Summary:
The U.S. Securities and Exchange Commission (SEC) filed formal lawsuits against cryptocurrency exchanges Binance and Coinbase, which triggered a series of chain events such as large-scale market sell-offs and the delisting of tokens involved in the definition of securities;
The SEC’s charges against Binance are more serious, including fraud, mixing assets across entities, and counterparty trading with customers;
The market reacted violently to this, with the prices of the 18 tokens defined as "securities" by the SEC falling by an average of 28.8%, compared with a 7.4% drop in BTC over the same period. However, even after being sued by the SEC for the first time, BNB’s market value share even increased slightly, showing that its price is relatively resilient;
The token industry defined as securities by the SEC this time is dominated by public chains, accounting for 13/18, followed by entertainment and metaverse, accounting for 4/18, and the latter also experienced a larger decline;
The report predicts possible future scenarios for SEC litigation, including possible legal impacts and market reactions, and also discusses the progress of crypto industry legislation;
The report summarizes precedents for crypto cases, including illegal token issuance and unregistered investment and financing cases.
text:
The U.S. Securities and Exchange Commission (SEC) alleged in separate lawsuits against cryptocurrency exchanges Binance and Coinbase on June 5 and 6 that 19 tokens were securities in nature, triggering a sharp market-wide sell-off.
SEC charges
The SEC accused Coinbase of operating an unregistered securities exchange, brokerage and clearing agent, as well as unregistering its crypto asset staking interest-earning service. But the charges against Binance are quite different. In addition to being accused of operating an unregistered stock exchange, brokerage, and clearing agent like CB, the SEC also accused it of engaging in more FTX-like activities: deception, mixing assets across entities, and Customers traded against each other, and the SEC did not bring similar charges against Coinbase.
The SEC has issued a warning to financial markets: most encrypted digital assets are securities, a stance that may impose strict regulatory requirements on digital asset exchanges.
Since Gary Gensler was sworn in as SEC chairman in 2021, the industry has been predicting stricter cryptocurrency regulation. Gensler mentioned when he was a blockchain professor at MIT that many cryptocurrencies are likely to be securities, which means they Should be regulated by the SEC and subject to the jurisdiction of the US government.
The SEC has taken enforcement actions against some industrial companies and projects, such as Ripple Labs, LBRY, Kraken, Bittrex, etc. Looking at it now, it seems likely that the SEC will first "practice" on small companies before taking action against the two largest exchanges.
chain reaction
The lawsuits and their aftermath have sent ripples through the industry. Binance.US announced a suspension of U.S. dollar deposits and withdrawals in response to the SEC’s action. Binance said that the challenges imposed by the SEC on its banking partners have led to the disruption of legal currency deposits and withdrawals.
Well-known brokerage Robinhood has decided to delist cryptocurrency tokens classified by the SEC as unregistered securities. After June 27, tokens such as Cardano (ADA), Polygon (MATIC), and Solana (SOL) will no longer be supported on the platform. It was said to have held $583 million worth of MATIC, SOL and ADA before the SEC action.
Crypto.com announced the closure of its institutional exchange, citing lack of demand due to the U.S. market landscape. The decision reflects the challenges crypto companies face as institutional investors, including pension funds, mutual funds, and university endowments, in a volatile market environment and regulatory scrutiny.
On June 16, Binance was under investigation by French authorities for suspected illegal provision of digital asset services and serious money laundering. On the same day, Binance also announced that it would withdraw from the Dutch market. Binance said it would stop providing services to users living in the Netherlands due to its inability to register in the Netherlands.
