Several crypto companies have expressed concerns over the lack of clear guidelines regarding the rules they should adhere to. However, the U.S. Securities and Exchange Commission took decisive action earlier this month by filing two lawsuits that eliminated any uncertainty regarding the regulatory stance.
The agency asserts that several business practices commonly accepted in the crypto industry during the prosperous years are deemed illegal in the U.S.
The lawsuits target the leading global cryptocurrency trading platforms, Binance and Coinbase, alleging that both platforms operate unregistered securities exchanges and brokerages. Both companies insist that they do not offer coins to U.S. investors that can be classified as securities.
According to a senior market analyst at Oanda Corp., Ed Moya, the SEC is engaging in a game of cat and mouse with crypto exchanges. He added If the SEC’s arguments succeed against these two companies, the implications could extend far beyond imposing restrictions on the operations of other trading platforms.
Moya also maintained it might compel creators of cryptocurrencies to register their tokens as securities if they wish to facilitate trading within the U.S.
A few minutes ago, the SEC filed its response to the last week's Third Circuit. You can read it for yourself below together with my own initial read of it. 1/5
— paulgrewal.eth (@iampaulgrewal) June 13, 2023
The lawsuit against Binance, the more comprehensive of the two cases, targets the purportedly decentralized structure adopted by several cryptocurrency companies.
Binance, which operates primarily outside the U.S. without an official headquarters, prohibits American users from trading on Binance.com. However, those users can trade on Binance.US, a more restricted platform intended to be distinct.
The SEC claims that all these businesses were under the tight control of Binance founder Changpeng Zhao. The financial watchdog also maintains that a significant amount of money from U.S. investors went to Binance.com.
Like a previous legal action initiated by the Commodity Futures Trading Commission in March, the SEC alleges that Binance engaged in covert practices. These practices encouraged U.S. customers to utilize virtual private networks (VPNs) to conceal their location and gain access to the primary exchange.
The SEC asserts that this is just one example of how the company knowingly breached federal securities laws. According to the complaint, Binance’s former chief compliance officer reportedly admitted in 2018 to another compliance executive that the company was operating as an unlicensed securities exchange in the U.S.
The SEC also accuses Binance of misleading customers through “wash trading,” which involves a single entity selling its securities to itself. The agency suggests that Sigma Chain, a trading company owned and controlled by Zhao, may have artificially utilized this practice to inflate crypto trading volumes on Binance.US.
Binance has denied these allegations and expressed disappointment in the SEC’s decision. In a blog post, the company criticized the regulator for opting for heavy-handed enforcement instead of a more nuanced approach.
In response to the SEC complaint, Zhao posted a tweet with “4,” which signals his customers and online followers to disregard any fear, uncertainty and doubt surrounding the company.
SEC’s complaint also identifies digital coins, such as ADA from Cardano, SOL from Solana and MATIC from Polygon, as securities traded on Binance’s platform.
1/ The stakes just keep getting higher for the ruling in SEC v. @Ripple.
— MetaLawMan (@MetaLawMan) June 8, 2023
In contrast to Binance, Coinbase operates as a cryptocurrency exchange based in the U.S. and has always emphasized its adherence to U.S. regulations. Coinbase regularly submits disclosures to the SEC regarding its operations as a publicly traded company. However, it is not officially registered as a securities exchange.
According to Hannah Miller from Bloomberg, this fact would not be an issue if Coinbase solely facilitated the buying and selling of Bitcoin. Traditionally, regulators view Bitcoin, the largest cryptocurrency globally, as a commodity akin to digital gold rather than an investment like stocks, bonds or mutual funds.
Similar to Binance’s case, the SEC’s lawsuit against Coinbase claims that ADA, SOL and several other coins should be classified as securities, necessitating registration.
The SEC argues that these coins’ value and performance depend on the actions and decisions of the entities offering them, a characteristic that aligns with the legal definition of securities falling under the SEC’s authority.
Just like stocks, creators of these tokens frequently raise funds for their projects. They do so by selling the coins to venture capital investors and conducting initial coin offerings. These offerings provide an opportunity for regular crypto enthusiasts to participate.
Coinbase provides a product called Earn that allows customers to earn interest on specific coins by staking them or using them to operate crypto blockchains. According to the SEC, this program is considered an unregistered security.
CEO Brian Armstrong took to Twitter to express his confidence in Coinbase’s compliance with the law. He pointed out that the SEC has not provided a transparent registration process for the company.
Armstrong said that Coinbase had made multiple efforts to comply with regulations but has decided not to list securities. Additionally, he emphasized that the SEC had thoroughly examined the business during its initial public offering.
According to Anthony Tu-Sekine, the leader of Seward & Kissel’s blockchain and cryptocurrency group, Armstrong’s statement to the SEC implies that the SEC approved its actions during its initial public offering. Now, the agency claims the company is “illegal.”
Tu-Sekine further explained that the SEC’s review of a company’s IPO filing does not usually serve as a sufficient legal defense against allegations of violating federal securities laws.
Armstrong also made a clear distinction between the challenges faced by Coinbase and the more severe allegations directed at Binance. “The Coinbase suit is very different from others out there — the complaint filed against us is exclusively focused on what is or is not a security,” he said.
As reported by Bloomberg, despite its technical nature, the lawsuit poses a significant threat to Coinbase’s operations. This is due to the company’s capability of offering a wide variety of coins, which enables users to engage in more trading activities and generates fees for Coinbase.
Owen Lau, an analyst from Oppenheimer & Co., echoed similar concerns regarding the potential impact on Coinbase’s financial stability. He highlighted the consequences if the SEC imposes restrictions on trading specific tokens classified as securities.
“I would say the revenue at risk could be over 50%,” he said. Lau also acknowledged that the SEC might not prevail on every argument in the case.
Moya said the lawsuit could potentially have a disastrous impact on the broader digital asset industry. He suggested that people who cannot trade their preferred currencies may move to Bitcoin or switch to alternative platforms.
Per Bloomberg, treating coins as securities could require significant changes for exchanges that choose to list them. The SEC maintains that Binance and Coinbase fulfill the roles of an exchange, a brokerage and a clearing agency.
In the securities industry, these functions are typically separated into different legal entities to mitigate conflicts of interest.
Bloomberg predicted that the legal disputes between the SEC and Binance and Coinbase are expected to extend over a prolonged period, potentially spanning several years.