The crypto industry is running out of ground to stand on, particularly in the US.
Since the price of Bitcoin tumbled off its exuberant $69,000 high in late 2021, the bear market in digital assets has often been described as a “crypto winter.” That’s not bleak enough to capture what’s happened. In quick succession, crypto has seen financial contagions, multiple cases of alleged fraud and outright theft, the collapse of several trading and lending platforms, and the evaporation of about $1.8 trillion in market value across all coins. Celebrity endorsers have been embarrassed and in some cases fined, trend-chasing venture capitalists have pivoted their attention to chatbots, and the letters “FTX” have been taken down from Miami’s basketball arena. And millions of ordinary investors have been badly burned.
Through it all, regulators including the US Securities and Exchange Commission have steadily ramped up enforcement actions, with hints of more to come. Many crypto businesses have complained about a lack of clarity concerning what rules, if any, they were supposed to follow. In early June the SEC filed a pair of lawsuits that remove any ambiguity about where the watchdog stands: The agency contends that many of the business practices people in crypto took for granted during the boom years are not legal in the US.
The suits take on the world’s two largest crypto trading platforms, Binance and Coinbase, accusing both of running unregistered securities exchanges and brokerages. Both companies say they don’t offer US investors coins that can be considered securities.
“The SEC is now playing whack-a-mole with crypto exchanges,” says Ed Moya, senior market analyst at Oanda Corp., a currency trading platform. But if its arguments prevail against these two companies, the impact could be far wider, reining in the activities of other trading platforms and perhaps forcing cryptocurrency creators to register their tokens as securities if they want them to be tradeable in the US.
The suit against Binance Holdings Ltd.—the more sweeping of the two—takes aim at the supposedly decentralized nature of many crypto companies. Binance has no official headquarters and operates mainly outside the US. Americans aren’t supposed to be able to trade on Binance.com, though they can trade on Binance.US, a more limited service that’s supposed to be separate. The SEC alleges that all the businesses were closely controlled by Binance founder Changpeng Zhao and that plenty of money flowed from US investors to Binance.com.
Echoing an earlier lawsuit filed against Binance by the Commodity Futures Trading Commission in March, the SEC says that Binance quietly encouraged US customers to use virtual private networks that would hide their location and allow them to access the main exchange, and that this is only one of the ways the company knowingly violated federal securities laws. The complaint states that in 2018, Binance’s chief compliance officer at the time told another compliance executive, “we are operating as a fking unlicensed securities exchange in the USA bro.”
The SEC also says that Binance misled customers through a practice known as “wash trading,” where the same entity sells its own securities to itself. The agency says Sigma Chain, a trading company Zhao owns and controls, might have used the practice to artificially inflate crypto trading volumes on Binance.US. In other words, some of the frantic crypto trading that people raced to get in on was an illusion, the SEC says. Binance has denied the allegations and said in a blog post that the company was “disappointed” with the SEC’s decision and that the regulator had chosen to use “blunt weapons of enforcement” rather than a more nuanced approach. Responding to news of the SEC complaint, Zhao posted a tweet that started off with “4”—a shorthand signal to his customers and online fans to disregard so-called fear, uncertainty and doubt about the company. (“Ignore FUD, fake news, attacks, etc.” is fourth on a list of his New Year’s resolutions for 2023.)
Even crypto enthusiasts who don’t do business with Binance may have felt some FUD over the next part of the SEC’s complaint. It listed several digital coins, including Cardano’s ADA, Solana’s SOL and Polygon’s MATIC, as securities that were sold on Binance’s platform. SEC Chair Gary Gensler has long called out crypto companies for peddling unregistered securities, and he’s said most existing tokens probably fit that definition. The June 5 Binance complaint essentially provided a list of some of the most popular coins that the SEC regards as securities. It foreshadowed the lawsuit that would hit Coinbase the next day, because the company offers many of the same coins on its platform.
Unlike Binance, Coinbase Global Inc. is a US-based exchange, and it’s long touted its compliance with US rules. This publicly traded company files regular disclosures about its business with the SEC. But it isn’t registered as a securities exchange. If Coinbase was only a place to buy and sell Bitcoin, that likely wouldn’t be a problem, because traditionally the world’s largest cryptocurrency is considered by regulators to be more like a commodity—a digital form of gold—than an investment such as a stock, bond or mutual fund.
But the SEC says in its suit against Coinbase that ADA, SOL and several other coins are in fact securities, triggering a requirement to register. It says the coins’ success depends on the efforts and the business decisions of those offering the tokens, a legal hallmark of securities that are subject to its jurisdiction. As with stocks, token creators often raise money for their projects by selling their coins to venture capital investors and through a type of sale known as an initial coin offering, in which regular crypto enthusiasts can participate.
Coinbase also has its own product, called Earn. It allows customers to collect interest on some coins by “staking” them or allowing them to be used as part of the technology that makes crypto blockchains work. The SEC says this program also amounts to an unregistered security.
Chief Executive Officer Brian Armstrong said in a tweet that Coinbase is confident it’s followed the law and that the SEC hadn’t provided a path for the company to register with it. “We tried, repeatedly—so we don’t list securities,” he wrote. He also noted that the SEC reviewed the business when it made its initial public offering.