Changes in the market
Table 1: Introduction and comparison of price changes of tokens mentioned in the SEC lawsuit in June as possible securities
Figure 1: Comparison of the total market value of the 18 tokens defined as "securities" by the SEC and the changes in the total market value of cryptocurrencies, Altcoins (excluding the total market value of BTC), and the total market value of Defi tokens in 2023
Figure 2: Comparison of the total market value of the 18 tokens defined as "securities" by the SEC with the total market value of cryptocurrencies, the total market value excluding BTC, and the total market value of Defi tokens in 2022
Figure 3: Comparison of the total market value of 18 tokens defined as “security” by the SEC with the market value of BTC and ETH
Figure 4: Comparison of changes in market value of 18 tokens defined as “securities” by the SEC
We have counted the price changes of the crypto tokens mentioned as securities by the SEC this month. In addition to BUSD, there are 18 named tokens. It can be seen that:
Table 1 shows that the majority of public chains in the industry are 13/18, followed by entertainment and metaverse 4/18, and asset management and lending 2/18;
Figure 4 shows that BNB has accounted for more than 50% this year. Even though it was sued by the SEC for the first time, its market value share has even increased slightly, showing that its price is relatively resilient; since the beginning of June, the price has fallen by an average of 28.8%, compared with the decline of BTC in the same period. 7.4%, which shows that the decline is very considerable;
Figure 3 shows that the peak market value of 18 tokens occurred in September 2021, when it exceeded US$300 billion. The low market value occurred after the SEC regulation was implemented this month, with only US$70 billion;
Since the beginning of June, the top three decliners are FLOW (-37.1%), SAND (-37.4%), and CHZ (-35.0%). It seems that the decline in entertainment-related tokens is relatively large;
Since the beginning of June, the ones with the smallest declines have been NEXO (-8.4%), ATOM (-21.1%), and BNB (-22.2%). NEXO has paid the fine and settled with the SEC at the beginning of the year, so it has been least affected. BNB has received the charges. It is understandable that the token with the largest market capitalization (nearly 50 billion U.S. dollars before the decline) has low volatility, but the limited decline of ATOM's market capitalization of only more than 3 billion shows its resilience;
Since their respective price historical highs, these tokens have fallen by an average of 91%, with the smallest declines being BNB (-58.4%), MATIC (-78.6%), and ATOM (-81.0%). BNB and ATOM have also experienced larger declines since early June. For currencies with low prices, it can be seen that their price resilience has continuity;
Since their respective price historical highs, the biggest decliners have been ICP (-99.5%) FLOW (-99%) and FIL (-98.5%). Among them, ICP has only fallen 5.6% this year, and FIL has increased by 14.6%. It can be seen that the big The price downward momentum has slowed down after the amplitude adjustment;
Figure 1 shows that before the regulatory incident in June, the performance of 18 tokens lagged behind the broader market in 2023. After the regulatory incident, the lagging range expanded and all gains were given up during the year and turned downward;
Figure 2 shows that extending the timeline to the beginning of 2022, the performance of 18 tokens still lags behind the broader market, but outperforms Defi tokens for most of 2022.
Figure 5: 30-day rolling beta values of 18 tokens defined as “securities” by the SEC and BTC+ETH
Figure 6: 30-day rolling correlation of 18 tokens defined as “security” by the SEC with BTC+ETH
Beta represents the systemic risk or market risk of a security token relative to a benchmark index. If Beta is greater than 1, then the security token's price volatility may exceed that of the benchmark index; if Beta is less than 1, then the security token's price volatility may be less than that of the benchmark index.
Judging from the rolling beta value, the market value fluctuations of these "security" token combinations are actually smaller than the fluctuations of the blue chips based on BTC and ETH. This result is not surprising, mainly considering that under decentralized allocation, each token is due to project factors The rise and fall cycles do not completely overlap, which also lowers the beta of the entire portfolio relative to the benchmark index.
From the data, we can see that beta values and correlations change significantly at different points in time, which may be related to market conditions, the fundamentals of the token, or macroeconomic factors. When the beta value is high, it indicates that the price changes of security tokens are more affected by the market. When the industry sentiment is extremely optimistic or pessimistic, both the correlation and the beta value tend to increase, which means that the effectiveness of diversified allocation is weakened.
Taken together, if the investment is weighted by market capitalization, such a combination has been inferior to BTC and ETH in the past two years, indicating that the price resilience of altcoins in the bear market is not as good as BTC and ETH.
What are securities?
Under U.S. rules, whether something is a security depends primarily on whether it resembles shares issued when a company raises capital. The SEC currently mainly applies the Howey Test (Howey Test) decided by the Supreme Court in 1946. Under this framework, when investors invest money with the intention of profiting from the efforts of the organization’s leaders, the assets may fall within the SEC’s jurisdiction.
What are the implications of being defined as a security?
