Could a class action lawsuit filed against the creators and early investors in Solana (SOL 3.07%) impact your ability to invest in crypto? Some commenters worry it might. A new lawsuit circulates around the question of whether cryptocurrency is a security. Alleging that the defendants were involved in illegal securities trading, the suit could be a harbinger of disruptive rulings revisiting whether crypto is a security and whether non-accredited investors can participate – or it could be a nothingburger. Although this suit uses some of Solana's problematic features to argue it is a security, many similar lawsuits have been filed against various crypto entities and businesses using similar lines of reasoning.
The gist of the complaint: Solana is a centralized security, and its creators misled the public in order to profit.
On July 1st, a class action lawsuit was filed against Solana Labs, the Solana Foundation, Solana Labs CEO Anatoly Yakovenko, the venture capital firm Multicoin Capital, and its CEO, Kyle Samani. Filed by lead plaintiff Mark Young "on behalf of all investors who purchased Solana tokens," the suit alleges that Solana Labs' negotiations prior to their initial coin offering (ICO, the crypto world's equivalent of an IPO) constitute multiple violations of the Securities Act. Deploying the Howey test (a court precedent for determining whether something is an investment contract), the suit alleges that SOL is an unregistered security. The suit claims the defendants used a series of negotiations to sell lots of SOL among themselves at rock-bottom prices, and then chose to sell relatively few SOL at much higher prices during the public ICO in order to maintain control over the platform before dumping SOL on gullible investors.
The core questions in the lawsuit relate to both the specifics of Solana and to crypto investing in general – and that is what concerns some crypto commenters. The complaint alleges that Solana creators used a series of private deals and their ICO to deliberately centralize and consolidate control of both the tokens and the network infrastructure. Many have criticized Solana for its centralization: Its network and governance structures make it possible for some stakeholders to have more power than others.
However, the broader legal argument suggests that purchasing almost any cryptocurrency with an expectation of profit would meet the threshold of a security -- and that the average retail investor lacks the knowledge and skills to make an informed investment.
The lawsuit could have major implications for retail crypto investing.
Any class action lawsuit hitting the developers of one of the top 10 cryptocurrencies will turn heads. But one thing about this case that has particularly concerned commenters is that it rests on the argument that Solana is a security. This classification is more than pedantic hair-splitting: For decades, American courts have used the Howey test to evaluate whether a transaction is a security. Many lawsuits have claimed that various crypto entities operate as securities. However, U.S. law generally considers crypto to be a commodity, so it falls under the purview of the Commodities Futures Exchange Commission (CFTC). There would be many implications if this classification changes, but one of the most direct potential consequences could be restrictions in which kinds of investors can purchase crypto or participate in ICO's. It's important to know that only accredited investors – wealthy individuals with a specific license and high net worth – can purchase certain types of investments. The mere idea of accredited investors is anathema to many who see crypto as a way to even the financial playing field. Plus, many businesses in the crypto sector, such as Coinbase (NASDAQ: COIN) use a business model that relies on retail investors to provide revenue. Yet many of the lawsuits claiming that crypto is a security rest on the argument that creators defrauded unsophisticated investors. That's why any legal proceeding that threatens to change this status quo could have ramifications that "ripple" beyond Solana. Ripple (CRYPTO: XRP) is already embroiled in a similar lawsuit with the SEC, and legal experts involved with that case are already warning that if Ripple loses, the case could transform the crypto sector.
But then again, maybe it won't.
The Solana suit is hardly breaking new legal ground: As of May 2022, there had been at least 200 lawsuits concerning cryptocurrency, many of which alleged that crypto creators defrauded investors by illegally selling securities. Though the initial complaint never specifies whether the plaintiff was an accredited investor, Young purchased more than $117,000 USD of Solana in August and September last year via altcoins such as Cardano and Ethereum. While nobody wants to watch a $117,000 investment plummet in value, it is also probably more than most retail investors are able to invest in crypto. The complaint's emphasis on the defendants' use of Twitter to promote Solana also suggests that the plaintiff, or others in the class of plaintiffs, might have influenced their investment decisions.
No matter how this lawsuit turns out, this is a great occasion to remind yourself that all investments carry risk, crypto is highly volatile, and you should only invest in proportion to your risk tolerance.