Considering the Republican control over executive and judicial powers, as well as industry protests against strong regulatory models, there is a certain possibility of victory for the eighteen states in the lawsuit.
Written by: TaxDAO
For more details, see: "Eighteen States Join Forces to Sue the SEC: What Are the Chances for Both Sides? (Part 1)"
3. Two Landmark U.S. Cryptocurrency Lawsuits
The Ripple case and the Terraform case are two landmark cases that the U.S. cryptocurrency industry cannot avoid. In the judgments of both cases, the courts defined the legal attributes of cryptocurrency from different perspectives, triggering a strong reaction from the cryptocurrency industry. The focal points of the disputes in both cases are highly similar to those in the current case, discussing the classification and regulatory issues of cryptocurrency, which have important reference implications for the future judgment of the current case.
3.1 Ripple Case
3.1.1 Basic Case Facts
Ripple Labs is the holder of Ripple and its native cryptocurrency token XRP, established in 2012, and is one of the earliest pioneers in the blockchain field. XRP aims to serve as a bridge tool to facilitate financial transactions, with its customer base primarily consisting of financial institutions.
In December 2020, the SEC filed a lawsuit against Ripple Labs and its CEO Brad Garlinghouse and co-founder Chris Larsen, accusing them of illegally issuing securities by selling the cryptocurrency XRP, raising over $1.3 billion. The SEC believes that XRP is essentially an investment contract, similar in nature to stocks or bonds, and therefore must strictly comply with relevant securities laws, including registering with the SEC and providing adequate information disclosure to investors. However, Ripple did not fulfill these obligations, violating securities laws. Ripple defended itself, arguing that XRP is a digital currency, functioning more like Bitcoin or Ethereum. At the same time, XRP does not meet the standards set by the Howey test and cannot be classified as a security.
The SEC's lawsuit caused a huge stir in the cryptocurrency industry, marking the first time the SEC has sued a mainstream cryptocurrency that is already in circulation, symbolizing a broader conflict between digital asset innovation and regulation.
3.1.2 Judgment Outcome
In July 2023, the court ruled that XRP (and all cryptocurrencies) is not a security when sold to the public on exchanges, but is a security when sold to institutional investors. This ruling triggered a strong market reaction, directly leading to a 70% increase in XRP's price.
In August 2024, the final ruling was made in the case. Regarding whether XRP should be classified as a "security," the court distinguished based on the sales scenario. On one hand, there are direct sales to institutions. The judge found that such sales meet the Howey test, as institutions purchasing XRP directly from Ripple expect to profit from the appreciation of XRP's value, which is typical investment contract behavior and constitutes a securities issuance. On the other hand, XRP sold in a programmatic manner on the open market does not constitute a security. The judge pointed out that buyers in the open market do not know who the sellers are and have not established profit expectations with Ripple. This programmatic sale does not meet the criteria for determining an investment contract and therefore does not constitute a securities issuance. Ultimately, the court ordered Ripple to pay approximately $125 million in civil fines, far less than the nearly $2 billion initially requested by the SEC, but higher than Ripple's intention to limit the fine to $10 million.
From the outcome, both Ripple and the SEC achieved certain victories in this case. For Ripple, it does not have to pay the massive fines demanded by the SEC, while the SEC also did not walk away empty-handed. However, it is evident that the SEC's expectations fell significantly short, leading to the SEC filing a Notice of Appeal in October 2024, appealing to the Second Circuit Court of Appeals in an attempt to overturn parts of the district court's ruling. According to the response from the Second Circuit Court, the SEC must submit its opening statement for the appeal by January 15, 2025, thus there is a possibility that the ruling in this case could be overturned.
3.1.3 Subsequent Impact
In terms of the subsequent impact of the case, on one hand, the Ripple case clarified the important role of the method of transaction in the classification of cryptocurrency. In the Ripple case, the court found that selling XRP to the public through the secondary market does not constitute a securities transaction, indicating that the method of sale or transaction of cryptocurrency will affect its classification. On the other hand, this case will to some extent limit the SEC's expansion of regulatory scope over cryptocurrency. Unless the SEC succeeds in the appellate court, the ruling in this case will be binding under U.S. case law, preventing the SEC from classifying a large number of cryptocurrencies as securities and bringing them under regulatory oversight.
Overall, the Ripple case marks an important victory for the cryptocurrency industry in its struggle against strong regulatory models. This ruling not only boosted the confidence of cryptocurrency practitioners and revived market sentiment but may also become a significant turning point in the future regulatory landscape.
