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Since Gary Gensler became Wall Street’s top agent two years ago, his message to cryptocurrency companies has been consistent: He would do anything to tame a world he likens to “the Wild West.”
This week, he delivered on that threat in a big way.
The Securities and Exchange Commission unveiled a barrage of charges against two of the world’s largest crypto exchanges – Coinbase and Binance – kicking off a legal battle that will help shape the future of cryptocurrencies.
Here’s what you need to know about the fight and why it’s so important.
What are these two cases about?
They are poised to answer a critical question: who will join the crypto company police force?
While Binance and Coinbase may not be household names, they are well known in the world of crypto. Billions of dollars in digital assets change hands every day on these platforms, and they have customers all over the world.
Yet crypto has been in a regulatory gray area since its inception. After all, most of the current financial rules were established before cryptocurrencies came into being.
A gang war is raging between the SEC and another federal regulator, the Commodity Futures Trading Commission (CFTC), over which the agency has the power to oversee these assets and the wider industry.
Gensler believes most cryptocurrencies are securities, and as such, current laws give his agency the authority to regulate them, as well as the sites and apps on which they are bought and sold.
While these two lawsuits are different in many ways, Coinbase and Binance are essentially both accused of failing to register their transactions with the SEC.
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That is something that crypto companies have fought tooth and nail against. By design, crypto is supposed to operate outside of the traditional financial system.
What many crypto companies want are new traffic rules that are crypto specific.
If the SEC prevails in the courts, it could potentially force crypto companies to register with the SEC, which would be a major change.
“I think these cases will be fundamental to the shape of crypto regulation,” said Timothy Massad, former chairman of the CFTC.
So what’s going to happen now?
In many ways, this is an existential struggle for these companies.
Binance is facing perhaps the most serious allegations, including that the exchange and its CEO, Changpeng Zhao, misled investors about the exchange’s ability to detect market manipulation, and misused client funds.
Meanwhile, Stephen Glagola, an analyst at TD Cowen who deals with Coinbase, a publicly traded company, says Coinbase could emerge from this battle as “a substantially different business than today.”
Both companies have decided to fight the charges against them and are preparing for the long haul.
“We are operating as usual,” said Paul Grewal, Coinbase Chief Legal Officer. “These cases are sometimes resolved not just for many months, but for many years.”
The longer this goes on, the more it may color how crypto investors view these two companies. Indeed, in the days since these lawsuits were announced, there have been significant outflows from Coinbase and Binance exchanges.
“This will affect people’s attitudes to trading, and Coinbase will have to think about that,” says Massad. “Can it really afford to just fight this out, or does it have any incentive to try and settle?”
What this means for the crypto world
It’s not just Coinbase and Binance. The lawsuits also threaten to create a lot of uncertainty and further erode confidence in the entire sector.
Coinbase and Binance join a list of crypto companies the SEC has taken action against, including Kraken, Genesis and Gemini.
But Coinbase and Binance don’t just run exchanges, they also operate as brokers and clearing houses. You don’t see this in traditional finance, and it’s a model Gensler is skeptical about.
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In crypto, sentiment is critical, and the industry has struggled since last year, with the collapse of FTX.
Now-former CEO Sam Bankman-Fried faces civil prosecution from the SEC and the CFTC, and the Justice Department has also filed criminal charges against him.
FTX’s spectacular collapse ushered in a so-called “crypto winter” that has yet to subside.
“I think the sentiment around crypto is likely to remain somewhat negative,” argues Glagola, noting that volumes – the amount of crypto being traded – have declined since the collapse of FTX, and continue to decline.
What could eventually arise?
There is an argument that this fight is good, or at least will be constructive – in that it will likely lead to greater regulatory clarity.
“This is an industry that I think is characterized by a lack of transparency,” says Giagola. “There’s not a lot of transparency.”
It’s not just the courts that can help determine the future of cryptocurrencies. Coinbase and other crypto companies, as well as the SEC, want Congress to get involved by passing laws for the industry, though action from lawmakers could take time.
Cryptocurrencies such as Bitcoin have become extremely popular, although they are still nowhere near as widespread as stocks.
A recent research report estimated that 12% of the population owns crypto investments, a small fraction compared to the number of households that own stocks, for example.
More transparency and trust in the industry could eventually lead to more investment in cryptocurrencies.
But the road to get there is likely to be messy.