Cryptocurrency at a Crossroads: Navigating Securities Law, Anti-Money Laundering, and Federal Oversight in a Decentralized Economy

In 2008, amidst a global financial meltdown, someone calling himself Satoshi Nakamoto—who has kept his identity a secret to this day—published a paper introducing the idea of Bitcoin. [1] Before Nakamoto’s foundational document of cryptocurrency, there was no functioning blockchain. Bitcoin, like other cryptocurrencies, is an “electronic coin.” It exists on a public ledger called a “proof-of-work chain” (PoW) blockchain, where transactions are verified by “miners,” or programmers who solve complex computational puzzles to add new transactions to the existing chain. [2] Each successful verification adds a block to the blockchain, which is publicly accessible and ensures that the transfer of funds is tamper-proof. This process is decentralized, meaning it can happen anywhere worldwide.

This article explores the limitations of current U.S. regulatory frameworks—securities laws, anti-money laundering (AML) rules, and tax enforcement—in addressing the unique challenges posed by decentralized cryptocurrencies. Examining cases such as SEC v. LBRY, United States v. Harmon, and IRS v. Coinbase reveals the urgent need to develop a nuanced “Digital Asset Framework” (The Organization for Economic Co-operation and Development (OECD) has developed the “Crypto-Asset Reporting Framework” (CARF), which is a global initiative aimed at promoting the automatic exchange of information between countries to tackle emerging tax evasion risks related to cryptocurrency and digital assets. While CARF is an acronym related to digital assets, it pertains explicitly to reporting standards rather than a general evaluation framework. Therefore, no formal acronym is currently used for “Digital Asset Framework” in cryptocurrency.) to balance innovation, privacy, and accountability in this transformative sector, which drives innovation through decentralized technologies, emphasizes privacy in peer-to-peer transactions, and challenges traditional notions of accountability. These cases underscore this struggle as regulatory agencies seek to balance privacy, tax compliance, and innovation with the need for oversight in a rapidly evolving digital economy.

Digital assets, like cryptocurrencies, have changed how we think about securities. To understand how digital assets fit into existing legal frameworks, it is important to first examine how the Securities Act of 1933 defines a ‘security,’ which includes a range of financial instruments. The Securities Act of 1933 provides a detailed definition of what constitutes a “security,” which includes a range of financial instruments. This definition covers notes, which are commitments to repay borrowed amounts along with interest, and stocks, which indicate ownership in a corporation. Furthermore, it also defines evidence of indebtedness, which serves as a record of debt, as well as investment contracts, in which individuals invest money with the anticipation of earning profits primarily based on the efforts of others. [3] These categories are significant because they help establish whether digital assets, like cryptocurrencies, share characteristics with traditional securities, making them subject to securities laws. In the evolving financial environment, applying this definition presents new opportunities and challenges, particularly with the emergence of digital assets such as cryptocurrency.

A notable case in regards to tension about the existing definition of securities is SEC v. LBRY, Inc. The U.S. Securities and Exchange Commission (SEC), the government agency that enforces securities laws to protect investors and promote fair markets, wanted to determine if a cryptocurrency was considered a security under the law. The defendant was LBRY, Inc.,  a software company based in New Hampshire that issued crypto-asset securities known as “LBRY Credits.” This asset was primarily intended to help users make transactions on its video-sharing platform, which is based on blockchain technology. The SEC claimed that LBRY Credits (LBC), the digital currency created by LBRY, Inc., was an unregistered security. They argued that LBRY’s sale of these credits to investors broke federal securities laws because LBRY did not register them with the SEC. This registration is required under the Securities Act of 1933 for securities offerings.

Judge Peter Barbadoro of the United States District Court for the District of New Hampshire ordered LBRY, Inc. to pay a civil penalty of $111,614. [4] The court further issued a permanent injunction against LBRY, barring it from further violations of federal securities laws’ registration provisions and participating in any future unregistered crypto asset securities offerings. [5]  The court justified this penalty on LBRY, Inc. for conducting an unregistered securities offering, violating the Securities Act of 1933. By issuing “LBRY Credits” without necessary disclosures, the company failed to protect investors. Judge Barbadoro highlighted the SEC’s role in ensuring market transparency. The ruling relied on the Howey Test, a standard established by the U.S. Supreme Court in the 1946 case SEC v. W.J. Howey Co. that defines securities as transactions involving investment, a joint enterprise, profit expectation, and reliance on others’ efforts. [6] In this landmark case, the Court determined that the sale of citrus grove plots and a service contract for harvesting and marketing the produce constituted an “investment contract” and, therefore, a security under the Securities Act. [7] 