3.2 Terraform Case
3.2.1 Case Overview
Terraform Labs is a platform that provides blockchain technology and cryptocurrency, founded by Do Kwon, who attracted investors in the secondary market by designing and selling various cryptocurrencies, including its native stablecoin UST and token LUNA. The UST coin is pegged to the U.S. dollar, and its stability algorithmically relies on the support of its sister token LUNA. However, Terraform's stability mechanism encountered serious issues in practice. In May 2021, the UST price depegged, but Terraform managed to temporarily restore the UST peg through secret arrangements with third-party companies. In 2022, UST again fell below $1, and without external support, its value plummeted rapidly, causing LUNA to also lose value. This collapse triggered a loss of over $40 billion in market capitalization and dragged down other cryptocurrencies, including Bitcoin, further impacting the entire cryptocurrency market and leading multiple companies to file for bankruptcy in 2022.
In February 2023, the SEC charged Terraform Labs and its founder Do Kwon with unregistered securities fraud involving billions of dollars. The SEC alleged that Terraform misled investors through multiple deceptive statements and fraudulent actions, violating the registration and anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.
In June 2024, a U.S. district court approved a $4.5 billion settlement agreement reached between Terraform Labs and the SEC. Under the agreement, Terraform must pay nearly $3.6 billion in illegal gains, $420 million in civil fines, and about $467 million in pre-judgment interest. Do Kwon must jointly pay $110 million in illegal gains and $14.3 million in pre-judgment interest with Terraform, and independently pay $80 million in civil fines. However, since Terraform filed for bankruptcy in January 2024, these fines may be difficult to pay in full and can only be treated as unsecured claims in the bankruptcy liquidation process.
3.2.2 Judgment Outcome
The core of the Terraform case's ruling lies in the determination of the legal attributes of UST and LUNA. The court found that purchasers of these cryptocurrencies reasonably expected their tokens to generate profits and viewed these tokens as a profitable investment, thus meeting the definition of an investment contract under the Howey test. The court further ruled that all relevant cryptocurrencies created by Terraform, including UST and LUNA, meet the definition of investment contracts under the Securities Act of 1933 and should be classified as securities.
Notably, in relation to the eighteen states suing the SEC, the court responded to Terraform's defense regarding the Major Questions Doctrine. The Major Questions Doctrine requires that "in special circumstances, an agency claiming the authority to regulate a significant portion of the U.S. economy with substantial economic and political significance must point to a clear congressional authorization of that power." The court found that (1) there is almost no comparability between Terra Labs and cases applicable to the Major Questions Doctrine (such as those involving the U.S. tobacco and energy industries). (2) The SEC's implementation of regulation in determining that certain cryptocurrencies are securities does not constitute a transformative expansion of its regulatory power.
At the same time, similar to the reasons for the eighteen states' lawsuit, Terraform argued that the SEC violated the Administrative Procedure Act. The court dismissed this, stating that the SEC's classification of Terraform's digital assets as investment contracts cannot be denied solely based on the Administrative Procedure Act. The SEC did not issue a new policy in this case but merely enforced its previously established policies. The court also confirmed that the SEC's complaint adequately charged Terraform with providing and selling tokens like LUNA as equivalent to the illegal public offering of unregistered securities, making false or misleading statements during the issuance process and profiting from it.
3.2.3 Subsequent Impact
The ruling in the Terraform case supports the SEC's regulatory stance and has drawn widespread attention in the cryptocurrency industry. Specifically: First, it raises the classification methods for cryptocurrencies again. The Terraform case indicates that cryptocurrencies traded in the secondary market can be classified as securities as long as they pass the Howey test, particularly if there is a reasonable expectation of profit from the issuer's efforts. Second, it strengthens the SEC's regulatory power over the cryptocurrency market. In the enforcement process, the ruling in the Terraform case has been cited by the SEC in lawsuits against other cryptocurrency exchanges, such as Binance and Coinbase, which may further promote the SEC's comprehensive regulation of the digital asset market. Third, it sends a warning to the cryptocurrency industry, urging practitioners to pay attention to the legal risks in the design and marketing processes of cryptocurrencies.
3.3 Summary
Although both the Terraform case and the Ripple case revolve around the classification of cryptocurrencies, the outcomes of the two cases show significant differences. In the Ripple case, the court found that the secondary market sale of XRP does not constitute a securities transaction, while in the Terraform case, it ruled that UST and LUNA meet the definition of investment contracts.
