Crypto Regulatory Turbulence: SEC Actions and Industry Impact

The US Securities and Exchange Commission (SEC) continues to ramp up its actions against the crypto sector. This is despite the fact that in January, the agency approved multiple spot Bitcoin ETFs, and currently, the regulator is considering multiple applications for a US spot Ethereum ETF. 

SEC Chairman Gary Gensler, who has been on an anti-crypto tirade and has maintained that crypto platforms should register with the agency as most cryptos are securities, recently deferred on the question of whether the regulator views Ethereum as a security. He said:

“On any one of these crypto tokens, it's about the facts and circumstances as to whether the investing public is anticipating a profit based on the efforts of others.” 

However, not everyone at the agency is in favor of these moves, signaling that the SEC isn't entirely united in matters related to crypto. Although this does offer a ray of hope for the crypto sector in the US, it's to be seen just how the regulatory landscape would shape as the regulator continues to target crypto companies without offering any clarity or guidance. 

The Case of ShapeShift: Ambiguity Reigns at SEC

This week, SEC Commissioners Hester Peirce and Mark Uyeda publicly criticized the securities regulator's enforcement action against crypto firm ShapeShift. According to the commissioners, the SEC's move only adds to the “ambiguity” in the crypto industry. 

They argue that their agency has not clarified which of the 70 cryptocurrencies offered by the exchange it considered securities. The letter from two commissioners comes after the SEC settled with ShapeShift for US$275,000, a fine for reportedly selling unregistered securities. 

The agency charged ShapeShift AG for operating the online platform ShapeShift.io, through which it bought and sold crypto assets from and to users from 2014 until early 2021. It acted as a market maker for these assets, which the SEC says included crypto assets that were offered and sold as securities. In response, ShapeShift agreed to the cease-and-desist order and to pay the penalty but without admitting or denying the SEC's findings.

Founded in 2014 by Erik Voorhees, ShapeShift is a crypto exchange that transitioned into a decentralized autonomous organization (DAO) in 2021. Despite changes in the business model, on March 5, the SEC published the enforcement action against ShapeShift AG and found that ShapeShift acted as an unregistered securities “dealer,” in line with the agency's recent adoption of new rules for “dealer” registration. 

As per the SEC, anyone who engages in buying and selling securities for their own account through a broker or otherwise is defined as a dealer. These new rules are designed to cover decentralized finance (DeFi) exchanges and their users into the definition of “dealer.”

In response, SEC Commissioners Peirce and Uyeda highlighted the ongoing challenges and ambiguities faced by crypto innovators in their letter of dissent. The commissioners said the SEC's expanding its definition of dealer to reach active liquidity providers only increases the need for clarity. 

Taking a dig at the Commission, Peirce and Uyeda shared this dialogue, which they say is by “no means hypothetical” and emphasizes how difficult it's been for industry participants seeking to adhere to constantly developing regulatory standards.

Peirce has been a vocal supporter of crypto and a staunch critic of the SEC's attitude to crypto, including its actions against other top exchanges like Coinbase and Binance.

Now, in their letter, Peirce and Uyeda argued that the agency not only failed to identify which cryptocurrencies were investment contracts but didn't provide any explanation for its conclusion either. 

Calling it all a “poorly conceived crypto policy,” the two Commissioners noted that the latest story of ShapeShift recounts the tale of an early innovator in the crypto market, which has changed its business model for over three years, not to mention it has stopped acting as the counterparty to any customer transactions.  

Nearly a decade after ShapeShift first started trading, the SEC is suddenly after the exchange because it now claims that certain unspecified cryptos it traded in the past were investment contracts without providing an explanation, but what's notable is that the regulator didn't assert any harm or that the exchange cheated its users. Peirce and Uyeda wrote:

“This enforcement action underscores the adverse consequences of the Commission's approach to regulation in the crypto space and adds to the ambiguity that hangs over the crypto world.” 

