The Securities and Exchange Commission’s barrage of lawsuits against cryptocurrency exchanges this week appears to be an assault on the structure of digital asset markets, with smaller companies likely to become targets if the agency prevails against the two market leaders
“More action wouldn’t surprise me,” said Kristin Smith, executive director of the Blockchain Association. “At the same time, I think this enforcement action against Coinbase is the message he (SEC Chairman Gary Gensler) wanted to send.” If the SEC prevails in its claim that most cryptocurrencies are securities and that exchanges are therefore under its authority, it is hard to see why the agency would stop at Binance and Coinbase unless Congress writes new laws more favorable to the industry.
Kayvan Sadeghi, partner at Jenner and Block, agrees, making it clear that other US crypto exchanges remain at risk even if the SEC is content to prosecute only these two cases for now. “The way they defend these claims makes it clear that the same allegations can be made against virtually any entity with a similar business model,” says Sadgehi. “But it’s hard to tell from the tea leaves if they want to go after everyone everywhere at once.”
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The model in question is the brokering and exchange of securities. The problem is that hardly anyone can agree on whether multi-billion dollar digital assets such as ether, sol, ada and hundreds of smaller cryptocurrencies are, in fact, securities. Through its enforcement actions and public comments from Gensler, the SEC has made it clear that it views virtually any crypto asset, with the exception of bitcoin, as a security. By this logic, if a crypto exchange in the US lists even one token, it could be against the agency’s rules.
This is a terrible danger to other exchanges and digital asset issuers. The SEC sued San Francisco-based Ripple in December 2020 alleging the payments company had an unregistered securities offering when it sold $1.3 billion of the cryptocurrency XRP to investors. This was the first enforcement action taken against a major blockchain company, and it led to XRP being delisted from many exchanges, including Coinbase, due to this legal hazard. It is worth noting that many of the tokens listed in the two suits this week, such as sol, ada and matic, are among the largest in the industry and are traded on virtually every major exchange not only in the US but all over the world. world.
So what are crypto companies going to do? Many are not yet ready to say. Forbes reached out to Kraken, Gemini, Robinhood, PayPal, and Bitstamp, all involved in brokering and exchanging digital assets. They did not respond or would not discuss the issue publicly.
So told an executive of a leading crypto exchange Forbes under the condition of anonymity to speak freely that there is no easy way for their company to register with the SEC. While traditional securities markets typically limit their activities to providing a forum to exchange assets, crypto exchanges play a role in brokerage, settlement and settlement.
One possible solution could be to register an exchange as an Alternative Trading System (ATS), which works in a similar way when it comes to securities trading. In fact, a bill recently introduced in Congress to help provide these guidelines specifies the ATS model, but the legislation was drafted in the Republican-dominated House and Democrats could have reservations.
There are a handful of ATS active in crypto, but they specifically focus on tokenized securities as opposed to native tokens for a blockchain, and they are not allowed to trade assets that are not security. “The ATS is not a golden bullet for this,” said Mike Cagney, CEO of Figure Technologies, which operates an ATS.
It is true that a token project could try to register with the SEC as a security, but that would be anathema to crypto’s decentralized ethos.
A spokesperson for Circle, publisher of the $29 billion USD stablecoin in partnership with Coinbase, expressed hope that new regulations would provide the industry with a way to operate. “These are highly anticipated actions and are on the eve of Congress taking very seriously the regulation of the stablecoin and digital asset market. We now effectively have the three departments of the US government clearly stating that they want to see legislation.
Even if the SEC won’t take major action against other notable exchanges for now, that doesn’t mean it won’t be looking at new targets later on. Two areas in crypto that are yet to see significant enforcement action likely to be on the agency’s radar are liquid staking and decentralized finance (DeFi) platforms.
Liquid staking is a new piece of financial engineering that allows users to maintain liquidity while placing tokens as collateral on a blockchain such as Ethereum to earn passive income. This has become a $17.19 billion industry and Lido, the largest platform, manages $13.36 billion in assets. Gensler has stated that the proof of stake tokens could amount to investment contracts, at least based on his interpretation of securities law. In February, the SEC fined Kraken $30 million and the exchange agreed to end the eviction program without admitting guilt.
Gensler has repeatedly said that simply calling a DeFi project “decentralized” does not guarantee an exemption from securities laws. “I feel like DeFi will be in the crosshairs,” says Sadeghi. He suggested that specific language in the Coinbase complaint could allow the government to characterize some user-controlled crypto wallets as stockbrokers because they are involved in routing transactions.
Increasing SEC activity could encourage Congress to write clearer digital asset rules that would limit the agency’s attack on the crypto sector. “The rhetoric from the SEC has clearly escalated in this most recent round of affairs,” said Daniel Stabile, a partner at Winston and Strawn. “The key is whether we get a ruling in any of these cases and the order of them any time soon regarding congressional actions that would radically impact the SEC’s authority to regulate this space.”