originalThe SEC Comes for Crypto, compiled by Odaily jk.
By Matt Levine Matt Levine is a Bloomberg Opinion columnist covering finance coverage. He was the editor of Dealbreaker, worked in the investment banking division of Goldman Sachs, served as an MA attorney for Wachtell, Lipton, Rosen Katz, and served as an associate judge on the U.S. Court of Appeals for the Third Circuit.
By Matt Levine Matt Levine is a Bloomberg Opinion columnist covering finance coverage. He was the editor of Dealbreaker, worked in the investment banking division of Goldman Sachs, served as an MA attorney for Wachtell, Lipton, Rosen Katz, and served as an associate judge on the U.S. Court of Appeals for the Third Circuit.Editors note: Matt Levines writing style is extremely beginner-friendly. This article was written after the SEC sued Binance;One of the fundamental disagreements between the SEC and Binance, and the central point discussed in this article, is whether or not a cryptocurrency is a security.
Disclaimer: The following does not represent the views of Odaily, nor does it constitute investment advice. Cover image via Marvel.
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SEC Sues Crypto Faucet
“There is a basic standard now that all cryptocurrency exchanges are criminal, and if you are lucky, the exchange you use is only criminal in procedure (not in result).” Why? Examples are as follows:Is your exchange illegally operating a stock exchange in the US? Yes! Indeed! At leastEvery Cryptocurrency Exchange in the U.S. Is Illegal According to the SEC
. You may not agree with this point of view - many executives of cryptocurrency exchanges do not agree, and we will discuss these arguments in detail below - but from a practical point of view, if you are trading cryptocurrency, you are not completely Thorough compliance with US securities laws.
Is Your Exchange Stealing Customers Funds? may be! Some are, but some are not. If youre a client, this is what you should be most concerned about."Running a stock exchange illegally and stealing client funds are related, but they are two different things."Oh, I shouldnt have entrusted my money to people who broke the laws of the United States
: Of course, yes, this is a reasonable position that will save you from a lot of cryptocurrency disaster, but will also prevent you from trading cryptocurrency at all. this is your choice!
My rationale for all this is exaggerating a bit -- but not too much.
Yesterday, the U.S. Securities and Exchange Commission (SEC) sued Binance, the world’s largest cryptocurrency exchange, and its founder Changpeng Zhao, accusing them of illegally operating a stock exchange. Today, the SEC filed another lawsuit against Coinbase Inc., the largest U.S. cryptocurrency exchange, for illegally operating a stock exchange.
There are basically two ways that cryptocurrency exchanges can get into disputes with the SEC. One good way is to get in trouble for running an illegal stock exchange (i.e. offering unregistered securities). In April, the SEC filed a lawsuit against Bittrex Inc. for allegedly illegally operating a stock exchange; any reasonable reading of the Bittrex case makes it clear that similar cases would also be brought against Coinbase and Binance. In the view of the SEC, as long as it is a cryptocurrency exchange in the United States, it is illegal.Another bad way to get in trouble for stealing client funds. Last December, the SEC filed a lawsuit against a major cryptocurrency exchange, FTX Trading Ltd. This is the SECs allegation against FTX. I can say with absolute certainty that the SEC believes that FTX is indeed operating a stock exchange illegally in the United States. But thats not mentioned in the indictment -- because there are so many other issues to deal with.
FTX allegedly stole all of its customers’ funds; when an exchange steals funds, the SEC will focus on this. When not all funds are stolen, the SEC is concerned with the issue of illegal stock exchanges.
So with these cases this week, the question is: Is the SEC suing Coinbase and Binance because they are crypto exchanges, or because they are nefarious crypto exchanges? Is the charge here you allow people to trade cryptocurrencies, which we consider illegal or you entice people to trade cryptocurrencies and steal their principal?
For Coinbase, I think the answer is obvious. Compared to other cryptocurrency exchanges, Coinbase is very legally compliant. It is a US public company registered in Delaware and listed on NASDAQ. It went public by going public in 2021, filing an exhaustive disclosure document with the SEC. Its financial statements are audited by Deloitte. Its business model appears to be to receive funds from customers, use those funds to purchase cryptocurrencies, and hold the cryptocurrencies securely in accounts named after the customers. I dare not make any bold assertions about any cryptocurrency player, and Ive been wrong before, but I dont think Coinbase is stealing customers funds.
