Stablecoins as Securities? What the Terraform Labs Ruling Means for Everyday Crypto Users

If you hold stablecoins — USDT, USDC, or any other dollar-pegged token — a federal court ruling issued on December 28, 2023, may affect you more than you think. US District Judge Jed Rakoff ruled that Terraform Labs, the company behind the collapsed TerraUSD (UST) stablecoin and Luna (LUNC) token, sold unregistered securities, sending ripples through the crypto industry and raising fundamental questions about how regulators view the tokens millions of people use every day.

The Basics

Here is what happened. Terraform Labs, founded by Do Kwon, created two digital currencies: TerraUSD (UST), a stablecoin designed to maintain a $1 peg, and Luna, a governance token that was supposed to stabilize UST’s price through an algorithmic mechanism. In May 2022, this mechanism failed catastrophically. UST lost its peg, Luna’s price crashed from over $100 to fractions of a cent, and approximately $40 billion in market value evaporated in days.

The US Securities and Exchange Commission sued Terraform Labs, alleging that both UST and Luna were unregistered securities. Judge Rakoff agreed, ruling that Terraform had violated US securities law. This was the first time a federal court classified a stablecoin as a security.

The ruling is significant because the Howey Test — the legal standard used to determine whether something is a security — requires an “investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others.” For most people, a stablecoin that stays at $1 does not seem like an investment with profit expectations.

Why It Matters

Judge Rakoff’s reasoning centered on a specific feature: staking. Terraform Labs allowed UST holders to stake their stablecoins on the Anchor Protocol, a DeFi platform that promised yields of up to 20%. The court found that the ability to stake UST for returns — regardless of whether any individual holder actually did so — was sufficient to classify it as a security.

This reasoning has alarmed legal experts. Pro-XRP lawyer Jeremy Hogan publicly questioned the logic: “How can a stablecoin be a security? How can you buy something ‘pegged’ to a dollar and expect profit from it?” Hogan pointed out that the core function of a stablecoin is maintaining a fixed value — the opposite of a profit-seeking investment.

Ripple’s Chief Legal Officer Stuart Alderoty also weighed in, criticizing the SEC’s approach of litigating token by token as “regulation through enforcement” rather than developing clear rules. He noted that Judge Rakoff did not challenge or reference Judge Torres’s earlier ruling in the Ripple case, where XRP was found not to be a security when sold to retail buyers on exchanges.

Getting Started Guide

If you are a crypto user wondering what this means for your stablecoin holdings, here is what you should know and do.

Step 1: Understand which stablecoins are affected. The Terraform Labs ruling specifically concerns UST and Luna — tokens that have already collapsed. Your USDT, USDC, or DAI holdings are not directly affected by this ruling. However, the legal precedent it sets could influence future regulatory actions against other stablecoins.

Step 2: Check if you are staking. The ruling hinges on the staking feature. If you are earning yield on your stablecoins through DeFi protocols, you should understand that regulators may view these arrangements differently than simple holding. This does not mean staking is illegal, but it does mean the regulatory landscape is shifting.

Step 3: Stay informed about upcoming regulations. The European Union’s Markets in Crypto-Assets (MiCA) regulation, which began taking effect in 2024, establishes clear rules for stablecoin issuers. In the United States, stablecoin legislation has been discussed in Congress but has not yet been enacted. The regulatory environment will likely remain uncertain through 2024.

Step 4: Diversify your stablecoin exposure. Rather than holding all your stable value in a single token, consider spreading across multiple regulated options. USDC, issued by Circle, has been increasingly transparent about its reserves and regulatory compliance. DAI, a decentralized stablecoin, operates differently from fiat-backed options and may face different regulatory treatment.

Common Pitfalls

The biggest mistake crypto users make is assuming that regulatory rulings only affect the specific tokens named in the case. Legal precedents have a way of expanding. The Terraform Labs ruling establishes that a token’s classification can depend not just on its design but on the ecosystem built around it — including staking features, marketing materials, and founder statements.

Another common error is conflating “security” with “illegal.” A token being classified as a security does not make it illegal — it means it must be registered with the SEC or qualify for an exemption. This is how stocks and bonds work. The challenge for crypto is that most tokens were not designed with securities registration in mind, making compliance retroactively difficult.

Finally, do not panic. The Terraform Labs case involves egregious fraud — Do Kwon was arrested in Montenegro and faces extradition to both the US and South Korea. Most legitimate stablecoin issuers operate with far greater transparency and regulatory cooperation than Terraform ever did.

Next Steps

Watch for the trial date set for January 2024, where penalties and remedies will be determined. Follow statements from the SEC and crypto industry groups about how this ruling will influence enforcement priorities. And most importantly, keep learning — the intersection of crypto and securities law is evolving rapidly, and informed users make better decisions. With Bitcoin at $42,099 and the market recovering, 2024 promises to be a pivotal year for crypto regulation.

Disclaimer: This article is for informational purposes only and does not constitute legal or financial advice. Consult with qualified professionals for guidance specific to your situation.