Applying this precedent, the court found that LBRY Credits met the criteria of the Howey Test, as investors purchased LBC with the expectation that its value would grow based on LBRY’s efforts to expand its platform. However, the ruling revealed challenges in applying a test designed for traditional securities to a context where tokens may have utility and investment features. This case emphasized that the Howey Test needs more clarity for distinguishing between securities and utility tokens, which are used to pay for cloud storage on a decentralized platform, access premium content in an app, or vote on decisions in a blockchain-based project. [8] The court classified LBRY Credits as securities because investors reasonably expected profits based on the company’s efforts to grow its network. Yet this overlooks the tokens’ functional role in the LBRY platform, demonstrating the need for more precise guidelines and updated regulatory frameworks to distinguish between investment and utility tokens.

As cryptocurrencies and blockchain technology continue to drive new ways of doing business, such as creating decentralized financial systems, automating agreements with smart contracts, and turning real-world assets into digital tokens, the rigid application of outdated regulatory standards risks stifling progress and discouraging investment in this growing industry. Revisions to the Howey Test should include criteria tailored explicitly to digital assets, such as distinguishing between tokens meant for practical use and those meant as investments based on their purpose and how decentralized their networks are.

Updating the Howey Test could prove challenging because it is a well-established legal standard based on past cases, making changes difficult and slow. The Howey Test was created to deal with traditional investments, not the unique, mixed features of digital assets like cryptocurrencies, which often mix utility and investment roles. To modify it, lawmakers, regulators, and industry experts must work closely to ensure that it reflects the complexities of decentralized technologies. Furthermore, any significant changes would likely face legal challenges and resistance from different stakeholders, making the process even harder.

Still, the challenges in applying the Howey Test to assets like LBRY Credits show that we need a more prudent approach. A clear “Digital Asset Framework” could help clarify what regulators expect and provide developers with guidance. A detailed framework would recognize these differences, separating assets meant for actual use on a platform from those sold as speculative investments. This framework would clear up confusion, making sure that regulatory actions match the unique features of today’s digital assets while encouraging innovation and protecting investors.

Furthermore, Anti-money laundering (AML) regulations must balance enforcement and preserving privacy in decentralized networks. Cryptocurrencies, by design, prioritize privacy and operate without a central authority, which directly conflicts with the transparency and oversight required for effective AML enforcement. For example, while tools like Bitcoin mixers enhance user privacy by obscuring transaction trails, they are frequently exploited to facilitate money laundering and other illicit activities. This inherent tension arises because decentralization resists centralized control, making it challenging to impose regulations without undermining the very principles of anonymity and autonomy that define cryptocurrencies.

In United States v. Harmon Defendant Larry D. Harmon faced charges for his alleged operation of Helix, an underground Bitcoin tumbler. According to the indictment, Helix “enabled customers, for a fee, to send bitcoins to designated recipients in a manner designed to conceal and obfuscate the source or owner of the bitcoins.” [9] Helix facilitated anonymous Bitcoin transactions worth hundreds of millions of dollars. [10] 

On December 3, 2019, a federal grand jury in Washington, D.C., indicted the defendant for conspiracy to launder money, running an unlicensed money-transmitting business, and illegally providing money transmission services under D.C.’s Money Transmitters Act (MTA). [11] The defendant sought to dismiss the latter two counts, questioning whether Bitcoin is “money” under the MTA and whether Helix, a Bitcoin tumbler, is an unlicensed money business. ​​Moving Bitcoin anonymously becomes illegal when it enables money laundering or other illicit transactions. Governments require financial transactions to be traceable to ensure that money isn’t being used for crimes, such as drug trafficking, tax evasion, or funding terrorism. [12]

In United States v. Harmon, the prosecution of the Helix mixer highlights the difficulty of regulating pseudonymous cryptocurrency networks. Mixers protect user privacy by obscuring transaction details but can be misused for unlawful activities. United States v. Harmon may strengthen the argument that illegal activities could represent the primary use cases for cryptocurrencies in the long term. Lawful uses of digital assets do not require the ability to evade law enforcement. As a result, such uses can rely on more efficient, centralized systems with known and accountable participants. [13] These centralized systems are considered reliable for lawful transactions because they comply with regulations and cooperate with law enforcement. Traditional AML laws, designed for centralized systems like banks, need intermediaries to monitor or report suspicious transactions to address decentralized platforms.