In fact, the SECs charges against Coinbase are pretty frivolous and focus entirely on the fact that Coinbase is not registered as a securities exchange. Again, in the SEC’s view, every cryptocurrency exchange violates U.S. securities laws. But relatively speaking, Coinbase’s breach was polite and relatively harmless. Not entirely harmless — the SEC said, “Coinbase’s unregistered conduct deprived investors of important protections, including SEC inspections, record-keeping requirements, and safeguards against conflicts of interest.” But the impact was relatively minor.
For Binance, the answer is more interesting. As far as cryptocurrency exchanges go, Binance has a little level of compliance with the law, but not much — it’s notoriously opaque and has an uncertain headquarters, designed to avoid a tangled web of regulations. (The SEC quotes its chief compliance officer as saying in 2018, “We never want [Binance] to be regulated.”) Similar to FTX, it has its own token — BNB; it has its own affiliate trading company; Separate platforms for US customers (Binance.us) and customers in the rest of the world (Binance.com). It was sued by the U.S. Commodity Futures Trading Commission in March for allowing large U.S. clients such as high-frequency market makers such as Jane Street and Tower Research to trade on its Binance.com exchange through its offshore affiliates, and The CFTCs indictment also raised the issue of terrorist financing.Similarly,The SEC’s complaint against Binance claims to have seized some evidence of wrongdoing by Binance.
Binance has a number of affiliated market makers, including firms such as Sigma Chain AG and Merit Peak Ltd., which are said to be controlled by Changpeng Zhao and trade on Binance’s Binance.com and Binance.us. The SEC hinted at suspicious activity:
For example, by 2021, at least $145 million will be transferred from BAM Trading (i.e., Binance.us) to Sigma Chain accounts, and another $45 million will be transferred from BAM Trading’s Trust Company B account to Sigma Chain accounts. Sigma Chain purchased a yacht for $11 million from the account. (Suggestion only, no actual evidence)
Moreover, from September 2019 to June 2022, Sigma Chain AG (hereinafter referred to as Sigma Chain), a trading company owned and controlled by Changpeng Zhao, conducted shuffled transactions, artificially exaggerating the value of encrypted asset securities on the Binance US platform. transaction volume.
Additionally, the SEC alleges that Changpeng Zhao and Binance exercised control over client assets on the platform, allowing them to mix or transfer client assets at will, including to Sigma Chain, a company owned and controlled by Changpeng Zhao.（However, the SEC has not put too much emphasis on these allegations, most of which are the same as those of Coinbase: Binance is accused of operating open to U.S. customers without registering as a U.S. stock exchange and listing some of the securities it has identified. Cryptocurrency exchange for crypto tokens for securities. I tend to think of yesterdays lawsuit as an endorsement of Binance by the SEC. The SEC, and before it the CFTC, scrutinized Binance and wrote a 136-page complaint），Odailys in-depth interpretation of the prosecution documents
But the only problem they could find was that Binance was just running a cryptocurrency exchange.
While the arguments in the two indictments are mostly the same, Coinbase and Binance take very different stances. The key legal question (which we discuss below) is whether crypto tokens listed on Binance and Coinbase are securities. If they are identified as securities, chances are that Coinbase and Binance (and Bittrex and every other exchange) are running illegal securities exchanges; if they are not securities, then everything is fine. Coinbase recognizes this as a potential risk and has established committees and procedures to consider and mitigate this risk. A description from the SEC’s complaint against Coinbase:
Given that at least some cryptoassets are offered, sold, and distributed by an identifiable group of persons or promoters, Coinbase publicly released the “Coinbase Cryptoasset Framework” around September 2018, which includes a framework for cryptoasset issuers and Application form for Promoters to list their crypto assets on the Coinbase platform.
Coinbase’s listing application requires issuers and promoters to provide information about their crypto assets and blockchain projects. It explicitly asks for information relevant to performing a Howey analysis on cryptoassets.
