Author: FinTax

1. Case fact sorting: A well-designed crypto scam

In 2023, the U.S. Securities and Exchange Commission (SEC) launched a landmark lawsuit against crypto company Green United LLC, accusing it of mass fraud by selling cryptocurrency mining machines called "Green Boxes", involving as much as $18 million. The SEC clearly requires in the complaint: permanently prohibit the defendant from participating in suspected securities trading and business activities, confiscate his illegal income, and prohibit Krohn and Thurston from participating in any unregistered securities issuance (including crypto-asset securities). Under the verdict of September 23, 2024, Judge Ann Marie McIff Allen found that the SEC had sufficiently proved that Green Boxes combined with the custody agreement constituted securities and that the defendant created the fictitious return on investment through false statements, ultimately supporting the SEC’s request for punishment. The core of this scam is to construct a seemingly perfect investment trap: after an investor paid $3,000 to buy a miner, the defendant promised $100 a month with an annualized return of up to 40%-100%. However, the truth is far from being so beautiful: Green United did not use mining machines for actual mining, but disguised itself as income by purchasing unmined "GREEN" tokens, which ultimately lost value due to lack of secondary market liquidity.

Green United's business model is extremely confusing: on the one hand, it is under the guise of hardware sales, and on the other hand, it deeply binds investors through custody agreements. Under the agreement, Green United claims to "do everything" to achieve the expected returns, and this "commitment + control" model is at the heart of the case's dispute. In September 2024, Utah District Court Judge Ann Marie McIff Allen made a judgment that the combination of mining machine sales and custody agreements constituted a securities transaction in accordance with the definition of an investment contract in the 1946 SEC v. W.J. Howey Co. case. This judgment not only overturned the defendant's defense of "not involving securities transactions", but also clearly included crypto mining machines in the scope of securities supervision.

2. Analysis of the focus of dispute: Why is mining machine trading recognized as a securities? 2.1 Applicable dilemma of Howey Test

The four elements of the investment contract established by the U.S. Supreme Court in Howey's case include: investment funds, common causes, expected profits, and profits fromOthers work hard. Green United's defense core is: emphasizing the attributes of mining machines as "end users' own products", and claiming that the income commitments in the custody agreement are commercial incentives rather than securities issuance, and there is no common undertaking required by securities. However, in this case, Judge Allen's ruling broke through traditional perceptions, especially through penetrating review, it determined that the correlation between control and the source of income had exceeded the scope of commodity trading, that is, the income in the custody agreement had the nature of securities investment income, and ultimately included mining machine trading in the category of common undertakings. The judge's specific judgment is as follows:

Funding investment: Investors pay US$3,000 to purchase mining machines, which meets the factors of capital investment;

Common cause: Investors' returns do not come from the mining capabilities of the mining machines themselves, but rely on Green United's control and operation of the system, forming a common cause between investors and promoters;

Profit expectations: 40%-100% ultra-high return commitment, far exceeding the normal business investment return, and meeting the characteristics of "expected profit";

Others' efforts: Green United Promising to "do all the work", investors do not need to participate in operations, and profits are completely dependent on the efforts of the promoters.

2.2 Multiple interpretations of legal experts

Although the court's judgment has been decided, there are still significant differences in the legal community on the case. Some views believe that this is a specific fraud. For example, Ishmael Green, a partner at Diaz Reus, pointed out that the SEC's allegations are aimed at Green United's false propaganda and custody agreement design, and do not deny the sales of mining machines themselves. As long as the mining machines are sold in the form of "end users' own use", securities characterization can still be circumvented. More importantly, the ruling also sparked heated discussions about the Howey tests among crypto industry practitioners and legal scholars. Supporters believe that this case reflects the core essence of Howey's test "substantially over form" - although mining machines are physical commodities, the strong correlation between the promoter's absolute control over the system and profits in the income model has constituted the substantive characteristics of the "common cause". Opponents warn that if this logic holds true, all hardware sales with profit commitments (such as profit sharing clauses when selling equipment in enterprises) may be considered securities, resulting in blurred boundaries of legal application. This disagreement essentially reflects the deep challenges facing crypto asset regulation: how to balance protecting investors and encouraging technological innovation? In the future, it is urgent to further clarify the standards through judicial precedents, such as clarifying when the sales of goods are accompanied by profit commitments., the securities attributes must be excluded at the same time (such as the user can decide on node operations independently) and "risk sharing" (such as investors need to bear the equipment maintenance costs).

2.3 Qualitative case reference for other crypto-asset securities

(1) Ripple case: The SEC accused Ripple of financing through the sale of XRP as an issue of unregistered securities. The court determined based on Howey's test that XRP sales for institutional investors met the definition of securities. Specifically, Ripple clearly binds XRP value to its own development through its promotional brochure (such as "The Ripple Agreement becomes the pillar of global payments, which will greatly increase XRP demand"). Investor purchasing behavior constitutes capital investment in common enterprises, and profit expectations are completely dependent on the technology development and marketing promotion of the Ripple team. Programmatic sales in the secondary market are not recognized as securities due to the lack of income commitment and the direct relationship between investors and issuers. This case clarifies for the first time the decisive impact of the transaction scenario on the characterization of crypto assets.

(2) Terraform case: The court found that UST and LUNA meet the definition of securities, and the core basis is the standard of "profit comes from the efforts of others". Although UST adopts an algorithmic stability mechanism, Terraform has enabled investors to form reasonable expectations that "profits come from the efforts of the Terra team" through continuous information disclosure (such as the white paper promises "UST and USD 1:1 anchoring") and founder Do Kwon's public platform. The judge specifically pointed out that the degree of decentralization is not an exclusion criteria for securities attributes - as long as there is a "sponsor-led marketing and income commitment", even if asset transactions are executed entirely through smart contracts, they may still be included in the supervision.

3. Qualitative future picture of cryptoasset securities

Green United alienates the income of mining machines into financial attributes through custody agreements, so that investors are essentially involved in the "common cause" operated by the initiator, rather than the mining machines themselves as hardware. In the short term, this case has a certain deterrent to the behavior of fraudulent packaging encryption projects, which is conducive to safeguarding the interests of investors in crypto asset; in the long term, this case will help promote the iteration of the securities regulatory framework. With the emergence of new technologies and new concepts such as crypto assets and smart contracts, traditional financial scenarios are undergoing earth-shaking changes. Simply applying Howey tests can no longer meet regulatory needs, but should dynamically consider the specific form of the project and balance the relationship between technological innovation and supervision in accordance with the law. In short, the healthy development of the crypto market is inseparable from the in-depth dialogue between legal rationality and technical logic. The future picture of crypto asset securities is slowly unfolding through such cases.