The rationale behind these calls to action—urgent appeals for policy reform and enhanced regulation—is that the current usage of terms like “money” and “business transaction” in regulatory frameworks lacks clarity regarding the capabilities of the technology. Furthermore, how power—referring to authority and control within these decentralized systems—is distributed and exercised needs to be clarified, with the potential for error in how law or regulation treats these systems and those within them.

Effective regulation requires understanding validator distribution, code control, and reliance on central infrastructure. A cryptocurrency is only partially decentralized if it depends on specific servers or systems. It could fail if those central points are disrupted—whether by hackers, technical problems, or government intervention. By analyzing these factors—who verifies transactions and controls the code, and how decentralized the infrastructure is—regulators can create more transparent rules for cryptocurrencies.

Tailored regulations help ensure decentralized systems remain secure and fair while identifying those that require stricter oversight. Such transparency can build user trust and confidence in using cryptocurrencies. Furthermore, distinguishing between legitimate privacy tools and services designed to facilitate illegal activity highlights the need for nuanced AML regulations that address these distinctions.

The challenges exposed in Harmon highlight the importance of balancing privacy and accountability, ensuring that legal frameworks do not discourage innovation while addressing security concerns. The prosecution of Helix reveals how enforcement gaps can allow bad actors to exploit cryptocurrency’s anonymity while leaving legitimate privacy tools vulnerable to overregulation. This delicate balance between enforcement and user rights is further illustrated by the IRS’s actions in 2017 when it issued a narrowed summons to Coinbase for user records. [14] 

In IRS v. Coinbase, Inc., the IRS requested access to user data, which could set a precedent for compromising privacy in the pursuit of tax enforcement. While tax compliance is essential, the broad data requests in this instance could undermine user anonymity and discourage the legitimate use of cryptocurrencies. The United States District Court for the Northern District of California—a federal trial-level court—partially granted and partially denied the enforcement of the petition. [16] It limited the summons to accounts with transactions exceeding $20,000 between 2013 and 2015, striking a balance between enabling the IRS to investigate potential tax evasion and protecting users’ privacy with lower activity levels. By narrowing its focus, the court determined that the summons serves a legitimate purpose for the IRS in investigating Coinbase account holders who may not have reported federal taxes on their profits from virtual currency. This case underscores the need for more transparent tax regulations tailored to digital assets, ensuring compliance without discouraging legitimate users or innovation. A “Digital Asset Framework” could provide clear guidelines for tax enforcement in the crypto space, ensuring compliance without compromising user privacy or innovation.

Building on these efforts, the IRS has determined that bitcoins are not “currency” for tax purposes. [16] Various regulatory bodies have affirmed the classification of Bitcoin and other cryptocurrencies as commodities, notably the Commodity Futures Trading Commission (CFTC), which regards them as commodities under the Commodity Exchange Act. Together, these developments underscore the importance of a “Digital Asset Framework” to provide clear guidelines for tax enforcement in the crypto space, ensuring compliance without compromising user privacy or innovation.

Regions must establish a framework that encourages innovation while also ensuring compliance. This can be achieved by revising securities laws, implementing more balanced anti-money laundering (AML) regulations, updating tax enforcement practices, and adapting central banking systems. For example, updating securities laws is important because cases like SEC v. LBRY show how current rules don’t easily apply to digital tokens, which can serve as investments and tools for accessing services.

Outdated regulations risk stifling innovation and increasing financial instability, as seen in cases like FTX’s collapse. [17] If cryptocurrencies remain unregulated or improperly governed, illicit activities such as money laundering and tax evasion may grow unchecked, undermining trust in the system and inviting stricter, reactionary measures that stifle legitimate uses.

The consequences of inadequate reform are already apparent. For instance, the SEC’s enforcement actions, such as SEC v. LBRY, highlight the confusion between investment and utility tokens, leaving both regulators and innovators uncertain about applicable rules. Additionally, the rise of international cryptocurrency “sanctuaries” indicates that U.S. regulatory gaps drive innovation and investment abroad. Reform must promote innovation while guaranteeing consumer protection and financial transparency. Without this balance, the cryptocurrency landscape could become chaotic, putting consumers at risk.

The legal definition of money should encompass both physical currency and the value of money itself. The Federal Reserve must adapt by exploring central bank digital currencies (CBDCs) or using decentralized finance (DeFi) systems. These adjustments would allow the Federal Reserve to remain relevant in a shifting financial landscape while supporting innovation.

