It looks like the private party is over for cryptocurrency.
Last week, the SEC filed two suits in rapid succession, accusing leading cryptocurrency exchanges Coinbase and Binance on trading unregistered securities. In doing so, the Commission is making an important claim, one that will likely shape the future of virtual currency.
In short, the Commission says cryptocurrencies are securities. If true, any unregistered exchange that sells these currencies, or any exchange which sells these currencies without registering them, is guilty of breaking the rules.
On the surface, that seems a pretty simple proposition. As securities, virtual currencies would be subject to some regulatory oversight, including greater transparency and investor protection.
But isn’t this a threat to the very spirit of decentralized finance? After all, the SEC is pretty central.
Well, here’s the thing. We’re not here to take sides in the battle of regulators versus crypto. As always, we side with individual investors.
And from that perspective, it’s possible that some regulation would be a good thing. Even if you are 100% sure that your Dogecoin will be the future gold standard, you can’t really argue that crypto is a safe or stable place to put your money.
At least not yet.
Teenage Dirtbag
Cryptocurrency is in its adolescence, and like a moody teenager, it is highly unpredictable, deeply volatile, and honestly kind of dumb. Maybe it’s just a phase or maybe this kid really sucks. Either way, a tiny bit of parenting could help.
Not worth it, you say? Let innovation drive the market, regulators be damned! Stay out of my business, government! Don’t tread on me! Get off my lawn!
Ok. Calm down Ron Swanson.
Let’s take a quick trip down memory lane. Remember last Thanksgiving? The turkey, the football, the turning leaves…the catastrophic free-fall of the crypto market writ large.
I love the autumn.
FTX Gets Fried
For critics who have ridiculed virtual currency as imaginary, behold FTX, which backed its FFT token with an imaginary security.
As trust-building exercises go…this is not a great play.
So here’s the capsule history on FTX.
Indeed, it seems FTX had labeled FTT a virtual cryptocurrency when it was, in fact, a mirage.
Over the next several days, Bankman-Fried’s accounts were frozen, he tendered his resignation, and filed for bankruptcy. At about the exact same time, it was reported that FTX had been hacked, and that the perpetrator had moved $477 million in FTT tokens to cold storage, then subsequently repositioned with Ether (ETH) tokens.
Caribbean Getaway
So yeah, that money’s gone. But it’s really just a drop in the ocean where lost money is concerned.
Bankman-Fried was subsequently arrested by authorities in the Bahamas and extradited to the U.S.
The court appointed John Ray to serve as interim CEO. He was the same man who was tapped to guide disgraced energy firm Enron through bankruptcy. This is fitting, because it turns out that FTX also perpetrated one of the biggest financial scams in history.
If it sounds complicated, Ray does an awesome job of simplifying things. Ray explains that FTX literally did “no bookkeeping” and characterized the whole shakedown as “old-fashioned embezzlement.”
Obviously FTX misunderstood the meaning of the word trustless.
Hazy Shade of Winter
Bankman-Fried is awaiting an October trial while wearing an ankle bracelet and living with his parents in Palo Alto. But before you get all swept up in a Martin Shkreli-kind of schadenfreude, you should know Bankman-Fried screwed all of us.
In the fall of 2022, crypto was already in a delicate state over inflation, war in the Ukraine, and the May 2022 collapse of the so-called stable coin, Terra. As events unfolded around FTX, the entire crypto market tanked like an NBA team angling for the #1 Draft Pick.
In late 2021, crypto market cap was pushing toward $3 trillion. One year later, in the immediate shadow of Bankman-Fried’s racket, that number had fallen below $900 billion.
Investors lost billions. Another crypto winter was upon us.
As for customers of FTX, John Ray suggests setting your expectations low. Translation—you ain’t getting your money back.
What’s the point of that whole story?
Oh yeah. Still think regulation of crypto would be a bad thing?