They further noted that ShapeShift had no way of discerning which crypto would be considered a security by the SEC. As for the agency's standards to determine which specific assets are securities, they are “so opaque and arbitrary that the Commission itself is unwilling to stand by its own analysis,” they noted.

This, they said, discourages new entrants from building and innovating in the US, as “Why spend time and effort creating something only to face an enforcement action ten years later?” adding maybe “ambiguity is exactly the result the Commission wants.”

“The environment we have created for the crypto asset markets… It exposes well-meaning entrepreneurs to a regulatory sword of Damocles,” said SEC Commissioners Peirce and Uyeda, and warned that “Cases like this do not protect investors; they intimidate innovators and entrepreneurs.” 

The Case of Kraken: Setting a Dangerous Precedent

Earlier last month, Commissioner Peirce also wrote another letter of dissent after the SEC shut down Kraken's crypto exchange staking program.

Under Kraken's staking program, the exchange allowed its customers to offer their tokens up for staking in exchange for returns minus a fee paid to the trading platform. While the SEC wanted Kraken to register its program with the SEC as a securities offering, Peirce argued, the “fundamental question is whether SEC registration would have been possible” when crypto-related offerings are unable to make it through the SEC's registration pipeline. 

Moreover, staking services pose many complex issues, including whether the entire staking program would be registered or whether each token's staking program would be separately registered. Then, there are questions related to disclosures and accounting implications.

“Using enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating,” wrote Peirce, adding, given that staking services are not uniform, cookie-cutter analysis won't work here either. 

The most pressing issue here, however, is that the regulator's solution to a registration violation has been to simply shut down the program completely while it has served people well. Now, staking services would no longer be available in the US, while Kraken is prohibited from offering its program in the country, whether or not the exchange gets registered.

The SEC Commissioner noted:

“More transparency around crypto-staking programs like Kraken's might well be a good thing. However, whether we need a uniform regulatory solution and if that regulatory solution is best provided by a regulator that is hostile to crypto, in the form of an enforcement action, is less clear.”

While Kraken settled charges over its staking service, the crypto trading platform was also sued by the SEC last November for not registering and allegedly commingling customer and corporate funds.

Most recently, the exchange filed a motion to dismiss the SEC lawsuit against it, saying the agency didn't allege fraud or consumer harm but rather that “Kraken has somehow operated in plain sight for almost a decade as an unregistered securities exchange, broker-dealer, and clearing agency, in violation of the Exchange Act.” 

Moreover, the regulator stretched the definition of a contract, it said, noting the agency didn't “plausibly allege” any of the crypto assets mentioned in its complaint are securities or investment contracts. Drawing on arguments made in other cases currently ongoing, the motion says comic books or baseball cards are not investment contracts. 

Filed in the Northern District of California, the motion further argues that cryptos listed in the complaint shouldn't be treated like securities but rather like commodities. The SEC is also overstepping its jurisdiction, said Kraken, arguing that there is a Major Questions Doctrine issue. According to the motion, it could set a “dangerous precedent” for the regulator's powers.

In support of Kraken, the non-profit organization, The Blockchain Association, also filed an amicus brief addressing the legal case's impact on the entire crypto space. The Association urged the court to “reject the SEC's attempt to improperly expand its jurisdiction” by regulating digital assets beyond its authority granted by Congress. 

Blockchain advocacy group, the Chamber of Digital Commerce, is another one to file an amicus curiae, criticizing the SEC's approach to regulation as “aggressive.” The case also saw an amicus brief from the DeFi Education Fund and US Senator Cynthia Lummis (R-Wyo.) filed a brief, similar to the one filed by her office in the SEC's case against Coinbase.

Last week, eight US state attorneys general from Arkansas, Iowa, Mississippi, Montana, Nebraska, Ohio, South Dakota, and Texas, along with industry lobbyists, released a joint statement opposing SEC regulation. They made it clear that they were not in support of the exchange but rather in opposition to the federal regulator.

The states argued that the agency's undelegated authority puts their consumers at risk and that some state laws are far better at protecting customers than federal securities laws. “The court should reject categorizing crypto assets as securities absent an investment contract,” said the statement.

