June 15 (Reuters) - A U.S. judge considered whether the digital assets created by Terraform Labs were securities at a hearing on Thursday, a question central to the U.S. Securities and Exchange Commission’s fraud case against the company and its founder Do Kwon.

Kwon and Terraform Labs were behind two cryptocurrencies whose implosion roiled crypto markets around the world last year. They have asked U.S. District Judge Jed Rakoff in Manhattan to dismiss the SEC's case alleging they defrauded investors and sold billions of dollars in digital assets that were unregistered securities.

TerraUSD, an algorithmic stablecoin supposed to maintain a 1:1 peg to the U.S. dollar, derived its value through another paired token called Luna.

Both tokens lost nearly all their value when TerraUSD, also known as UST, slipped below its 1:1 dollar peg in May 2022. Prior to its collapse on May 9, TerraUSD had a market cap of more than $18.5 billion and was the 10th-largest cryptocurrency.

According to the SEC's complaint, Terraform Labs and Kwon misled investors about the stability of UST, and claimed that the firm's crypto tokens would increase in value.

At the hearing, Rakoff questioned whether Terraform Labs offering of a so-called Anchor protocol, which offered up to 20% returns on deposits of TerraUSD, shouldn’t be considered a security.

“It is something you created, that only people who had taken this first step could take advantage of. I don’t see why that’s not a securities contract at that point,” he said.

Terraform Labs and Kwon argue the case should be dismissed because its digital assets do not fit the definition of securities and the SEC lacks authority over the industry.

“We’re not doing anything new here,” said SEC attorney Devon Staren at the hearing. “We are simply applying the securities laws.”

The judge said he will rule on the motion to dismiss the case by July 14.

The case is SEC v. Terraform Labs Pte Ltd. et al., No. 23-01346, U.S. District Court, Southern District of New York.

Reporting by Jody Godoy in New York; Editing by Lincoln Feast

Our Standards: The Thomson Reuters Trust Principles.

Thomson Reuters

Jody Godoy reports on banking and securities law. Reach her at jody.godoy@thomsonreuters.com

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