The Ripple Effect
Meanwhile, at the Hall of…well…not Justice. Let’s say, the Hall of Trying Their Best…
Meanwhile, at the SEC, Commissioners were working to bring some order to the crypto frontier.
It’s hard to view FTX as anything other than corporate freedom run amok. The SEC made its position clear on this subject when it issued an Investor Alert in March 2023. The general theme was that investors need to be extremely cautious when entering into a space that is not only volatile and speculative, but which lacks investor protections.
The SEC makes an important point here, that we’ll include in its entirety:
“Those offering crypto asset investments or services may not be complying with applicable law, including federal securities laws. Under the federal securities laws, a company may not offer or sell securities unless the offering is registered with the SEC or an exemption to registration is available. Similarly, the law requires parties such as securities broker-dealers, investment advisers, alternative trading systems (ATS), and exchanges to register with the SEC, a state regulator, and/or a self-regulatory organization (SRO), such as FINRA. Moreover, entities and platforms involved in lending or staking crypto assets may be subject to the federal securities laws.”
The SEC stakes out a pretty clear position. Virtual currencies are securities and therefore must be registered with the SEC before trading may occur. Additionally, exchanges facilitating the trade of these securities must also register with the SEC.
This is not a new position either. The SEC has been locked in legal battle with Ripple since 2020. In short, the SEC accuses Ripple of trading an unregistered security—in this case, its native XRP token. Most observers agree that the outcome of this case could set a major precedent in the crypto space.
The SEC’s case recently took a hit when a 2018 document surfaced in which then Division of Corporation Director Finance William Hinman explicitly stated that Bitcoin and Ether were not securities.
Security of the First World
The Hinman remarks loom large in light of the SEC’s most recent actions. On June 5th, the SEC sued Binance for operating an unregistered securities exchange, along with claims of fraud for misrepresenting the controls and oversight used to facilitate trading.
The next day, the SEC leveled the same charges against Coinbase.
Collectively, Ripple, Binance, and Coinbase represent an absolutely enormous share of the crypto market space. The respective outcomes of these cases will shape the future regulatory environment around cryptocurrency exchanges for years to come.
And really, in spite of the Hinman statements, the SEC’s position has been made quite clear in many other places. While we can’t predict the legal outcomes in these cases, there is good reason to think the longer road leads toward greater regulation.
Commenting this week, strategists at JPMorgan observed that "Eventually, the SEC position might be confirmed by lawmakers and Coinbase, Binance.US and other U.S. exchanges would have to register as brokers and most cryptocurrencies would be treated as securities.”
JPMorgan predicted that "This could be more onerous and more costly for the crypto industry but there could be positives as well, as crypto markets would be subjected to similar regulations applied to traditional markets such as equities and thus offer more transparency and investor protection.”
Of course, you can take it from JPMorgan—registering with the SEC is not exactly a stop sign when it comes to breaking the rules. It’s more of a “yield, look both ways, and proceed” sort of arrangement.
In fact, it might be helpful to think about this whole thing from JPMorgan’s perspective. Crypto firms don’t want to be regulated, and they want you to believe that regulation would be a threat to your freedom.
If JPMorgan told you the same thing, would you believe them?
We’re not here to advocate for a crypto police state. The crypto space, and Web3 in general, are built innovation. That innovation could lead to greater democratization of investing in the future.
But of course, there was nothing innovative about what happened at FTX. Like John Ray says—“old fashioned embezzlement.”
Bankman-Fried’s crimes suggest we’re living in relative anarchy right now—and it is not to your benefit as a consumer. Absent regulation, investors are without protection.
Possibly there’s a happy medium.
We’d rather find that happy medium now, before investors once again lose billions overnight.
Dave Lauer is a co-founder and CEO of Urvin Finance, where he leads the team in building Urvin Terminal. Prior to founding Urvin Finance, Dave spent over a decade advocating for financial market reform after quitting his job as a high-frequency-trader.