The SEC Takes Its Crypto Crackdown Seriously

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Hello Quartz members!

In March 2021, when Gary Gensler was named head of the United States Securities and Exchange Commission (SEC), Quartz watched his confirmation hearing primarily to see what he would have to say about cryptocurrencies. It was at the height of a crypto boom: bitcoin’s price rose 30% that month, ending at nearly $59,000, in a run so wild it seemed to require some sort of supervision.

Gensler indicated at the time that under his tenure, oversight would come. While he wanted to encourage blockchain technology, he noted that any type of trading involving securities would fall under the jurisdiction of the SEC, which would want to ensure there is proper investor protection.

A year into the crypto winter, an industry-wide downturn exacerbated by the crash of popular stock exchange FTX and, yes, rising interest rates, Gensler has taken his biggest hits against crypto so far by suing two of the biggest brands in the industry.

I have been in finance for four decades. I have never seen so much non-compliance and hype disguised as reality than in this area.

SEC Chairman Gary Gensler in an interview on June 6

Last week, the SEC filed lawsuits against Binance and Coinbase, the world’s largest cryptocurrency exchanges by volume. In large part, the SEC’s actions against Coinbase hinge on what cryptocurrencies actually are. Gensler has often said that the vast majority of cryptocurrencies are, in fact, unregulated securities over which his agency should have authority. As a result, the SEC accused Binance and Coinbase of illegally operating as unregistered securities brokers, exchanges and clearinghouses.

Coinbases’ senior counsel told Quartz that the SEC is pursuing an enforcement-only strategy for crypto regulation and called on Congress to pass new legislation. But the SEC has long argued that the government doesn’t need new laws to govern crypto because, well, it’s securities, pure and simple. Which begs the question: what is this distinction in nomenclature that Gensler and crypto companies are arguing over?

HOWEY’S TEST

To define a security, regulators go back to a time when crypto was not a gleam in anyone’s eye. In 1946, a US Supreme Court decision defined the merits of the Howey test, which uses four criteria to determine whether an investment contract should be considered a security.

Is there an investment of money? Is there an expectation of profits from the investment? Is the money invested in a joint venture? Are benefits derived from the efforts of a promoter or a third party?

If the answer to all of these questions is yes, the transaction is likely to involve a security, the Supreme Court has ruled.

Gensler admits that bitcoin is likely a commodity, not a security, and should therefore be regulated by the US Commodity Futures Trading Commission (CFTC). But the SEC insists that some crypto tokens, such as Solana and Polygon, as well as tokens from some gaming platforms, are securities and therefore must be registered and regulated by the SEC.

Since Coinbase traded many of the tokens classified as securities by the SEC, the agency considered the platform an unregistered broker. The SEC also described the Coinbases staking program, which allows users to earn interest on their tokens, as a security. Binance, meanwhile, is facing accusations of misusing customer funds. But the SEC lawsuit also argues that some of Binances’ products, such as BNB and BUSD, should have offered investors the same kind of protection as registered securities.

CITABLE

[W]We operate as an unlicensed fking stock exchange in the United States.

Binances Chief Compliance Officer, in 2018 Message to Colleague, Cited in SEC Lawsuit

WHAT’S IN A NAME

The crypto industry claims to be decentralized. This word implies many things, including the idea that cryptocurrencies are financial instruments free from the control of governments or central banks.

Anything defined as a title, on the other hand, is strictly regulated, especially in the United States. Security exchanges must follow rules of transparency, so that the public knows who owns and runs these companies; they must make mandatory financial statements, so that investors know how the securities are performing. The SEC imposes stiff penalties for lying and limits what companies and insiders can say publicly.

All of these rules would surely result in serious compliance costs and stomach aches for crypto companies. And in some ways, real regulation would put an end to the illusion of decentralization. People who embrace crypto by vision may not be able to deliberately suspend their disbelief when their favorite crypto companies have to answer directly to the US government.

A THING

Many SEC lawsuits end with companies quietly settling down and agreeing to change the way they operate. Coinbase, however, said it has no such plans. Were going to continue to operate as usual, and these assets will continue to trade until the court issues a ruling, Coinbase CEO Brian Armstrong told Axios.

Taking the matter to court is a high-risk and very rewarding strategy. The court could side with the SEC, which would prevent the tokens in question from trading on exchanges like Coinbase. But if the court decides the SEC is wrong about what constitutes a security, that would be a huge win for Coinbase.

The case should be straightforward because it involves fundamental statutory interpretations and not constitutional issues. But it’s hard to say what today’s partisan Supreme Court justices will do, said Tyler Gellasch, president of the Healthy Markets Association, a Washington-based think tank.

It’s a reasonable thing for the industry to argue that the SEC let this all go for years and had plenty of opportunities to shut it down, Gellasch told Quartz. But traditionally, that’s not how laws work. You might be able to speed every day on the same road for 10 years, and all of a sudden a cop stops you. You can say, I sped on this road for 10 years! But it’s not a great defense.

Thanks for reading! And feel free to send us any comments, questions, or topics you want to learn more about.

Have a safe weekend,

Scott Nover, journalist; Samanth Subramanian, Global Editor

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