The collapse of FTX underscored a critical need: comprehensive, clear, and legally sound regulation of the U.S. crypto market. At the heart of this regulatory challenge lies a foundational question—are cryptoassets securities under U.S. federal law? The answer determines not only how these digital assets can be sold but also how they must be held, traded, and regulated within a system built for traditional financial instruments.
Despite years of debate, regulatory ambiguity persists. The Securities and Exchange Commission (SEC) has long relied on a controversial theory—whether a blockchain project is “sufficiently decentralized”—to determine if a cryptoasset qualifies as a security. However, this approach has proven impractical, legally ungrounded, and economically distorting.
A groundbreaking legal analysis, The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities, offers a clearer, more legally coherent framework. It argues that fungible cryptoassets themselves are not securities, even if the initial sale of those tokens may constitute a securities offering. This distinction is crucial—and transformative.
The Flaws in the SEC’s “Decentralize-and-Morph” Theory
In 2018, then-SEC official William Hinman introduced the idea that a cryptoasset could “morph” from a security into a non-security as its underlying blockchain network becomes sufficiently decentralized. This theory was expanded in 2019 through staff guidance listing around 50 factors—ranging from developer influence to token liquidity—to assess decentralization.
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Under this model:
- A token sold during an Initial Coin Offering (ICO) might start as a security.
- Over time, if the network becomes decentralized, the same token could cease to be one.
While this framework offered temporary reassurance—suggesting that Bitcoin and Ethereum were no longer securities—it has failed in practice.
Why the Decentralization Standard Doesn’t Work
- Subjectivity and Lack of Clarity: The 50+ factors are vague and often depend on non-public information. There’s no weighting system or clear threshold for what “sufficient decentralization” means.
- Dynamic Status Creates Legal Uncertainty: If a token can switch between being a security and not, every market participant—exchanges, traders, developers—must constantly monitor regulatory status.
- Inconsistent Enforcement: The SEC has applied the theory unevenly. In the Ripple case, XRP was labeled a “digital asset security,” while in other filings, the SEC described tokens as “embodying” or “representing” investment contracts—without clarifying whether the asset itself is a security.
- Market Distortion: Projects now rush to “decentralize” not for technological or economic reasons, but to avoid securities regulation—a phenomenon known as “decentralization theater.”
This regulatory whiplash harms innovation and investor confidence alike.
A Better Framework: Separating the Transaction from the Asset
The Ineluctable Modality paper proposes a legally grounded alternative: distinguish between the capital-raising transaction and the cryptoasset itself.
This approach relies on the Howey test—the Supreme Court’s 1946 standard for identifying investment contracts. Under Howey, an investment contract exists when:
- There is an investment of money
- In a common enterprise
- With an expectation of profit derived from the efforts of others
Applying Howey to Crypto: Two Key Insights
- ICO Sales Are Likely Securities Offerings
When a blockchain team sells tokens to fund development, buyers expect profits based on the team’s future work. That fits Howey perfectly. The transaction is a security—not because of the token, but because of the promises made by the issuer. - The Token Itself Is Not a Security
Once sold, the fungible token—like ether or bitcoin—functions as a digital commodity. It does not carry contractual rights or profit guarantees. Just as citrus groves in Howey weren’t securities, neither are tokens after the initial sale.
“The cryptoasset sold under the investment contract is never a security—no more than were the citrus groves in Howey.”
This separation resolves key contradictions:
- No need for tokens to “morph” over time.
- No requirement to assess decentralization constantly.
- Regulatory focus shifts to who is selling and under what promises, not what is being traded on exchanges.
Practical Implications for Crypto Markets
Adopting this framework would bring immediate benefits:
- Exchanges and traders could operate without fear that every secondary-market trade violates securities law.
- Developers could innovate without being forced into artificial decentralization.
- Investors would still be protected during fundraising phases, where disclosure and registration matter most.
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Yet this doesn’t mean crypto markets should be unregulated. FTX’s failure proves otherwise. But regulation should come through new, tailored laws, not by stretching 80-year-old securities rules beyond their intent.
The paper recommends Congress empower the Commodity Futures Trading Commission (CFTC) to oversee cryptoasset markets and intermediaries—similar to how it regulates commodities and derivatives.
Frequently Asked Questions (FAQ)
Q: If cryptoassets aren’t securities, why regulate them at all?
A: Just because an asset isn’t a security doesn’t mean it lacks risk. Crypto markets need rules around custody, market manipulation, transparency, and consumer protection—best addressed by specialized regulators like the CFTC, not securities law.
Q: Doesn’t this approach let bad actors off the hook?
A: No. The framework still treats initial token sales by insiders as securities offerings when they meet the Howey criteria. Fraudulent or unregistered fundraising remains illegal.
Q: What about Ethereum? Is ETH a security?
A: Under this framework, the 2014 ether sale likely was a securities transaction. But ether itself, as a fungible utility token traded today, is not a security—just like shares of stock aren’t commodities after an IPO.
Q: How does this affect ongoing SEC lawsuits?
A: Courts are increasingly scrutinizing the SEC’s broad claims. This framework provides a legally sound alternative that respects precedent while adapting to modern technology.
Q: Can a token ever be a security?
A: Yes—if it’s designed as one. Tokenized stocks or bonds, or tokens with explicit profit-sharing rights, can qualify as securities. But fungible cryptoassets used for network access or payments generally do not.
The Path Forward: Clarity Through Law
The current regulatory uncertainty stifles innovation and pushes activity offshore. The Ineluctable Modality framework offers a principled solution grounded in existing law—not bureaucratic improvisation.
Congress should act to:
- Codify that fungible cryptoassets are not securities.
- Empower the CFTC to regulate crypto markets.
- Require disclosure and registration for initial token offerings that qualify as investment contracts.
Courts, too, should embrace this clearer legal standard in pending cases.
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Only with clear rules can the U.S. foster responsible innovation, protect investors, and maintain leadership in the global digital economy.
Core Keywords:
cryptoassets, securities law, Howey test, decentralized blockchain, ICO regulation, SEC enforcement, CFTC jurisdiction, fungible tokens