Anthony Tu-Sekine, who heads the blockchain and cryptocurrency group at law firm Seward & Kissel, says that Armstrong is telling the SEC, “You approved our conduct back when we went public, and now you’re saying it’s illegal.” But Tu-Sekine says the fact that the SEC reviewed a company’s IPO filing typically isn’t an adequate legal defense against alleged federal securities law violations.
Armstrong also draws a distinction between his company’s woes and the harsher allegations against 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 wrote. But as technical as the suit may sound, it poses a serious threat to Coinbase’s business. By offering a variety of coins, the company gives its users more things to trade, and trades generate fees. “If the SEC stops Coinbase from trading some tokens they deemed securities, that could have a huge impact on Coinbase’s financial health,” Oppenheimer & Co. analyst Owen Lau told Bloomberg News. “I would say the revenue at risk could be over 50%.” He added that the SEC may not win on every point.
Oanda’s Moya says the lawsuit could also have a devastating effect on the wider digital asset industry. “If you’re not able to trade your favorite currencies, you might jump ship or switch to Bitcoin,” he says. In theory, exchanges could offer coins considered securities if they registered; that means they’d be subject to extensive US securities laws including rules on disclosure and investor protection.
But many coin developers argue they don’t need to do this, because digital assets have unique features that make them unlike stocks or bonds. IOG, the developer of the Cardano blockchain, said in a statement that its ADA token is “under no circumstances” a security. The SEC’s filing “contains numerous factual inaccuracies and will not impact IOG’s operations in any way,” the statement said.
Treating coins as securities could force big changes at exchanges that choose to list them. The SEC says that both Binance and Coinbase combine the functions of an exchange, a brokerage and a clearing agency. In the securities business, those functions are typically split among separate legal entities, to avoid conflicts of interest.
The battles between the SEC and Binance and Coinbase are likely to drag out for years. A lawsuit against Ripple Labs over its XRP token was initiated in 2020, and it still hasn’t reached a conclusion. Coinbase is also pushing for legislation in Congress that may define crypto coins differently than the SEC does.
The SEC’s actions are likely to spook investors and cause venture capitalists, who were once crypto cheerleaders, to pull back even further from their fundraising efforts. And few investors want to hold a coin that could end up being difficult to trade.
Seeing the chill descending over US crypto, many in the industry have been setting their sights on other markets. Coinbase has sped up its yearslong effort to introduce new hubs and obtain new licenses around the world. “We’ve spent a lot of time doubling our core outside of the US,” says Nana Murugesan, vice president for international and business development at Coinbase, speaking before the SEC lawsuit was filed.
In the Americas, Coinbase has made Brazil one of its top priorities. It scrapped acquisition talks with Brazilian crypto brokerage 2TM Participacoes SA last year, but Murugesan says the company has had recent successes, such as an integration with Pix, the digital payment system developed by Brazil’s central bank. He adds that Coinbase is interested in using local developers to understand more uses for crypto. One of the options they’re seeing in Brazil is popularizing “play to earn” in favelas. The model allows people to earn crypto tokens that can be exchanged for cash by playing online games, and it’s become part of the gig economy in countries such as the Philippines. But it’s also been criticized for exploiting impoverished workers. Murugesan says that play-to-earn can incentivize young people to engage in learning and educational opportunities.
Murugesan calls the UK the largest international market for Coinbase and says the company recently added PayPal as a payment method for its UK customers. Armstrong said in April that relocating his company’s headquarters there is “on the table.” Venture capital firm Andreessen Horowitz, which raised the largest crypto fund last year, recently announced plans to open a new office in London, citing the welcoming environment the UK government has created for digital asset companies. (Bloomberg LP, which owns Bloomberg Businessweek, has invested in Andreessen Horowitz.)
Binance has had a frostier reception in the UK. Chief Strategy Officer Patrick Hillmann said at a conference last month that his company is doing what it can to be regulated there, despite the country’s top market regulator banning the company in 2021 over concerns about the risks it posed to customers.
Murugesan says Coinbase already has a license in Germany, operations in Ireland and registrations in Italy and the Netherlands, and the company hopes to be able to do more now that the European Union has approved crypto asset rules. Coinbase is also considering expanding further in the United Arab Emirates, where many in the crypto industry have flocked because the government is considered friendly to digital assets. Zhao lives in Dubai, home to one of Binance’s biggest offices.
Regulators in Dubai recently clashed with a new exchange called OPNX, saying it was operating without the required local license. The startup drew attention because it’s connected to Kyle Davies and Su Zhu, the founders of the crypto hedge fund Three Arrows Capital, whose blowup last year helped trigger the crisis in digital assets. (The exchange’s CEO says it hasn’t marketed to UAE customers.)
Anywhere in the globe the crypto industry turns, it’s going to be navigating the impact of the deep crypto downturn. As part of a marketing campaign in Australia, Murugesan and his team recently posed for pictures in front of landmarks such as the Sydney Opera House while wearing Coinbase T-shirts and waving flags. Massive rains soaked the team as they took their photos. It was a far cry from earlier efforts in the US, which included a Super Bowl commercial and an NBA sponsorship. “We’re trying to be creative now,” Murugesan says, “especially in the current environment, this resource-constrained environment.” —With Yueqi YangRead next: When Is a Digital Token a Security, and Why Does It Matter?
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