In today’s Finshots, we explain why the US SEC says that memecoins aren’t securities.

The Story

A few months ago, a Canadian teenager did something wild. He created his own cryptocurrency called Gen Z Quant. It wasn’t meant to be a serious project, just a fun memecoin. And if you’re wondering what memecoins are, they’re basically cryptocurrencies inspired by internet jokes, pop culture or social media trends, you know, like Dogecoin. They have no real-world use case, but people buy and sell them anyway, hoping to make a quick buck. The hype around these coins can send their prices soaring or crashing in no time, making them super volatile and risky. 

And Gen Z Quant was no different. 

The teenager released the coin into the market and then bought 51 million of them or about 5% of the total supply, for just $350. Then he did something clever. He started live-streaming on a website called Pump.Fun, a platform that makes it incredibly easy to create and distribute memecoins. Before this, launching a cryptocurrency was complicated and expensive, but Pump.Fun changed the game.

But there was a catch. While Pump.Fun tried to prevent outright scams (like rugpulls), it didn’t stop creators from buying and selling their own coins. So while the teenager live-streamed, people watching got excited and started pressing the ‘buy’ button on Gen Z Quant. And within just 10 minutes, the price shot up by a jaw-dropping 8,400%! This meant that the teen’s $350 investment was suddenly worth $30,000. And without wasting a moment, he sold them all and cashed out.

Sidebar: A rugpull is when scammers hype up a new crypto project, collect money from investors, and then disappear, leaving buyers holding the bag.

The result? A massive price crash.

But the teenager wasn’t done yet. Seeing an opportunity, he quickly created two more memecoins, pulled off the same trick, and walked away with a total of $50,000 in just one night.

In the stock market, this would be called a pump and dump scheme — buy low, hype up the stock, get others to buy in and then sell high, leaving everyone else with losses. But in the crypto world, things are different. There aren’t many rules, and a lot of what happens exists in a legal grey area.

And that grey area just got even bigger. Because the US Securities and Exchange Commission (SEC) recently ruled that memecoins aren’t securities. Simply put, people who create or trade memecoins don’t need to register with the SEC. So, if you lose money because of a scam or price manipulation, you can’t go crying to regulators. Sure, you can try suing under regular fraud laws, but the strict protections that exist for stocks (like bans on insider trading and pump-and-dump schemes) don’t apply here.

And this stance has raised some eyebrows, especially given how many scams exist in crypto. For context, Chainalysis estimates that about 5% of all crypto tokens issued in 2024 may have been rugpulls, leading to $2.8 billion in investor losses. And with numbers like these, you’d think that the US government would want tighter regulations to boost investor confidence. 

So why isn’t the SEC stepping in, you ask?

Well, their decision isn’t based on whims and fancies. Instead, it’s based on something called the “Howey Test”. This legal precedent determines whether an asset is a security and should be regulated. And it comes from SEC vs. W. J. Howey Co., a 1946 US Supreme Court case. 

To put things in perspective, W. J. Howey Co. was a Florida company that sold citrus groves to buyers who then leased the land back to the company. And since the company hadn’t registered these leaseback transactions with the SEC, the regulator sued the company. The SEC argued that this counted as an investment contract, and the court agreed. But how did the court decide that? It checked for four criteria:

1. There must be an investment of money – Investors must put in money or something of value. In Howey’s case, investors paid for the land. (Memecoins pass this test since people buy them with money or other crypto.)
2. A common enterprise must exist – Funds should be pooled into a venture where profits are shared, like how investors and Howey were part of this citrus grove project. (Memecoins don’t pass this test because they don’t involve a shared investment.)
3. There must be an expectation of profit – Investors must believe they’ll make money. Here, investors expected profits from the deal, which is why they leased the land back to Howey in the first place. (Definitely applies to memecoins!)
4. Profits must come from the efforts of others – The investment must rely on someone else’s work. In Howey’s case, investors made money based on how well the company handled everything, from planting to harvesting and selling the citrus produce. (Memecoins don’t pass this test either, as their prices are driven by hype and not a business or a team’s performance.)

And since memecoins fail two out of four tests, they aren’t considered securities.

But here’s where things get tricky. 

The SEC’s previous Chair, Gary Gensler, believed that most cryptocurrencies were securities. And guess what? He used the same Howey Test we just went through to make his point. He was worried that crypto traders would use loopholes to avoid regulation. But now, the SEC seems to be singing a different tune. So, what changed?

Well, two things. 

For one, the fact that every cryptocurrency is unique. Take USD Tether (USDT), for example. It has a much stronger case for being considered as a security than a memecoin. USDT is a stablecoin pegged to the US dollar, and its backing by Tether Ltd. could be seen as a common enterprise. Plus, the stability of its value depends on Tether Ltd.’s actions, meaning profits (or stability) come from the efforts of others. So, it has a much higher chance of passing the Howey Test. That’s why Gensler previously argued that most digital assets should be regulated.

And secondly, the SEC’s substance over form principle. This means even if a crypto technically meets the Howey Test, the SEC can still decide that it’s not a security based on how people actually use it. For example, if a cryptocurrency is marketed as a utility token (used to pay fees or unlock premium features of the cryptocurrency), but investors are buying it purely for profit, the SEC might say, “Sure, it looks like an investment, but it’s really just a collectible.”

All that makes regulating crypto incredibly complicated. 

So yeah, a separate governing body might be needed to oversee it properly. Until that happens, anyone can create a memecoin without worrying about breaking securities laws.

And that’s exactly what the Canadian teenager did. After the Gen Z Quant stunt, he came back and launched two more memecoins called test and dontbuy. The names were clear warnings, yet investors still rushed to buy them. And just like before, he made a killing.

Crazy times, and crazy investors, eh?

Until next time…

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