(Bloomberg) -- In the wake of the implosion of cryptocurrency exchange FTX, one urgent question keeps resurfacing: Who should regulate the industry?

An upcoming ruling in New York federal court could help determine the answer, along with the fates of numerous crypto investors and companies. The case hinges on whether a prominent digital token should be treated as a security, which would fall under the Securities & Exchange Commission’s jurisdiction. The dispute dates back to 2020, when the SEC accused San Francisco-based Ripple Labs Inc. of selling unregistered digital tokens without adequate disclosure. 

SEC chairman Gary Gensler has been working to position his agency as the force that would rein in the crypto industry, and should the regulator prevail it would strengthen its grip at a crucial moment. A decision could come in the first half of 2023.

Among a handful of closely watched fintech lawsuits, the Ripple decision is the most high profile: its digital token, XRP, is the sixth-largest crypto token with a market value of almost $20 billion, according to CoinMarketCap. 

The recent turmoil in crypto markets could taint the court’s view, said Joseph Hall, a partner at Davis Polk & Wardwell who worked at the SEC from 2003 to 2005. 

“You just have to imagine that the judges will be influenced by the investor losses they’ve seen,” Hall said. “And the SEC will make clear to them that if you rule the other way, we will not have the tools that we need to fight this kind of activity.”

FTX’s bankruptcy in November left customers and investors facing billions of dollars of potential losses, and several of the company’s executives have been charged with various types of financial fraud. Before his arrest, FTX’s founder, Sam Bankman-Fried, was a prominent voice in the policy debate around regulation.

He formed close ties with US legislators and advocated for a bill to give the Commodity Futures Trading Commission oversight of certain tokens — a move some saw as an attempt to wrest jurisdiction away from the SEC.

The fallout from FTX’s implosion was swift and devastating, pounding an industry that had already had a rough year. Token prices plummeted, deepening a rout that began last April, several crypto firms filed for bankruptcy and high profile backers of FTX were forced to write investments down to zero.

“The potential contagion effects of crypto collapses are now more apparent,” said Howard Fischer, a partner at Moses & Singer and former senior trial counsel at the SEC. “The FTX disaster will be more of a touchstone in inspiring government regulation.”

For an asset to be classed as a security it must meet a legal standard from a 1946 US Supreme Court ruling about the sale of tracts of Florida citrus groves to investors. The test is met if investors kick in money with the expectation of profiting from the efforts of an organization’s leadership.

Ripple has contended that XRP doesn’t meet that test because sales took place in the secondary market and there was no pooling of profits.

“Selling an asset on a secondary market is most akin to a commodity, and should be regulated as such,” the company’s general counsel, Stuart Alderoty, said in an interview. “You don’t lose consumer protection and you keep bad actors out. Regulation needs to be done in a way that respects the reality of what an asset is.” 

An SEC spokesperson declined to comment on the Ripple suit.

Trading in digital asset commodities, which US regulators have largely agreed includes Bitcoin, is subject to a patchwork of state regulation but not federal oversight. Some policymakers have sought to rectify that through legislation to give the CFTC authority over those types of tokens.

But if the Ripple ruling determines that XRP is a security, it would give the SEC ammunition to claim jurisdiction over the majority of digital assets, said Carol Goforth, a professor at the University of Arkansas School of Law who specializes in fintech regulation. 

Gensler has slapped multi million-dollar fines on crypto companies and those who promote digital assets. The SEC, however, hasn’t produced specific guidance for when a digital token amounts to a security — and Gensler has said existing rules are clear.

He’s faced criticism from crypto industry insiders over the approach, which they say relies on enforcement instead of clarifying rules. In its latest salvo, the SEC on Jan. 12 sued crypto firms Genesis Global Capital and Gemini Trust Co. for raising billions of dollars worth of crypto assets from investors through a program that it said amounted to an offering of unregistered securities.

“Instead of engaging in transparent and public rulemaking, with industry comments, the SEC has chosen to mark its digital asset territory via the federal court system,” said Arthur Jakoby, a former SEC attorney and partner at Herrick Feinstein.

Read more: How Crypto’s Woes Changed the US Regulatory Debate: QuickTake

One recent court decision did define a digital asset as a security. A federal judge in New Hampshire ruled in November that blockchain-based publishing platform LBRY Inc. violated US securities law by selling its token without registering offerings with the SEC. The Ripple case has more at stake — $1.3 billion in allegedly unregistered issuances, versus $12.2 million for LBRY — and is in NY federal court, which generally carries more weight than New Hampshire, said Bloomberg Intelligence litigation analyst Elliott Stein.

The first insider trading allegations involving digital coins could also influence the industry’s future. In July, a former Coinbase Global Inc. product manager and two others were charged by the Justice Department and sued by the SEC for allegedly participating in a scheme to trade on confidential information. Ishan Wahi, the Coinbase manager, has pleaded not guilty. His brother, Nikhil Wahi, admitted to one count of conspiracy to commit wire fraud and was sentenced on Jan 10. to 10 months in prison. A third defendant hasn’t appeared to face charges.

No case has captured as much attention as Ripple. Since the SEC filed the suit, a nearly 150,000-strong group known as the XRP Army has kept crypto social media abuzz with round-the-clock posts discussing proceedings and searching for trails that they hope might lead to a victory.

The company has hired former SEC heavyweights to defend it: Mary Jo White, who led the agency for almost four years under President Barack Obama; and Andrew Ceresney, who served as her director of enforcement.

“Most of the projects the SEC has gone after have either not had the resources to fight, or for other reasons have found it financially expedient to enter into a settlement,” said Ripple’s Alderoty.

More than a dozen entities have submitted briefs to the judge in support of Ripple’s position, including the Chamber of Digital Commerce and the Blockchain Association.

While observers often look to a judge’s past decisions for clues as to how a case might turn out, that’s more difficult in younger industries like crypto with few examples to draw from. 

While US District Judge Analisa Torres, who’s overseeing the case, hasn’t presided over many other crypto-related cases, she has supervised major business cases. One — a gender-bias class action against Goldman Sachs Group Inc. — is scheduled to go to trial this summer.

Both the SEC and Ripple have asked Torres for a ruling in their favor without a trial, arguing that she has enough information to make a decision. Now they just have to wait.

Even if Ripple triumphs, it might not be the ticker-tape parade moment that crypto enthusiasts are hoping for, said Andrew Stoltmann, a securities litigation attorney in Chicago. 

Lawmakers were mulling a number of crypto oversight bills before FTX filed for bankruptcy, but those efforts had largely stalled. Now, given the publicity around FTX’s collapse and the contagion that’s imploded other crypto firms, the federal government is more likely to wade in. 

“I anticipate Congress will come in over the top and basically decide who gets jurisdiction with respect to enforcement,” Stoltmann said.

--With assistance from Lydia Beyoud.

©2023 Bloomberg L.P.