The rating from the Crypto Rating Council means that researchers believe the coin that powers Justin Sun’s decentralised blockchain has the highest chance — more than Bitcoin, XRP, Ethereum or Bitcoin Cash — of being considered a security in the eyes of powerful regulators.

Why securities matter

The treatment of securities underpins the entire private and corporate investing system in the US and around the world.

Market regulators like the Securities and Exchange Commission (SEC) have the power to issue huge fines if they find issuers attempting to skirt the rules and defraud investors.

A ‘security’ is simply an investment in a common enterprise where the investor is given the expectation of future profits, primarily from the efforts of the person or company he is paying money to. But it isn’t always obvious, and certainly not with cryptoassets, whether investments meet this legal standard. Those that do have responsibilities under federal law to register with the SEC, and owe a financial duty to the people who put forward their hard-earned cash.

The gold standard for the SEC as to what constitutes a security is enshrined in the Howey Test.

This was a famous test case, SEC vs WJ Howey Co., heard by the US Supreme Court in 1946, and set a precedent for how the term ‘security’ would be defined.

Regulators aren’t often given to a sense of humour, I think it’s fair to say. But in 2018 while retail interest in Bitcoin was intensifying, and sharks were circling, the SEC created its own fake cryptocurrency in an attempt to fool potential investors. It’s still live, if you’ve not seen it.

HoweyCoin promises implausible guaranteed returns of 72% a year and boasts fraudulent lies about being registered with the US government.

Back in 2017, Cooley LLP partner Marco Santori  told Forbes: “Lots of tokens, especially the tokens we’ve seen over the last year, probably have passed the Howey Test. It’s the one test you don’t want to pass.”

ICO under fire

Most recently the SEC has been taking a carving knife to the ICO market, deeming many of the token sales behind Bitcoin’s 2017 bull run to its $19,000 all time high as ‘unregistered securities’.

The SEC’s most prominent recent scalp is Telegram, the Russia/UK messaging giant which was forced to abandon its TON project and the planned distribution of its highly-anticipated Gram tokens in the face of massive legal opposition.

Block.one, the publisher behind EOS, paid a $24m penalty last year over its unregistered $4bn ICO token sale and faces a further securities class action suit in New York.

BitClave is the latest company on the chopping block, being forced to return $25m in May 2020 to around 9,500 investors who parted with cash for CAT tokens, originally intended to power a blockchain-based search engine.

Why rate?

Efforts by the Crypto Rating Council to rate cryptoassets on their closeness to the legal definition of a security appear to have two obvious motives.

First, to legitimise the space by working hand in glove with regulators.

Second, to get ahead of another wave of fines and legal issues and head the SEC off at the pass.

Investors want to be able to stash their cash in cryptocurrency and the myriad cryptoassets on the market. The appetite is crystal clear, not just from institutional investors, 60% of whom want digital assets in their portfolio, according to Fidelity. But they want to be able to do so in a legal way in which they are afforded the same protections as when they invest in any other standard asset class.

The CRC came into existence in September 2019. Its founding members are exchanges Bittrex, Coinbase, Gemini and Kraken, custodian Anchorage, Goldman Sachs-backed payments firm Circle, which in 2018 bought Poloniex for $400m and Grayscale Investments. Some might call these companies among the most trusted leaders in the space. They are certainly among the richest.

So what do the ratings mean, exactly?

CRC rate each coin or token on a scale of 1 to 5.

Before the TRX assessment — which by the way has not been formally published by CRC, rather leaked to TheBlockCrypto — the highest score ever was assigned to XRP, which scored a 4 out of 5.

At the lower end coins can score 1, 2 or 3. At the higher end of the scale are 3.5, 3.75, 4, 4.25. 4.75, and 5, with finer gradations between the larger scores meant to spotlight more acute levels of risk.

And how is it determined? “The CRC’s analytical framework is based on relevant federal law, including the Howey test, and statements from SEC Staff relating to digital assets, including the SEC’s ‘Framework for Investment Contract of Digital Assets’,” the website reads.

Most of the rules on the legal treatment of cryptoassets have still not yet been written. So CRC’s outside counsel has a look at each coin in question along with its website, presentations and social media accounts and tries to determine its intention.

Along with each coin’s score is an outline of its blockchain’s main features, along with assessment of its financing.

For XRP this includes

• “Ripple Labs conducted a Series A funding in 2015 and subsequent equity raises”;
• “Tokens were reportedly sold privately to venture and crypto-affiliated investors”

It appears to be more important not what type of blockchain or product underlies the coin but whether the company behind it has gone to public markets to raise cash in exchange for an equity stake.

Decentrailzed smart contract platform Tezos (XTC) for example, is rated 3.75 out of 5. It is open source, with the code freely available on Github, and yet raised $232m in a July 2017 token sale, 12 months after raising money for an equity investment.

Coins designed as a payment or means of exchange, like Bitcoin (BTC), Horizen (ZEN) and Litecoin (LTC), along with stablecoins like USDC, are all rated 1 out of 5. This means the CRC finds they have the fewest characteristics that are security-like.

Certainly those projects with scores closer to 5 than 1 likely face closer legal and financial scrutiny.

Why Tron?

Tron completed its $70m ICO just weeks before Chinese regulators brought the hammer down and banned token sales in 2018. 12 months later the swirl of suspicion around its flamboyant 30-year-old CEO Justin Sun grew larger when he formally apologised to the Chinese government for aggressive marketing practices.

And the founder of BitTorrent noted how Sun had failed to pay the $140m bill for acquiring his peer-to-peer filesharing website in 2019.

The hostile takeover of Steemit in May 2020 was the latest drama to capture the crypto world’s imagination.

Being deemed a security brings with it a whole host of very expensive and cumbersome financial and regulatory necessities. The CRC assessment suggests that Tron may be next on the SEC’s hitlist. This is the kind of spotlight Tron may not be willing to receive.