After years of grandstanding on crypto, U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler has finally put skin in the game.
A lot of skin.
The crypto-skeptic regulator – who over the course of his tenure has insinuated that proof-of-stake tokens are securities, intimated that all crypto exchanges are illegal enterprises and implied that all but one cryptocurrencies are "investment contracts" in line with the Howey Test, a standard for deciding whether financial assets are securities – this week sued Binance and Coinbase.
Up against the world’s largest crypto exchange (Binance) and the largest publicly-traded crypto company (Coinbase), it’s likely Gensler is in for a fight. Coinbase CEO Brian Armstrong said months ago that the SEC was building its case, and, if it sued, the exchange would counter.
Gensler’s is the type of federal enforcement action that could end up before the U.S. Supreme Court. The case against Coinbase, an exchange used by tens of thousands of U.S. citizens (that went public days before Gensler’s confirmation), could spur congressional action on crypto regulation. Further, the more wide-ranging accusations against Binance, damning if true, could capsize what is likely one of the most profitable businesses of the 21st century so far.
See also: Can Binance Survive the SEC's Charges? | Opinion
Those are the known-unknowns. But the SEC’s one-two punch this week also revealed new information about the agency’s approach to crypto, and why it has been so aggressive.
CoinDesk reached out to a number of legal authorities and crypto observers to get a better sense of what is likely to happen next with the cases and what they could mean for the future of the industry. The resulting roundtable discussion offers a diverse view on an uncertain situation with many moving pieces.
Are there reasons for the companies to be optimistic about the lawsuits?
Brian Frye, attorney: Yes. Maybe. I am not optimistic about the SEC’s claim against Binance. The complaint is brutal. Binance has essentially admitted to everything the SEC alleges. It’s a disaster.
I think Coinbase is much better situated. It has been trying to comply with the SEC’s rules for quite some time and the SEC has refused to even engage with Coinbase’s good faith efforts at compliance. I don’t think that’s a good look, and I think at least some courts might object to it.
Courts expect agencies to act in predictable ways. Coinbase has been asking the SEC what it wants and the SEC has been refusing to respond. That could make Coinbase look like the good actor and the SEC look like the bad actor.
Also, I think it is a problem that the SEC has still not provided an even remotely coherent explanation of what it wants to regulate, what it thinks it’s authorized to regulate, why it wants to regulate, how it wants to regulate, what it wants its regulations to achieve or really literally anything.
The SEC has spent years saying it dislikes crypto assets of any kind, but it hasn’t explained why it dislikes them, it hasn’t explained why it thinks they’re a problem and it hasn’t even pretended to explain how it would regulate crypto assets in a way that it thinks would be more consistent with its regulatory mandate.
It’s a security if the SEC wants to regulate it – Brian Frye
That’s a problem. Agencies have to be credible and the SEC has a credibility problem. It’s flexing its muscles and can create a lot of pain for crypto companies in the short term. But it has to think about the longer term as well.
The SEC has recently been slapped down by the courts for overstepping its authority in relation to ALJs [the Administrative Law Judge]. I wouldn’t be surprised if courts at least take a hard look at its approach to crypto assets. Especially in relation to businesses that are trying to comply, but being rebuffed by the agency.
Mike Selig, attorney: The SEC lawsuits aren’t entirely bad for crypto. Against the backdrop of these lawsuits, foreign jurisdictions are adopting crypto laws and regulations and U.S. lawmakers are debating crypto market structure legislation on the Hill. Political pressure on U.S. lawmakers to pass sensible crypto legislation becomes stronger every time that the SEC sues another crypto business – especially if that business has been vocal about its attempts to comply with applicable laws and regulations.
These lawsuits encourage businesses seeking to comply with clearly applicable rules to leave the U.S. since foreign jurisdictions welcome them with open arms and a fresh set of laws and regulations. Yet there is reason to be optimistic about the recent SEC lawsuits leveled against two of the largest crypto businesses in the world because these lawsuits can catalyze Congress to recognize that the SEC’s approach to regulation by enforcement is not working and comprehensive legislation is needed – or else the industry will flee to more accommodating jurisdictions.
Kristin Smith, Blockchain Association CEO: This week’s actions by the SEC make the path forward clear – and urgent: Congress must act. Last week’s introduction of the Digital Asset Market Structure discussion draft by Rep. Patrick McHenry, chairman of the House Financial Services Committee, and Rep. Glenn Thompson, chairman of the House Committee on Agriculture, is a step forward in the process toward effective regulation. It’s critical that the United States remains competitive at a time when countries around the world are taking action to bring responsible regulation to crypto.