This difference first exacerbates the legal uncertainty in the field of digital assets. The ruling in the Ripple case emphasizes the importance of the method of transaction, indicating that anonymous transactions in the secondary market may not meet the requirements of "common enterprise" or "relying on the efforts of others to profit" in the Howey test. In contrast, the Terraform case focuses more on the profit expectations of investors and the actions of the issuer, suggesting that even in secondary market transactions, as long as the issuer's efforts play a key role in the investors' returns, it can still be classified as a securities transaction. This difference in legal application adds uncertainty to the digital asset industry.
Secondly, it affects the SEC's regulatory strategy, which may lead to fluctuations in the SEC's regulatory stance. In the Terraform case, the SEC's claims were supported by the court, reinforcing its regulatory power over secondary market cryptocurrency transactions. However, in the Ripple case, the court's ruling limited the SEC's regulatory expansion over secondary market transactions. This contradiction reflects that the SEC's regulatory strategy in the digital asset field needs to be adjusted on a case-by-case basis, and in the future, it may compensate for these limitations through more segmented regulation targeting the actions of issuers.
At the same time, it triggers market volatility and influences the direction of industry development. The signals sent to the market by the Terraform case and the Ripple case are starkly different. The Terraform case is seen as support for the SEC's regulatory power, increasing market expectations for strict regulation, which may suppress innovation in cryptocurrency assets. Conversely, the Ripple case is viewed as a victory for the cryptocurrency industry, boosting market sentiment and temporarily raising the prices of digital assets. This dual impact may lead to more pronounced volatility in the market in the near future.
Moreover, such repeated judicial rulings may provide momentum for legislative clarification. The differences in the rulings of the two cases indicate that existing securities laws are inadequate in addressing the complexities of digital assets. The outcomes of the Ripple and Terraform cases may prompt the U.S. Congress to further push for specialized legislation on digital assets to clarify their legal attributes and regulatory scope. Only through systematic legislation can the current regulatory ambiguities caused by judicial interpretation discrepancies be resolved. In this regard, the FIT21 bill, which is still awaiting a Senate vote, may improve this situation.
4. Motivations and Chances of Success for the Eighteen States' Lawsuit
4.1 Analysis of Litigation Motivations
The eighteen states' joint lawsuit against the SEC for unconstitutional regulation of the cryptocurrency industry essentially aims to use judicial means to limit the SEC's regulatory expansion over the cryptocurrency industry while seeking more autonomy for state rights within the constitutional framework. The possible motivations for the eighteen states to file the lawsuit are: First, to establish universally applicable legal rules through constitutional rulings. In recent years, the SEC has expanded the application of the Howey test, imposing securities regulatory requirements on a large number of digital assets, which has sparked widespread controversy both within and outside the industry. The eighteen states chose to invoke the First Amendment and the Tenth Amendment of the U.S. Constitution to raise constitutional claims, intending to negate the SEC's enforcement actions from a constitutional perspective through federal court rulings. If the U.S. Supreme Court ultimately supports the claims of the eighteen states, this ruling will have nationwide binding force, providing legal precedents for future similar disputes and forcing the SEC to adjust its regulatory strategy.
Second, to restrain executive power and prevent policy continuity. Currently, the SEC, under the leadership of Gary Gensler, has adopted a stringent cryptocurrency policy, including intensive enforcement actions against cryptocurrency companies such as Ripple and Terraform, along with hefty fines. This regulatory model has severely suppressed industry development while infringing on the autonomy of state governments. Through this lawsuit, the eighteen states not only seek to curb the strong regulatory actions of the current SEC chair but also aim to establish legal boundaries for future governments to prevent the continuation of similar policies.
Third, to fill legislative gaps and promote industry development. Federal legislation in the U.S. regarding digital assets is still incomplete, and disputes over the attributes and regulation of digital assets have long existed. By promoting judicial rulings, the cryptocurrency industry can establish rules with precedential effect within the existing legal framework, providing clearer compliance pathways for the digital asset industry while creating a more favorable environment for innovation and development.
4.2 Favorable Conditions and Adverse Factors
Overall, the eighteen states chose to file the lawsuit after the Republican Party, represented by Trump, won the election, creating several favorable conditions for success while also facing many uncertainties.
