The Howey Test, Crypto, and Community Banks: How the Debate between the SEC and CFTC Impacts Community Banks

What is the true nature of cryptoassets? Are they securities or commodities? This question, perhaps more than any other, has propelled policy debates over the past few years. At the center of this dispute are two federal agencies: the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC).

The CFTC has been involved in crypto since 2015, when it initiated a case against a Bitcoin options trading platform and asserted, for the first time, that virtual currencies are defined as “commodities.” Since then, it has continued to pursue other crypto-related cases, including a 2021 settlement with the stablecoin Tether that resulted in a $41 million fine.

However, the CFTC does not have control over all aspects of the crypto markets. The Financial Stability Oversight Council highlighted this concern in its 2022 report by calling on Congress to create “explicit rulemaking authority for federal financial regulators over the spot market for crypto-assets that are not securities.” Under the leadership of CFTC Chair Rostin Behnam, the agency is now seeking to expand its statutory authority to include authority over the cryptocurrency spot markets.

In contrast, the SEC under Chairman Gary Gensler has argued that many cryptoassets are likely unregistered securities because people acquire them with the expectation of profits stemming from the issuer’s efforts to boost the value of the asset by managing, promoting, or improving the protocol. In fact, Gensler has asserted that the “vast majority” of crypto tokens are securities. However, he has also acknowledged that a “small number” of tokens may not meet all of the prongs of the Howey Test, or the standard for determining what may qualify as a security.

The Howey Test, which was developed by the Supreme Court in a landmark 1946 case, defines an “investment contract” as possessing the following attributes:

1) An investment of money.

2) In a common enterprise.

3) With the reasonable expectation of profits.

4) Due to the managerial efforts of others.

Many crypto advocates believe that the Howey Test is outdated and should not continue to serve as the standard. They argue that cryptoassets do not possess these key characteristics, and some have even likened cryptoassets to collectibles like Beanie Babies or baseball cards.

Earlier this summer, in response to a request for comment from the SEC, ICBA asserted for the first time that the Howey Test remains relevant in the modern debate over cryptocurrencies. In fact, ICBA argued that most cryptoassets likely qualify as securities, so crypto entities should therefore be subject to any relevant securities laws and regulations. Bankers have repeatedly said they view most cryptoassets as highly volatile and speculative investments, and they believe the SEC is best positioned to protect investors and ensure that bad actors are held accountable.

Community Banks and the Securities vs. Commodities Debate

The debate over how to regulate cryptoassets may seem separated from the day-to-day operations of a community bank, but it is one of the most pressing concerns facing the banking industry as crypto entities seek to disrupt the traditional financial system.

Some crypto entities continue their push for access to the Federal Reserve and U.S. payments systems, whereas others want to develop decentralized systems that aim to eliminate traditional financial intermediaries, such as community banks.

There are also ongoing debates in Congress over which agency—the SEC or the CFTC—should be the lead crypto regulator. Therefore, the push to bring order to the crypto “Wild West” is much more than addressing the risks that crypto poses to investors—it is also a way to help ensure that crypto does not harm community banks and the communities they serve.

To that end, ICBA is continually part of these discussions and has urged policymakers to harmonize regulations to ensure strong, clear, and consistent oversight of cryptocurrency service providers. We have also encouraged regulators to collaborate on a comprehensive approach to prevent the rise of decentralized finance (DeFi), a shadow banking system filled with unregulated, decentralized platforms that pose risks to consumers, the financial system, and U.S. national security.

ICBA recognizes that the markets regulators—the SEC and CFTC—have important roles in realizing these objectives. ICBA continues to voice community banker concerns with these key agencies and stands firm in ensuring that any proposed changes to the crypto regulatory framework do not create opportunities for crypto entities to amplify risks to community banks or the stability of the U.S. financial system.