In the short-term, do you expect Binance or Coinbase will change their approach to business?
Smith: The SEC doesn’t make the law – it only makes accusations. An enforcement action is just the opinion of the regulator – the courts will decide if its interpretation of the law is correct. Until and unless the SEC prevails, it will likely be business as usual.
Did the SEC’s suits against Binance and Coinbase reveal anything new about how the agency has been thinking about crypto?
Frye: Yes and no. I think the lawsuits illustrate what I’ve been saying for a long time, but people just don’t want to hear. “Is it a security?,” just isn’t an ontological question. It’s a security if the SEC wants to regulate it. So the real question is, what does the SEC want to regulate, why does it want to regulate those things, how can companies comply with the SEC’s regulatory objectives and does any of it make any sense.
Selig: To quote Battlestar Galactica, “All of this has happened before. All of this will happen again.” The SEC has been incrementally building legal theories with regard to the security status of crypto assets and the proper registration categories for various crypto asset intermediaries for many years. The Coinbase and Binance lawsuits are the culmination of everything that came before. Neither case provides a significant amount of new information about how the SEC is thinking about crypto, but, if you want to understand the agency’s views on crypto, then these are the complaints to read.
That said, there are a handful of novel aspects to these complaints. With Coinbase, the SEC for the first time asserts that offering unhosted digital wallet software is broker-dealer activity because the wallet can be used to buy and sell alleged securities via third-party decentralized applications and the software developer takes a fee.
In Binance, the SEC asserts that BUSD, a U.S. dollar stablecoin issued by a New York limited purpose trust company regulated by the New York State Department of Financial Services, is a security under novel theories – i.e. Binance using profits from sales of BUSD to offer various yield programs to BUSD holders. And in both complaints, the SEC argues that many crypto assets are securities that it has not previously deemed to be securities in lawsuits against the issuers or other secondary participants.
Thinking long term: What would crypto look like if the SEC wins, and Coinbase/Binance lose in the Supreme Court?
Frye: Good question, it depends on what the SEC wants to achieve. If it wants to destroy crypto, it probably can, if Congress lets it. Or at least, it could regulate crypto back to its late 2000s stage. But I don’t think it will happen. The SEC is conservative and finds novelty distasteful, but it also recognizes that it’s in the business of regulating markets. I think it will eventually realize it has to take its regulatory role a little more seriously.
SEC hasn’t even tried to promulgate coherent regulations for crypto assets
But again, I am disappointed by the SEC and its response to crypto regulation. I think regulation can be good and effective. But the SEC hasn’t even tried to promulgate coherent regulations for crypto assets. It’s just punting over and over again. It’s embarrassing and the regulators should be ashamed of themselves. The public deserves better. And the regulators should care about actually doing their job, which means understanding the markets they purport to regulate and explaining the rationale for their regulatory decisions. It’s a total fail on that front and it’s unacceptable.
Selig: The future of crypto within the U.S. is likely to be determined by Congress rather than the courts. If the SEC wins in its lawsuits against Coinbase, Binance, Ripple and others (even all the way up to the Supreme Court), we are nevertheless likely to see legislation that establishes a sensible regulatory market structure for crypto assets work its way through Congress. Coinbase, Binance and other crypto ecosystem participants will eventually have a path to compliance. Every major foreign jurisdiction is moving in this direction and it is very unlikely that the U.S. will remain the sole holdout.
If you were/are a lawyer for one of the major tokens named as a security in either suit, how would you counsel that token’s foundation?
Frye: I would advise them to write off the asset and anticipate paying a fine. Maybe a big one.
Selig: Development companies and foundations associated with any of the crypto assets named in the lawsuits may be inclined to intervene to defend the non-security status of the crypto asset. These entities should carefully consider the potential risks and benefits of doing so with legal counsel. Developers and users on these networks should likewise consult with legal counsel regarding their activities, but the SEC’s assertions that certain crypto assets are securities are just assertions. They are not yet supported by a judicial determination on security status.
Do you suspect these cases will change how Congress approaches crypto regulation?
Frye: I think this is absolutely a watershed moment. Ultimately, Congress decides what agencies can do. The Biden administration seems to be IDGAF to whatever Gensler wants when it comes to crypto, which honestly makes sense; he’s got bigger stuff on his plate. But Congress can pass new legislation, at least in theory. It can encourage the Biden administration to appoint new administrators. And it can object to how the SEC makes decisions.
