Government cracks down on crypto industry with flurry of actions

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Cryptocurrency executives hoped 2023 would herald a fresh start after a year of disastrous setbacks. Instead, the industry found itself the victim of aggressive government repression.

Last month, the Securities and Exchange Commission imposed fines and other penalties on crypto lending companies, while federal banking officials issued policy statements that appeared calculated to make it more difficult for crypto companies to participate. to the traditional financial system.

Over the past few days, the pace has picked up. Two high-profile crypto companies, including a popular exchange where people buy and sell digital coins, have come under intense pressure from state and federal regulators. After announcing a settlement with the exchange, the SEC also fined a crypto promoter and sued a startup that issued digital coins, for a total of three penalties in just over a week.

These actions are likely the prelude to a long period of legal wrangling, as regulators react to the market turmoil that caused major crypto firms to file for bankruptcy last year and cost investors billions of dollars. And the app signals a growing urgency in Washington to address the threat posed by cryptocurrencies, an experimental technology that enables new forms of financial speculation.

I called it crypto carpet bombing, said Kristin Smith, executive director of the Blockchain Association, a crypto industry trade group. Every two hours we hear about new enforcement actions.

For years, regulators have been criticized for failing to get the crypto industry under control, even as it grew into a multi-trillion dollar business. In November, crypto exchange FTX, once considered one of the industry’s most trusted freewheeling companies, failed virtually overnight and its founder, Sam Bankman-Fried, was accused of orchestrating a year-long fraud.

This has put regulators under intense pressure to act. Crypto companies have long existed in a legal gray area, with lawmakers and government officials debating how they should be classified for regulation. The industry’s growth has outpaced the sluggish federal bureaucracies that oversee other parts of the financial industry, like traditional banks and publicly traded companies.

After FTX filed for bankruptcy in November, the SEC, the Justice Department and the Commodity Futures Trading Commission, another regulator, all filed lawsuits against Mr. Bankman-Fried and two of his top aides.

But activity against the wider industry picked up again last month when the SEC fined crypto lender Nexo $45 million and accused one of its competitors, Genesis, of offering securities. not registered.

Last week, the SEC announced a settlement with crypto exchange Kraken that pulled one of its popular investment products from the US market, which could have wide ramifications for the industry. The agency also sent Paxos, a company that issues so-called U.S. dollar-pegged stablecoins, a warning of a potential securities violation lawsuit.

This week, the SEC sued Terraform Labs, the company that developed Luna and TerraUSD digital coins, which collapsed last spring and sparked a broader cryptocurrency price crash. On Friday, the agency announced that former National Basketball Association star Paul Pierce agreed to pay $1.4 million to settle charges that he traded cryptocurrency without proper disclosures.

Beyond the SEC, three prominent financial regulators sent a letter to banking organizations last month, warning them to exercise caution when dealing with cryptocurrencies. Also last month, the Federal Reserve rejected an application by Custodia Bank, a crypto firm, to join the central bank payments system.

The wave of enforcement has caused outrage and anxiety in the crypto industry. Some industry advocates have referred to the government’s efforts as Operation Choke Point 2.0, alluding to a law enforcement campaign in the 2010s to stop banks working with certain companies.

An industry lawyer said he advised executives to prepare for five years of costly, high-stakes litigation with the government. The crypto companies privately exchanged advice on which law firms to hire to handle government lawsuits, said the lawyer, who requested anonymity to describe sensitive legal discussions.

What is happening today is a coordinated effort that cuts across multiple agencies and seemingly reflects a unified view that the entire crypto industry needs to be restricted, said Paul Grewal, chief legal officer of Coinbase, the largest American crypto exchange. It is important for the crypto industry to prepare for a long fight.

Representatives from the SEC and the Federal Deposit Insurance Corporation, a banking regulator, declined to comment. Other federal banking regulators did not respond to requests for comment.

Almost since its inception, the crypto industry has attracted the attention of regulators. And in 2021, as the market reached record highs, some officials in Washington sounded the alarm. SEC Chairman Gary Gensler argued that the vast majority of cryptocurrencies are securities, like exchange-traded stocks, and should be subject to the same strict regulations. His office has spent months building cases against crypto firms, some of which are now coming to fruition.

At the same time, the crypto industry cultivated allies in Congress who proposed legislation that would have made it easier for companies to offer a wide range of experimental products in the United States.

Since the FTX implosion, the tenor of these discussions has changed. In private discussions, Capitol Hill staffers who once seemed enthusiastic about working with the crypto industry expressed skepticism and were more supportive of Mr. Gensler’s enforcement campaign, according to a person involved in the talks.

The SEC’s $30 million settlement last week with Kraken, one of the largest US exchanges, has crypto enthusiasts alarmed. Kraken has agreed to stop offering a service known as staking, which allows investors to earn interest on their crypto savings and has been lucrative for the industry. Enthusiasts fear that the SEC could block other crypto companies from offering similar services.

On Monday, the New York Department of Financial Services announced that it had ordered Paxos to stop issuing BUSD, a popular stablecoin affiliated with Binance, the world’s largest crypto exchange. On the same day, Paxos said it received a letter from the SEC warning that the company could soon be charged with BUSD securities violations.

We are seeing an arms race between federal agencies in the United States, competing to show how tough they can be on crypto, said Jason Weinstein, a lawyer at Steptoe & Johnson who works on crypto issues. There are many sheriffs in town, and each tries to exert control over the same town.

Some of the actions raised fears that crypto firms would have a harder time developing relationships with the mainstream financial system. In January, the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a joint statement outlining in stark terms the risks of getting entangled in crypto.

The administration’s efforts are no secret, crypto investor Nic Carter wrote in a widely cited blog post last week. He added that the exchanges could be completely cut off from the banking system.

As dire predictions spread, crypto executives took to Twitter to attack the SEC Days after Kraken settled with the agency, company founder Jesse Powell posted a lewd meme on Mr. Gensler. It was later deleted. Kraken did not respond to a request for comment.

There is no doubt that the current moment is different, said Mr. Grewal, Coinbase’s attorney. Our mindset was that we were ready to commit for as long as it takes to get the rules right.

Matthew Goldstein contributed reporting.

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