Gary Gensler, former chairman of the U.S. Commodity Futures Trading Commission (CFTC), jumped into a contentious cryptocurrency debate yesterday at the MIT Blockchain conference by declaring that tokens for ethereum and Ripple may be classified as securities. “There’s a strong case, particularly for Ripple,” he said.  

Ethereum’s ether and Ripple’s XRP rank as the second- and third-most valuable cryptocurrencies (as of this writing) and their classification as securities could subject tokens for initial coin offerings (ICOs) to strict compliance and disclosure requirements. There are currently no regulatory requirements binding on ICOs, whose market has exploded in the last year. (See also: What Crackdown? ICO's Raised $2 Billion This Year.) 

Why Counts as a Security? 

Gensler used the Howey test, developed by the SEC to classify securities, as an argument for his assertion. The test states that an offering is an investment contract if a “person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter of a third party.” According to Gensler, the 2014 ether ICO had a 50% profit written into the offering. In Ripple’s case, he highlighted the share of XRP’s backers, who reportedly own 60% of overall coins and Ripple’s links to 16 market makers, who are XRP’s main holders, as proof of expectation of profit. “Is there a common enterprise? Ripple Labs sure seems like it,” he said. According to him, Ripple Labs and the Ethereum Foundation are both working to promote their cryptocurrency and benefit its holders. 

In an emailed statement to Bloomberg, Ripple Labs disputed Gensler’s point of view. “XRP does not give its owners an interest or stake in Ripple and they are not paid dividends. XRP exists independent of Ripple, was created before the company and will exist after it. Ripple has always promoted XRP as a useful digital asset for enterprise payments because it’s faster, more scalable and more inexpensive than other digital assets. That utility exists separate from Ripple,” the company stated.

The Third-Party Test

Coincenter, a nonprofit research and advocacy center for cryptocurrencies, also put up a blog post defending ether’s status as a token. Peter Van Valkenburgh, research director at the group, stated that the ethereum network was no longer dependent on its foundation to promote ether, rather its value "flows from the efforts of thousands of unaffiliated developers, miners, and users.” In other words, ether failed the Howey test because it does not depend on the efforts of a third-party promoter. 

Gensler’s statement is the latest among a slew of warnings from current and former regulators. In particular, SEC Chairman Jay Clayton has ratcheted up the volume on cryptocurrency classification and had earlier said that all the ICO tokens he had seen earlier were securities. (See also: Is Ethereum A Security? SEC Chair Sows Confusion.)  

In his speech yesterday, Gensler said that a security classification for Ripple might end up with the matter being discussed in the courts. The Supreme Court has intervened earlier in such cases and its ruling on the Howey test is still widely cited. Classification as a security "could have a chilling effect on a frothy ICO market,” said Gensler, who will teach a course on financial markets and blockchain this fall at MIT, to audiences at the conference. But it would be a net positive for the cryptocurrency market, he added. 

Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns 0.01 bitcoin.