Additionally, around September 2019, Coinbase and other crypto-asset businesses created the “Crypto-Asset Rating Council” (CRC). The CRC then released a framework for analyzing cryptoassets that distills a concise set of yes-or-no questions designed to unambiguously answer the four elements of the Howey test, assigning cryptoassets a scale of 1 to 5. A score where 1 means the asset has few or no characteristics consistent with an investment security and 5 means the asset has many characteristics that strongly align with a security.
In announcing the formation of the CRC, Coinbase said: “While the SEC has issued helpful guidance, determining whether any given cryptographic asset is a security ultimately requires a fact-based analysis.” Based on the opinions of the SFC and the court.)
Very responsible, right? Still, the SEC disagreed with Coinbase’s conclusions and took some issue with its process:
The number of crypto assets traded on the Coinbase platform more than doubled between late 2019 and late 2020, and more than doubled again in 2021. During this period, Coinbase offered crypto assets that scored high under the CRC framework on the Coinbase platform. In other words, in order to achieve the exponential growth of the Coinbase platform and increase its own trading profits, Coinbase made a strategic business decision to add these crypto assets to the Coinbase platform even recognizing that they have securities characteristics superior.
In the meantime, here’s how Binance’s “brilliant” head of compliance describes fact-based analysis of whether Binance is listing security tokens in the U.S.:
As Binance’s head of compliance candidly admitted to another Binance compliance officer in December 2018, “We’re running a fucking unlicensed stock exchange in the US, bro.”
How clear is this angle! Coinbase hired a lot of lawyers, did a lot of analysis, and wrote a lot of checklists to convince itself that it was legal to operate a crypto exchange in the United States. The attitude of Binance is maybe this is illegal in the United States, well, it doesnt matter. The SEC completely agrees with Binance. (i.e. feel both are illegal at the same time)This could be good news for Coinbase: It may be able to appear in court as a good-faith actor trying to comply with the law, while Binance looks like a malicious actor trying to ignore the law; Coinbase may win its lawsuit with the SEC while Binance may fail.Binance notes that operating a crypto exchange in the U.S. is likely to be illegal, but it does so anyway, but it minimizes and compartmentalizes its U.S. exposure: it has relatively few clients in the U.S. and appears to place most of its business in the U.S. placed outside the United States. Coinbase is all-in on trying to operate a legal and regulatory-compliant crypto exchange in the U.S., and now the SEC says that’s not possible. If the SEC is right, whats left for Coinbases business?
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What exactly are securities?
Alright, let’s discuss the basic theory the SEC is proposing here, which we’ve discussed before when the SEC sued Bittrex:
1. If you operate an exchange that offers securities trading in the United States, you need to register with the SEC as a securities exchange.
2. Crypto tokens offered by Binance and Coinbase are securities.
3. They did not register their US exchange as a stock exchange.
4. Violation!
The first point is a bit more complicated than you might think; for example, there are stock trading venues that are not registered as stock exchanges, they are registered as other forms of organizations under other rules. But from the SECs perspective, what matters is that the rules of the stock exchange protect investors. In particular, they often call for a separation of three key functions that are often combined together in cryptocurrencies, including an exchange that matches buyers and sellers, a broker/dealer who trades on the exchange on behalf of clients, and the actual Clearing house for moving money and securities. In the stock market, you place an order on Robinhoods website to buy shares on the New York Stock Exchange, and the Depository Trust Co., the depository, keeps the shares and settles the trade. Whereas in the cryptocurrency market, you place an order on Coinbases website to buy cryptocurrency on Coinbase, and Coinbase holds the cryptocurrency and settles the transaction.But the focus here is on the third point: Are crypto tokens considered securities?The SEC’s basic view is that most crypto tokens — not all, excluding Bitcoin, but most — are securities under U.S. law.
Coinbase apparently doesnt think many of them are securities. The specific issue at stake here is that a range of popular crypto tokens, including Solana’s SOL, Cardano’s ADA, Polygon’s MATIC, Filecoin’s FIL, Decentraland’s MANA, Algorand’s ALGO, Axie Infinity’s AXS and Voyager Digital’s VGX, are they listed as securities, the SEC mentions that they are listed on Binance and/or Coinbase.