Selig: The SEC’s jurisdictional land grab may serve to bite it. Lawmakers on the Hill have been keen to expand the Commodity Futures Trading Commission’s (CFTC), rather than the SEC’s, jurisdiction over crypto assets and even contract SEC authority to the extent it has any over crypto assets associated with decentralized or functional networks. Instead of issuing sensible rules that are workable for the crypto asset industry and thereby lessening the need for a comprehensive legislative solution involving the CFTC, the SEC has regulated by enforcement and antagonized the industry. As a result, industry participants are likely to favor the other market regulator.
Is there a chance the current situation will result in a regulation that would either outlaw most (if not all) cryptocurrencies, or subject them to prohibitive registration and other requirements?
Frye: Yes, but I doubt it. I think it’s more likely that the SEC will make it harder to introduce new cryptocurrencies.
Selig: It is highly unlikely that the current situation will result in laws or regulations that effectively ban crypto assets within the U.S. Lawmakers and regulators across the globe recognize the immense potential of crypto as a technology and are developing sensible legal frameworks for the asset class. The U.S. is late to the party, but will FOMO in too. Every novel investment product from renewable energy credits to credit default swaps goes through a period of regulatory hazing before becoming initiated as a properly regulated and validated asset class. Crypto will be no different.
Is there anything you think is missing from the public discourse regarding crypto law?
Matt Stoller, antitrust activist: It seems like while the courts or Congress could do random things, the hype machine of crypto has moved to AI, which – while it has a lot of hype associated with it – is a useful technology. So the only question for crypto boosters is, can they deliver an actual use case beyond money laundering and speculation?
What message do these cases send to other crypto exchanges? If you were a U.S. crypto exchange would you be worried?
Frye: Yes. The SEC is making it clear that it is acting, but it isn’t what the SEC wants to achieve. That’s a problem.
Selig: The SEC Enforcement Division’s message is clear: “We generally agree with SEC Chair Gensler’s view that most crypto assets are securities.” This is evidenced by the fact that the agency has now asserted that the majority of the top-ten crypto assets by market capitalization are securities, notably excluding bitcoin and ether.
Nevertheless, the law is not settled and will be litigated in numerous lawsuits, including the Coinbase and Binance cases. The agency is spending a ton of resources to litigate with Coinbase and Binance. I would be surprised if we see many more crypto asset exchange-related cases brought by the SEC in the near term. Crypto asset exchanges must continue to evaluate whether each crypto asset is a security based on the unique facts and circumstances associated with each crypto asset.
There are several accusations made about Binance that would be damning if true, including accusations of wash trading and practices that would put customers at risk (some reminiscent of FTX). Is there a cause of concern about using the exchange going forward?
Frye: I have no idea, but maybe yes?
Is there an SEC Chair that would be worse for crypto than Gary Gensler? (I.e. what would be even more damaging for crypto than these two cases?)
Frye: Everyone in the crypto space complains about Gary Gensler. I am also critical of his approach to regulation. But what if the head of the SEC was Lina Khan [head of the Federal Trade Commission]. Or more realistically, what if Lina Khan decided the FTC ought to regulate crypto offerings. Good luck, you’ll be begging for Gary.
Smith: No, unfortunately, it’s clear Chair Gensler has a flagrant disregard for his agency’s own mission to protect investors. In this week alone, the SEC indirectly called some $120 billion worth of crypto assets securities. How does attempting to eliminate a market for these tokens protect investors?
Is it possible that the lawsuit will lead to either Binance or Coinbase, or both, shutting down in the U.S.?
Frye: Yes. I think it’s a very real possibility for Binance, based on the complaint, but very unlikely for Coinbase, which has done everything it can to comply with SEC rules and expectations, even when the SEC has misbehaved.
What did you make of Gary Gensler's statement about the world not needing digital currencies because the dollar, euro and yen are all digital? Why does Gensler make normative claims about the industry, rather than focusing on his actual mandate?
Smith: Gensler appears to now be showing all his cards: he doesn’t think digital currencies should exist in the United States. He clearly understands the technology and has been open to exploring its potential in the past. He also understands the business of publicly traded companies like Coinbase, what products and services the SEC has already approved, and their obligations to financial disclosures. So without additional information, observers are left wondering what Chair Gensler’s motives are.