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The crypto community celebrated a victory in court on Jan. 30 when the United States Securities and Exchange Commission (SEC) admitted in the remedies hearing of the LBRY case that secondary sales of its LBC coin were not securities sales. John Deaton, who represents Ripple in court in the SEC’s case against it, was so excited that he created a video for his Twitter-hosted CryptoLawTV channel that evening.

Deaton, a friend of the court, or amicus curiae, in the case, recounted a conversation he had with the judge that day. “Look, let’s not pretend. Secondary market sales are a problem,” then “I brought up to him that Lewis Cohen article,” Deaton recalled.

Deaton was referring to the paper “The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are Not Securities” by Lewis Cohen, Gregory Strong, Freeman Lewin and Sarah Chen of the DLx Law firm, which Cohen co-founded. Deaton had praised the paper before, in November 2022, when it was submitted in the Ripple case, in which Cohen is also an amicus curiae.

There is a growing buzz around the paper. It appeared on the preprint repository Social Science Research Network on Dec. 13. When Cointelegraph spoke to Cohen in mid-January, he said the paper was the most downloaded in the website’s securities law category, with 353 downloads after about a month. That number more than doubled in the following two weeks. The paper has also garnered attention in mainstream and legal media and crypto-related podcasts. Its unusual title is a nod to James Joyce’s Ulysses.

The Cohen paper looks closely at one of the timeless adages of crypto securities law: Securities are not oranges. This refers to the Howey test, established by the U.S. Supreme Court in 1946 to identify a security. The paper makes an exhaustive examination of the Howey test and proposes an alternative to how the test is currently applied.

When Howey met Cohen

Not everyone favors applying the Howey test to crypto assets, often arguing the test works better for prosecuting fraud cases than as an aid for registration. Cohen himself agreed with this position in a Feb. 3 podcast. Nonetheless, the paper’s authors do not challenge the use of the Howey test — which arose from a case concerning orange groves — on crypto assets.

A short summary cannot come close to capturing the breadth of the paper’s analyses. The authors discuss SEC policy and cases involving crypto, relevant precedents, the Securities and Exchange Acts and blockchain technology in just over 100 pages, plus annexes. They reviewed 266 federal appellate and Supreme Court decisions — every relevant case they could find — to reach their conclusions. They invite the public to add any other relevant cases to their list on LexHub GitHub.

The Howey test consists of four elements often referred to as prongs. According to the test, a transaction is a security if it is (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, or (4) to be derived from the efforts of others. All four test conditions must be met, and the test can only be applied retrospectively.

Cohen and coauthors argue, in extremely basic outlines, that “fungible crypto assets” do not meet the definition of a security, with the rare exception of those that are securities by design. This is the insight captured in the adage about oranges.

The paper’s authors continue that a crypto asset offering on the primary market may be a security under Howey. However, they note, “To date, Telegram, Kik, and LBRY are the only thoroughly briefed and decided cases relating to fundraising sales of crypto.”

They were referring to the SEC suit against messaging service Telegram, claiming its $1.7 billion initial coin offering was an unregistered securities offering, which was decided in favor of the SEC in 2020. The SEC case against Kik Interactive also concerned token sales and was decided in favor of the SEC in 2020. The SEC also won its unregistered securities sales case against LBRY in 2022.

Related: The aftermath of LBRY: Consequences of crypto’s ongoing regulatory process

The paper’s biggest innovation is its views on transactions with crypto assets on secondary markets. The authors argue that the Howey test should be applied anew to sales of crypto assets on secondary markets, such as Coinbase or Uniswap. The authors write:

“Securities regulators in the U.S. have attempted to address the many issues raised from the advent of crypto assets […] generally through an application of the Howey test to transactions in these assets. However, […] regulators have gone beyond current jurisprudence to suggest that most fungible crypto assets are themselves ‘securities,’ a position that would provide them with jurisdiction over nearly all activity taking place with these assets.”

The authors claim crypto assets will not, for the most part, meet the Howey definition on the secondary market. The mere ownership of an asset does not create a “legal relationship between the token owner and the entity that deployed the smart contract creating the token or that raised funds from other parties through sales of the tokens.” Thus, secondary transactions do not meet the second Howey prong, which requires a third party.

The authors conclude, based on their comprehensive survey of Howey-related decisions:

“There is no current basis in the law relating to ‘investment contracts’ to classify most fungible crypto assets as ‘securities’ when transferred in secondary transactions because an investment contract transaction is generally not present.”

What it all means

The effect of the paper’s argument is to separate the issuance of a token from a transaction with it on the secondary market. The paper says that the creation of a token may be a securities transaction, but subsequent trades will not necessarily be securities trades.

Sean Coughlin, principal at law firm Bressler, Amery & Ross, told Cointelegraph, “I think he’s [Cohen’s] taking ownership of the fact that the issuings [of tokens] are going to be regulated and he’s trying to suggest a way to then have it [a token] trade in an unregulated manner.”

Coughlin’s colleague, Christopher Vaughn, had reservations that the paper was in places “disingenuous.”

He said, “It disregards the realities everyone who’s ever traded in crypto knows, which is that these liquidity pools and these decentralized exchange transactions don’t happen unless the issuer of the token facilitates them.”

Nonetheless, Vaugh praised the paper, saying, “I would love for this to be the be-all and end-all of crypto.”

John Montague, attorney at digital asset-focused Montague Law, told Cointelegraph that custody issues might complicate Cohen’s argument, particularly how self-custody of crypto assets affects the investment prong of Howey.

Montague acknowledged the high quality of the paper’s scholarship, calling it:

“The most monumental thought piece in the industry with respect to securities law perhaps ever, […] definitely since Hester Peirce’s safe harbor proposal.”

In her final version of the proposal, SEC commissioner Peirce suggested network developers receive a three-year exemption from federal securities law registration provisions to “facilitate participation in and the development of a functional or decentralized network.”

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“One thing I like about the world of crypto is that it’s adversarial,” Cohen told Cointelegraph. He said he hoped to “lift the level of discussion” with the paper. It did not find a lot of resistance in public responses. There have been expressions of cynicism, though.

“You are a novelist. You found in crypto a character best explained by law,” one network developer commented on Twitter.

“Intelligent legal opinions rarely move the needle on SEC opinions or enforcement cases,” a financial services executive said on LinkedIn.