These cases underscore the urgent need for a comprehensive legal and regulatory approach that reflects digital assets’ evolving nature. A forward-looking framework—encompassing balanced reforms like a “Digital Asset Framework” and updated AML regulations—should address compliance and consumer protection and foster innovation, economic growth, and equitable access in a digital economy. By embracing regulatory clarity and collaboration, lawmakers and regulators can shape a global standard, ensuring the integrity of financial systems and the empowerment of individuals in this transformative era.

Edited by Ashley Park

[1] Michael Lewis, Going Infinite: The Rise and Fall of a New Tycoon (New York: W.W. Norton & Company, 2023), 104.

[2] While this article focuses on Proof of Work (PoW), it’s worth noting that an alternative consensus mechanism, Proof of Stake (PoS), also exists. PoS relies on validators who hold and ‘stake’ cryptocurrency to secure the network rather than miners solving computational puzzles, as in PoW.

[3] Jerry Brito et al., The Law of Bitcoin (Bloomington, IN: iUniverse, 2015), 232-33.

[4] U.S. Securities and Exchange Commission, “SEC Charges Creator of CoinDeal and Others in $45 Million Fraudulent Crypto Scheme,” Litigation Release No. 25775, January 4, 2023, accessed October 31, 2024, https://www.sec.gov/enforcement-litigation/litigation-releases/lr-25775.

[5] U.S. Securities and Exchange Commission, “SEC Charges Creator of CoinDeal and Others in $45 Million Fraudulent Crypto Scheme,” Litigation Release No. 25775, January 4, 2023, accessed October 31, 2024, https://www.sec.gov/enforcement-litigation/litigation-releases/lr-25775.

[6] SEC v. W.J. Howey Co., 328 U.S. 293 (1946), accessed November 26, 2024, https://supreme..

justia.com/cases/federal/us/328/293/.

[7] Brito et al., The Law of Bitcoin, 232-33.

[8] Utility tokens are digital assets that provide access to specific services on a blockchain, like storage or premium content. Unlike investment tokens bought for profit, utility tokens serve practical purposes within their ecosystem. The regulatory debate around them stems from challenges in applying traditional securities laws, exemplified by the SEC v. LBRY case, where LBRY Credits were classified as securities. This situation highlights the need for updated regulatory frameworks that address the unique nature of cryptocurrencies while encouraging innovation and protecting investors.

[9] United States v. Harmon, No. 19-395 (D.D.C. July 24, 2020), accessed October 31, 2024, https://casetext.com/case/united-states-v-harmon-98/.

[10] United States v. Harmon, No. 19-395 (D.D.C. July 24, 2020), accessed October 31, 2024, https://casetext.com/case/united-states-v-harmon-98/.

[11] United States v. Harmon, No. 19-395 (D.D.C. July 24, 2020), accessed October 31, 2024, https://casetext.com/case/united-states-v-harmon-98/.

[12] Moving Bitcoin anonymously can violate laws against money laundering and terrorist financing. Governments require traceable transactions to prevent crimes like drug trafficking and tax evasion. Bitcoin mixers, such as Helix, obscure transaction origins and destinations, undermining anti-money laundering (AML) regulations that promote transparency.

[13] Chris Brummer, Cryptoassets: Legal, Regulatory, and Monetary Perspectives (New York: Oxford University Press, 2019), 6.

[14] United States v. Coinbase, Inc., “ORDER RE PETITION TO ENFORCE IRS SUMMONS,” No. 17-cv-01431-JSC, 2023 U.S. Dist. LEXIS 123456 (N.D. Cal. 2023), accessed October 31, 2024, https://casetext.com/case/united-states-v-coinbase-inc.

[15] Brito et al., The Law of Bitcoin, 243.

[16] United States v. Coinbase, Inc., “ORDER RE PETITION TO ENFORCE IRS SUMMONS,” No. 17-cv-01431-JSC, 2023 U.S. Dist. LEXIS 123456 (N.D. Cal. 2023), accessed October 31, 2024, https://casetext.com/case/united-states-v-coinbase-inc.

[17] FTX, a significant cryptocurrency exchange, filed for bankruptcy in November 2022 after allegations of financial mismanagement and fraud came to light. Its founder, Sam Bankman-Fried, was accused of misusing customer funds for risky investments through Alameda Research, a trading firm he owned. The collapse resulted in billions of dollars in customer losses and sparked global calls for stricter cryptocurrency regulations.