ll talk about it more at length.
Until next week.
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Certificate here means interchangeably a contract, a slip of paper delineating share ownership in an enterprise, or a cryptocurrency token.
They are only precedential within the circuit, but they are still influential elsewhere. If other circuits do not have their own opinion on an issue it is probably the district courts there will follow the ruling of circuits that do, and other circuits will give some credence to what they say. Of course, sometimes circuits disagree, and that, friends, is when you go to the big panel upstairs and ask them pretty please to write some esoteric gibberish in your favor.
Though I am not actually sure about this, and it could depend on the character of the ruling.
There were several matters pending but Crypto.com dropped the case that I wrote about a few months ago. It is unclear why they dropped the case, though the timing was quite close to a meeting between CEO [KRIS] and Donald Trump. It is also possible that they knew that other litigation would get at the same points, and they would have a long uphill fight on standing, so they could safely dismiss and free-ride with the rest of us. Hard to say for sure.
Fed-soc[k] puppet is too strong, but they’re predictable.
Interestingly, while judges love to dump on the Major Questions Doctrine, the potential field preemption arguments about CFTC regulated prediction markets crowding out state licensed sports books could actually be a good place to apply it.
Good analysis and great job keeping your piece neutral. It'll be interesting to see what happens, but I do believe given the politics of today, eventually the courts will determine that they are not securities. Then there will be kind of a lawless era, until too many people lose their life savings speculating on these currencies, and eventually Congress will pass a new statute specifically over-regulating crypto-currencies and the cycle will continue.