U.S. securities laws define securities to include, but are not limited to, stocks, certificates of interests or shares in profit-sharing agreements, pre-establishment or subscription certificates, transferable shares, investment contracts, [or] voting trusts, Certificate. One of the most commonly used terms is investment contract, as interpreted by the U.S. Supreme Court in a famous 1946 case, SEC v. WJ Howey Co.
According to the Securities Law, an investment contract means a contract, transaction or scheme in which an individual invests funds in a joint enterprise with the expectation of making a profit purely through the efforts of the promoter or a third party, regardless of whether the shares in the enterprise are formally certificated or issued by Proof of nominal interest in real assets. Such a definition ... makes it possible for legal purposes to require full and fair disclosure of the multitude of instruments that are conventional concepts of securities in our business world ... it embodies a flexible rather than static principle, capable of adapting The myriad and varied schemes devised by those seeking to use other peoples funds for profit on their promises.
Investors provide capital and share in proceeds and profits, and promoters manage, control and operate the business. Therefore, whatever the legal terminology used for the specific arrangement of these investor interests, an investment contract is involved.
The point is whether the scheme involves investing money in a joint venture, with profits derived entirely from the efforts of others. If this test is satisfied, it does not matter whether the business is speculative or non-speculative, whether there are property sales with or without intrinsic value.This creates the Howey test, where the court asks whether: (1) the funds invested; (2) the joint venture; (3) the expected profits; and (4) whether the profits are solely the result of the efforts of others.
The SEC has argued since 2017 that most crypto businesses fit this description.
Take Solana as an example. Solana is a blockchain that runs cryptographic applications and its native token is called SOL. Heres how the SEC explained Solana:
SOL is the native token of the Solana blockchain. The Solana blockchain was created by Solana Labs, Inc. (hereinafter referred to as Solana Labs), a Delaware company headquartered in San Francisco, founded by Anatoly Yakovenko (hereinafter referred to as Yakovenko) and Raj Gokal (the current CEO of Solana Labs and COO) was founded in 2018. According to Solanas website www.solana.com, the Solana blockchain is a network on which decentralized applications (dApps) can be built, consisting of a platform designed to increase blockchain scalability and enable high transaction speeds, Adopt a combination of consensus mechanisms.
According to Solana’s website, SOL can be “staked” on the Solana blockchain to earn rewards, and a tiny amount of SOL must be “burned” when a transaction is proposed on the Solana blockchain. This is a common feature of native tokens on blockchains, and is used to avoid potential bad actors from “crowding” a blockchain with an infinite number of proposed transactions through a cryptographically distributed ledger.
Solana Labs is selling SOL tokens to raise funds for building the Solana ecosystem:
Solana Labs has publicly stated that it will funnel the proceeds of private and public SOL sales into a comprehensive encrypted asset wallet under its control, and will use these funds for the development, operation, and marketing of the Solana blockchain to attract more users to the blockchain. Blockchain (since those wishing to interact with the Solana blockchain need to provide SOL, this may increase the demand and value of SOL itself). For example, in its private sale of SOL in 2021, Solana Labs publicly stated that it would use investor funds to: (i) hire engineers and support staff to help grow Solana’s developer ecosystem; introduce users to market-ready applications in the crypto space”; (iii) “launch an incubation studio to accelerate the development of decentralized applications and platforms built on Solana”; and (iv) establish a “dedicated Venture Capital Department and Trading Department.
Howeys test:
1. Has the investor committed capital? Yes, SOL tokens are being sold as currency to raise funds to build Solana.
2. Is there a joint enterprise? Yes, Solana is a business; its a blockchain ecosystem competing with Ethereum, Cardano, etc., designed to attract users.
3. Are there any profit expectations? Yes, people bought SOL hoping that its price would go up, and it actually did.
4. Does the profit come from the efforts of others? Yes, the price of SOL increased because its promoters and developers made Solana a popular blockchain, increasing the demand for SOL.
