How Crypto Startups Can Avoid SEC Enforcement: Lessons from Recent Actions

The U.S. Securities and Exchange Commission (SEC) has clarified that its focus on the cryptocurrency and digital asset industry is aggressive and unrelenting. In recent years, and as evidenced in the case against eToro USA LLC , the SEC has pursued enforcement actions against crypto platforms that fail to comply with securities laws. Understanding the regulatory landscape from day one is critical for crypto startups, as compliance post-launch is often too late to avoid costly penalties, operational disruption, or worse.

The SEC's Approach: Case Study on eToro USA LLC

The September 2024 enforcement action against eToro USA LLC highlights the SEC's assertive stance on digital asset regulation. In this case, eToro , a prominent trading platform, was found to have violated U.S. securities laws by offering crypto asset securities without registering with the SEC or adhering to federal regulations governing broker-dealers and exchanges.

The key findings in the eToro case included:

• Operating without SEC Registration : eToro facilitated trades of digital assets deemed securities without registering as a broker or securities exchange.
• Custody of Customer Assets : eToro's custody of U.S. dollars and crypto assets without the appropriate legal frameworks exposed them to legal action.
• Marketing Crypto Securities : eToro marketed its platform to U.S. customers, using misleading claims that it provided secure and compliant crypto trading.

Crypto startups that plan to offer any form of trading or custody of crypto assets, especially those that could be classified as securities, should see this as a clear warning. The SEC is focused on enforcing the Securities Act of 1933 and the Securities Exchange Act of 1934 , and platforms that ignore these obligations will face similar enforcement actions.

Lessons for Crypto Startups

1. Determine if Your Token Is a Security. One of the most critical factors in staying compliant is determining whether your platform's assets qualify as securities under U.S. law. The SEC uses the Howey Test to evaluate whether a digital asset is a security. If your token or asset is classified as an “investment contract,” you may be required to comply with U.S. securities laws.

• Action : Before launching, consult with legal experts who understand the nuances of U.S. securities law to evaluate your token structure. This may involve changes to your business model or the utility of your token to avoid classification as a security.

2. Register or Seek an Exemption. If your platform plans to offer securities, you must register with the SEC unless you qualify for an exemption. Registration involves filing the appropriate forms and disclosures, similar to what traditional securities brokers must do.

• Action : Explore exemptions under Regulation D or Regulation A , but do not assume that non-registration is an option simply because your business is based on blockchain technology.

3. Comply with Broker-Dealer and Custody Requirements. The SEC requires entities that act as intermediaries in securities transactions to register as broker-dealers. This is especially relevant for crypto exchanges or trading platforms. Holding client assets without adhering to federal requirements exposes startups to enforcement actions.

• Action : If you offer trading services, ensure your platform meets the strict regulatory standards for broker-dealers and custodians . This may include having appropriate internal controls, compliance programs, and third-party audits.

4. Disclose , Disclose, Disclose. The SEC emphasizes full disclosure of financial information, risks, and other material factors affecting investors. Crypto startups often neglect these disclosure requirements, resulting in SEC scrutiny.

• Action : Adopt a robust disclosure regime that includes transparent information about your business operations, risks, and potential conflicts of interest. Ensure that all materials provided to investors are clear, accurate , and updated regularly.

Be Proactive, Not Reactive

One key lesson from recent SEC actions is that crypto startups must approach compliance proactively. Waiting until after you've built and launched your platform to address regulatory concerns can result in significant legal and financial headaches. By integrating compliance into your business plan from day one, your startup can confidently operate and avoid the fate of companies like eToro .

Conclusion

With the SEC continuing its aggressive enforcement of cryptocurrency and digital asset regulations, startups must prioritize regulatory compliance as part of their operational strategy. From proper asset classification to broker-dealer registration and investor disclosures, crypto companies should align with SEC expectations before bringing products to market. The message is clear: it's far easier and cheaper to build compliance into your business than to face enforcement actions after the fact.

If you have any questions about securities regulations or how to stay compliant as a crypto startup, contact FinTech Law at FinTechLegal.io/contact. We're here to help you navigate these complex requirements and safeguard your business.