The Case of Binance & Coinbase: Impacting Businesses

In addition to Kraken, the SEC has filed a similar complaint against the US branches of other crypto exchanges, including Binance, Coinbase, and Bittrex. While Bittrex has already settled, lawsuits against the other two exchanges are ongoing.

Recently, Judge Tana Lin of the US District Court for the Western District of Washington ruled that transactions made in the secondary market for certain cryptos breached the security law. She further stated that the defendant, Sameer Ramani, who never showed up, used insider information to trade crypto before their listing on Coinbase, breaching federal securities law.

The ruling came from the federal judge in the Coinbase case from 2022 when the Department of Justice (DOJ) alleged that former Coinbase product manager Ishan Wahi, his brother Nikhil, both of whom pleaded guilty to charges and steel charges, and Ramani committed wire fraud and insider trading. 

In her ruling, Judge Lin noted that issuers promoted tokens based on their potential for returns, derived from the promoter's promised efforts to create, develop, and maintain an ecosystem that would increase the demand for a token and, in turn, its price.

While it was a default judgment and no amicus briefs were filed to counter the regulator's motion, the SEC has already submitted the ruling as supplemental authority in its cases against Coinbase and Binance.US. The SEC spokesperson said in a statement:

“The court specifically held that Howey applies in that context and that Ramani's trades of certain crypto assets on secondary market platforms were transactions in investment contracts.”  

Meanwhile, in the case of Binance.US, a deposition from its COO claims the SEC's suit last year in June caused banks to pull support from the exchange, “effectively choking the business.” According to the COO, it was a “near-mortal blow” to the platform, resulting in an immediate outflow of $1 bln and the termination of over 200 staff as revenues plunged about 75%.

“To banks, we're radioactive,” said Christopher Blodgett, Binance.US COO, in a December deposition shared in a March 5 court filing.

About a year ago, the SEC charged founder Changpeng Zhao, aka “CZ,” Binance, and its US arm, Binance.US, with selling unregistered securities, being involved in wash trading, and commingling user funds. Then, in November, Zhao and Binance admitted to violating money laundering and terrorism financing laws and settled with the DOJ, Treasury, and the Commodity Futures Trading Commission (CFTC) for $4.3 billion.

Binance.US, however, is still fighting the SEC in court. This week, the watchdog requested the court intervene in the discovery process after coming to an impasse with the exchange. The SEC claims the platform isn't cooperating and doubts that it is in the custody of wallets' private keys.

Representatives of Binance.US counter that they provided all the answers even when they had been “exceptionally broad” and that they've only declined to offer information on trade secrets as they don't affect the ownership of customer assets. Having provided thousands of pages of documents, reports, and inspections of custody devices, Binance.US now requests an end to the discovery process so that the court can make a decision regarding its affairs.

Final Thoughts

While the SEC has taken an anti-crypto stance, the CFTC has been friendly towards the sector. This week, CFTC Chairman Rostin Behnam repeated the need for Congress to pass legislation to address its jurisdiction in the cryptocurrency space.

“We need to fill the gap in crypto regulation,” said Behnam when he made an appearance before the US Senate Committee on Agriculture. Expecting crypto to go away is a “false narrative,” and as such, there is a need to act and Congress to fill this gap, he added.

Benham then went on to say that if Congress passes the Financial Innovation and Technology Act for the 21st Century (FIT Act), he's “confident” that his agency can create a regulatory framework in a year.

CFTC's friendly approach is certainly helpful. However, for now, the SEC remains a major agency when it comes to digital assets regulation, which has been taking an enforcement approach to the crypto industry. Moreover, all these actions taken by the SEC only show that there is much confusion surrounding how to determine which crypto assets are considered securities. This regulatory ambiguity affects the broad crypto industry and creates a challenging environment for entrepreneurs in the US.

Click here to learn how regulators will shape 2024 for crypto, not ETF approval or halving.