These are often difficult questions to judge. Most large crypto blockchains are decentralized to some extent; Solanas growth depends not only on the efforts of Solana Labs, but also on the efforts of third-party users and developers who enjoy using it. For some crypto tokens, it can be reasonably argued that people buy tokens not as an investment in anticipation of profit, but to pay for transactions on the blockchain; the SOL token is the way people run programs and The fuel used in transactions, if SOL is purchased as a pure utility token, then it can be said that it is not a security. Most crypto tokens have both utility value and speculative investment characteristics, which complicates the analysis.
Also, even if youre buying SOL as a speculative investment, its not clear that youre buying it to share in the profits of the underlying business. Your thought process might be If I buy SOL, a lot of other people will probably buy SOL, its price will go up, and Ill make money. Thats not the expectation of profit from the efforts of others; The speculative frenzy and the anticipation of profits in online memes. We talked about Dogecoin yesterday, which is a joke crypto token where people openly promise not to do anything to build the ecosystem; people buy Dogecoin because they think other people will buy Dogecoin. Personally, I take this to mean that Dogecoin is not a security; the effort of others involved in a purely meaningless token is not enough to qualify. (No doubt, teddy bears like Beanie Babies are not securities.) And even where crypto projects do promise hard work, ecosystems, and hard-working, smart developers, the sheer reason many people buy tokens may not be the same reason they buy Dogecoin Same, that is, for numerical gains.But I like to think of the relationship between crypto and securities as that most crypto tokens are in some way clearly similar to stocks of some underlying technology business. In Solana (and Cardano, Polygon, etc.), the underlying business is a platform business for building a blockchain ecosystem of applications, primarily financial services applications, primarily for trading cryptocurrencies. Everyone who buys these tokens is, in some loose sense, a quasi-shareholder in the business.
They get rewarded in the same way as traditional shareholders: stock buybacks. And a stock buyback in crypto terms is called a burn.
Additionally, Solana Labs promotes its burning of SOL tokens as part of a deflation model. As Yakovenko explained in an article titled Solana (SOL): Scaling Cryptocurrency to the Masses published on gemini.com on April 14, 2021: Solana transaction fees are paid in SOL, and By burning (or permanently burning) as a deflationary mechanism to reduce the total supply and thereby maintain a healthy SOL price.” As explained on the Solana official website, since the launch of the Solana network, the “current total supply” of SOL has been traded Burning of fees and planned token reductions due to reduced activity. This marketing of the burning of SOL as part of the Solana networks deflationary mechanism gives investors reason to believe that their purchases of SOL have profit potential, as the built-in mechanism reduces the supply and thus increases the price of SOL.
In its complaint against Binance, the SEC cited Changpeng Zhao’s description of Binance’s own BNB token burn mechanism:
In fact, on July 9, 2019, Changpeng Zhao described Binance’s planned BNB burn in an interview posted on YouTube, stating that “the benefit we promised in the white paper is that every quarter we will use 20% of the Profits buy back [BNB] at market value...we will buy back and burn these tokens. We will burn up to 100 million BNB. Basically half of all tokens available...financially, its the same as the economy Dividends on it are the same way.”i mean i would sayIt works the same way as a stock buyback
, but of course dividends and stock buybacks are essentially equivalent. The point is, in a crypto project, shareholders (sorry, token holders) share in the projects profits when a portion of the revenue is used by the project to buy back and burn tokens, increasing the value of the remaining tokens, just as stock buybacks do the same way.
One way to understand cryptoeconomics is that cryptocurrencies construct a new way to sell shares in promised promising technology and financial businesses without calling them stocks. For example, if you were launching a cryptocurrency exchange and wanted to raise capital, you could offer investors shares in your business. If the business does well, there will be substantial profits (from transaction fees charged to clients) which you will share with your investors. But there are some problems with this:
1. If selling stock to the public, you will need to register with the SEC.
2. If selling stock to large VCs, they will need to register for resale with the SEC, or otherwise seek an exemption from SEC registration.
3. Either way, you may need to provide some kind of financial information about the business to investors in order to secure funding.
4. Shareholders may expect voting rights, ongoing financial disclosure, etc., which are customary and often required by law.
