SEC vs. Coinbase Hearing: Are Tokens Securities?

• A judge at the U.S. District Court for the Southern District of New York is deciding whether to dismiss the Securities and Exchange Commission’s lawsuit against Coinbase.

• The ruling will hinge on whether trading in any of a dozen crypto tokens should be classified as unregistered securities.

The Securities and Exchange Commission’s (SEC) lawsuit against Coinbase involves a raft of complex issues, but before it can proceed, a judge must decide whether more than a dozen tokens traded on U.S. exchanges are securities.

The SEC and Coinbase both agreed at a court hearing on Wednesday that the tokens themselves are not securities. SEC lawyers argued that each transaction was equivalent to an investor buying into a token ecosystem in which the purchaser expected to share in the profits, and as long as one of the transactions could be considered an investment contract, Coinbase would have violated securities laws. But the company said these were secondary market transactions, there were no contracts, and therefore could not be securities.

Coinbase is seeking to speak with U.S. Judge Katherine Polk Failla. The District Court for the Southern District of New York dismissed the SEC's allegations that it violated the law. Failla decided not to make a decision on the bench and did not clearly reveal which way she would rule as she answered 14 pages of questions in more than four hours that challenged the regulator's and the company's positions.

Her final decision — expected in the coming weeks, though she did not hint at a timeline — will be made alongside other recent rulings by other judges on the same court. It will either strengthen the SEC’s pursuit of crypto platforms as unregistered exchanges trading unregistered securities, or add to the agency’s legal losses in that regard and further reinforce the industry’s perception of regulator overreach. Either way, similar cases brought by the SEC against exchanges like Binance and Kraken are also likely to influence Judge Failla’s opinion.

“It’s the same computer code no matter who owns it,” said Patrick Costello, an attorney at the U.S. Securities and Exchange Commission. He argued that no matter how buyers acquire digital assets, they acquire a contract. “The token is the key to entry into the ecosystem. Without the ecosystem, the token is worthless.”

William Savitt, an attorney at Wachtell, Lipton, Rosen & Katz who is representing Coinbase, argued that an “investment contract” — a type of security as defined by the so-called Howey test — actually requires the existence of a contractual obligation between the token issuer and the buyer.

“There has to be a statement that communicates enforceable promises,” Savitt said. “If you don’t have that, then you don’t have a contract.”

He called it "a purely legal question."

The judge was careful not to express his own opinion, only acknowledging at one point, "That's a difficult question to answer."

Costello also sought to counter warnings that the SEC’s stance could expand the definition of a security to collectibles such as art or trading cards, saying those assets lack a centralized ecosystem.

“Collectibles have value,” he said. “There’s no way to make baseball cards more valuable.”

Judge Failla touched on several key decisions in the SEC’s crypto cases, including the agency’s loss against Ripple and win in the Terraform Labs lawsuit.

She said “I was not shocked” that Judge Jed Rakoff found in Terraform that crypto asset transactions were securities. But that did not involve the listing of tokens on secondary exchanges. “Terraform departed significantly from the facts of this case.”

Failla also acknowledged that there are “core issues” with invoking the so-called “significant issues doctrine,” which Coinbase believes should block the SEC’s actions before Congress has a chance to enact cryptocurrency laws.

The judge appeared skeptical of some of the agency’s arguments during the hearing, a move that was welcomed by cryptocurrency insiders.

“The entire hearing was filled with deep skepticism about the SEC’s claims,” Justin Slaughter, policy director at Paradigm, wrote in a post on X.

“This is a pretty extreme case of regulators wanting to have their cake and eat it too,” said Dave Rodman, founder and managing partner of Rodman Law Group. “After all, the SEC deemed Coinbase sound enough to list on a U.S. stock exchange, but now it appears to be backpedaling.”