From the favorable conditions: First, the policy stance of the Trump administration. President-elect Trump has clearly expressed support for the cryptocurrency industry and has announced plans to replace the SEC chair. The new chair nominated by Trump may adopt a more lenient regulatory policy, potentially reducing the SEC's future antagonism in this case, making the court's ruling more inclined to protect the cryptocurrency industry. Second, the conservative leanings of the Supreme Court. This case involves constitutional issues, and the U.S. Supreme Court has final authority over constitutional-related cases. Currently, the conservative majority in the Supreme Court, with justices like Thomas and Alito, tends to support state rights in matters concerning the relationship between federal and state powers. This political inclination may provide the eighteen states with more support in their claims of SEC unconstitutionality. Additionally, conservative judges are generally more receptive to claims that limit the powers of federal administrative agencies, providing favorable conditions for the case's success. Finally, widespread support from the industry. There is widespread criticism of the SEC's current regulatory policies both within and outside the cryptocurrency industry, with many companies believing that strict regulatory requirements stifle technological innovation and increase compliance costs, creating a strong demand to break the strict regulatory model.
However, adverse factors also exist: First, judicial uncertainty. The U.S. judicial system lacks a unified standard for the classification of digital assets. In the Terraform case, the court rejected similar defenses based on the "Major Questions Doctrine" and the "Administrative Procedure Act," which may serve as unfavorable references for this case. Additionally, the discrepancies between state courts regarding the classification of digital assets increase the difficulty for the eighteen states to win the case. Second, high costs in terms of time and resources. This case is initiated in a local district court and may go through multiple appellate stages, potentially reaching the U.S. Supreme Court. The lengthy judicial process requires substantial time and resources, and the regulatory uncertainties during the case's progression may have short-term negative impacts on industry development. Furthermore, the eighteen states will need to continuously respond to the SEC's defenses during the judicial process, which may put significant pressure on their policies and litigation resources. Third, slow legislative progress. As mentioned earlier, although the House of Representatives has passed the FIT21 bill in an attempt to clarify the regulatory framework for digital assets, there has been no substantial progress in the Senate. Therefore, the passage of future bills may still face obstacles. This legislative gap may lead the courts to be more inclined to maintain the status quo rather than impose substantial limitations on executive power through rulings.
Overall, considering the Republican Party's current control over executive and judicial powers, represented by Trump, as well as the industry's protests against strong regulatory models, the eighteen states have a certain possibility of success in this lawsuit. A friendly government policy towards the cryptocurrency industry will provide potential positive momentum for the case's success, and the conservative leanings of the Supreme Court may support the claims of unconstitutionality. However, the case also faces issues of slow legislative progress and judicial discretion uncertainty, especially in light of ongoing disputes over the classification of digital assets. How to persuade the court to impose substantial limitations on SEC policies will be key to determining the outcome of the case.
5. Summary and Outlook
The case of the eighteen states suing the SEC is a significant game involving constitutional principles and the future of digital asset regulation. Although there is a certain chance of success, the case still faces multiple challenges at the judicial and policy levels. Regardless of the final outcome, this case will have a profound impact on the legal and policy landscape of the U.S. cryptocurrency industry.
If the court ultimately rules that the SEC's regulatory policies are unconstitutional, it will directly limit its regulatory scope over digital assets, potentially leading to a greater delegation of regulatory authority to the CFTC or state governments, thereby forming a more decentralized and diverse regulatory system. Such a change would help alleviate the current overly strict regulatory style of the SEC, creating a more favorable development environment for the cryptocurrency industry and potentially clarifying the classification of digital assets, reducing disputes over the application of the Howey test, and enhancing compliance certainty. This case will also play an important role in the rebalancing of state and federal relations. State governments may design regulatory policies that better meet local needs, creating a competitive regulatory landscape and promoting the U.S.'s leading position in the field of digital assets. Furthermore, a reduction in regulatory pressure may greatly incentivize industry innovation. Companies will be able to experiment with new technologies and business models in a more lenient environment, promoting the widespread application of digital assets, particularly benefiting decentralized finance (DeFi) and cross-border payment sectors.
However, the ruling of the case may also bring new risks and challenges. Policy changes may trigger market volatility, especially during the case's proceedings, as investors are particularly sensitive to regulatory uncertainties. Additionally, if regulatory authority is delegated to state governments, policy differences between states may increase the compliance complexity for businesses operating across state lines. Moreover, international competitive pressure may also intensify. Countries and regions such as the European Union and Singapore have made certain progress in digital asset regulation, and if the U.S. regulatory framework becomes too decentralized, it may weaken its competitiveness in the global market.
Overall, the case of the eighteen states suing the SEC is an important milestone in the development of the U.S. cryptocurrency industry, providing an opportunity to advocate for more favorable regulatory policies. In the future, the healthy development of the U.S. cryptocurrency industry will require a balance between regulation and innovation, and with reasonable judicial rulings, the U.S. has the opportunity to continue leading global innovation and growth in the digital asset field.
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