Or, if youre starting a cryptocurrency exchange, you can go to investors and offer them tokens from your business. If the business works well, there will be substantial profits (from charging clients transaction fees) and you will share these profits with investors (by buying and burning tokens). This is very nice:
1. If you sell tokens to the public, you can declare that they are not securities and do not need to register with the SEC.
2. If you sell your tokens to large VCs, they can declare that these tokens are not securities and resell them freely.
3. You will write a white paper to sell the tokens, which does not necessarily need to contain extensive financial or operational details.
4. You can give tokens any rights you want.
You can see why crypto folks love this! It combines regulatory arbitrage with an exciting philosophical novelty. You can also understand why the SEC doesnt like this! The SEC is well aware of countless and varied schemes that seek to use other peoples funds for the promised gain. The SEC is the regulator that gets bypassed in arbitrage. And it clearly doesnt like this.
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What happens after the SEC sues?
In principle, here are several possible outcomes:
1. The SEC wins and cryptocurrencies are more or less banned in the US. Bitcoin, Ethereum, and possibly Dogecoin can still be purchased in the US because they are not securities, but any other crypto item may be considered a security and not be traded in the US. Cryptocurrencies fade and die, and people turn to artificial intelligence. The SEC has killed cryptocurrencies with a slow vengeance as they try to bypass the SEC’s oversight.
2. Same situation, except that cryptocurrencies have grown and grown elsewhere, and the US has missed out. Cryptocurrencies are proving to be of great world change and value, and the US is left behind in the race. Or cryptocurrencies are proving to be a strange niche financial product that can be traded in Europe but not in the US, like binary options or contracts for difference. Either way, cryptocurrencies have survived abroad but failed to grow in the United States.
3. The SEC wins, and then some existing crypto companies, new crypto players, and traditional financial services companies work together to find a way to trade cryptocurrencies in compliance with US securities laws. Everyone goes all out and says “well, Solana will start filing annual reports and audited financial statements,” people are going to build crypto exchanges that are registered with the SEC, separate from clearinghouses and brokerages, etc. This seems very difficult since the SEC is clearly not interested in any crypto projects. Im not going to sit here and tell you how crypto companies can register their tokens as securities. No doubt Coinbase has been trying to figure out how to do this, constantly harassing the SEC for regulations that allow it, but so far, no luck. But I think its also possible.
4. The SEC fails, the court says what, no, none of these things are securities, and cryptocurrencies continue to trade in the US without much securities regulation.
5. Congress (or future SEC) steps in to change the rules, saying Of course, all of this is technically illegal under existing law, but its insane to stifle innovation like this, so were going to make new rules that allow U.S. for regulated transactions in cryptocurrencies.”I dont know which outcome will happen.
This last outcome is what the cryptocurrency industry expects, and Congress seems to have some interest in creating cryptocurrency regulations.But what I want to say is,The SEC is clearly betting on the first outcome.
That’s why these cases are only now being brought after the collapse of FTX and many other large crypto companies, after the price of cryptocurrencies fell, and venture capitalists turned to AI. These cases against Binance and Coinbase are high-stakes cases for the SEC: Coinbase and Bitcoin are large companies with sufficient funds, good lawyers and lobbying teams, they have the resources and incentives to fight to the end, and do have Pretty good legal point. The SEC may lose! But it is strategically maximizing its odds. I wrote in February:
When cryptocurrencies are popular and looking exciting and going up, if youre a regulator that says no, we have to stop this, you look like a poacher. Investors want to put their money in something thats going up, and youre holding them back, and theyre angry. Politicians love things that go up and hold hearings on how you stifle innovation. Crypto founders are rich and popular, criticize you on Twitter and get tons of likes and retweets. Your own regulatory staff is eyeing their next private sector job, where they want to be leaders in crypto innovation, not just ban everything.
When cryptocurrencies drop and many projects disappear as frauds and bankruptcies, you can say I told you so (its a scam). Back then, people would have preferred regulation, or banning everything altogether. A sued founder of a bankrupt crypto company can say you stifled innovation, but no one cares.