Calling tokens securities makes operating a cryptocurrency trading platform more expensive and complex. Under U.S. rules, this label has strict investor protection requirements for platforms and issuers. This means that exchanges will face ongoing scrutiny from regulators, which may result in penalties and, in the worst-case scenario, criminal offenses if criminal authorities are involved.
If a large number of cryptocurrencies were classified as securities, it would fundamentally change the way the cryptocurrency industry operates. First, compliance with securities laws becomes critical, requiring these altcoins and their issuers to adhere to strict regulatory requirements. This includes registering with the SEC, providing required disclosures, and complying with reporting obligations.
In addition, classification may result in potential trading restrictions. If most altcoins are considered securities, they can only be traded on registered stock exchanges that are subject to specific rules and regulations. This may limit the liquidity and accessibility of these assets to retail investors and introduce additional barriers to market participation.
For POS public chains like Polygon or BInance Smart Chain, being labeled as securities will cause many problems, such as financial accounting used by users to pay transaction fees, KYC of verifiers, taxes, and whether any DeFi applications on the chain are Legally authorized. These labels are arguably more damaging to the long-term health of the industry than the closing of several exchanges or their withdrawal from the U.S. market.
The future of SEC litigation
The lawsuits against Binance and Coinbase reflect growing tensions between governments and the cryptocurrency industry. SEC Chairman Gary Gensler made it clear that there is no need for more digital currencies, stressing that the United States already has a digital currency called the U.S. dollar. U.S. Treasury Secretary Janet Yellen also expressed support for the SEC's actions and favored the use of regulatory tools to protect consumers and investors. This reflects regulators taking a clearer stance against cryptocurrencies becoming a fundamental tenet of the traditional financial system.
We may see the following four trends in the future:
1. Expand regulatory enforcement and launch direct prosecutions against more blockchain projects, especially public chains with large market capitalization. Recently, the SEC has mainly initiated lawsuits against exchanges. Except for BUSD and NEXO, the 19 tokens mentioned in relevant documents have not yet directly issued warnings or lawsuits. This may indicate that there may be more law enforcement actions in the future.
2. Charges ranging from civil to criminal. Since the SEC and CFTC have no authority to initiate criminal charges, those charges may yet to come. Criminal charges against cryptocurrency exchanges or projects often involve fraud, money laundering or other illegal activities. Such cases are usually handled by law enforcement agencies such as the FBI or the US Department of Justice. For example, last year the DoJ announced criminal charges against six defendants in four cryptocurrency issuance cases for allegedly engaging in cryptocurrency-related fraud. Another example is Sam Bankman-Fried (SBF), who was involved in 12 criminal charges in a case involving FTX and Alameda, including SBF conspiracy to commit bank fraud and conspiracy to operate an unlicensed money transfer business, as well as committing wire transfer fraud on FTX customers and investing in FTX He committed securities fraud and conspired to make illegal political contributions and defraud the Federal Election Commission.
3. SEC or Gensler’s authority may be stripped. Many American politicians do not approve of the SEC's tough supervision.
For example:
U.S. Senator Bill Hagerty wrote on Twitter, "The SEC is using their role to eliminate an industry. Allowing a company (Coinbase) to go public and then preventing them from registering as a compliant exchange."
U.S. Senator Cynthia Lummis also wrote on Twitter, “The SEC has failed to provide a path for digital asset exchanges to register, or even worse, failed to provide adequate legal guidance to distinguish between what is a security and what is a commodity. .”
On June 16, two Republican congressmen, Warren Davidson and Tom Emmer, proposed a bill called the "SEC Stability Act," which aims to reshape the SEC and remove current Chairman Gary Gensler. This bill proposes to increase the number of SEC members and add directors to supervise the committee to prevent regulatory policies from being affected by the personal ideas or political struggles of the SEC chairman.
4. Legal tug-of-war or quick rectification of fines. The teams and individuals being sued are actively responding to the lawsuit, and the legal tug-of-war may last for several years. For example, the lawsuit between Ripple and the SEC has continued since December 2020 and still has no result. Of course, if the accused team or individual quickly compromises, makes business rectifications, and accepts fines, the case may also be settled quickly. For example, Kraken and the SEC settled earlier this year in less than one month.
Progress in Crypto Industry Legislation
Congress is likely to pass a legislative framework for cryptocurrency regulation that will provide clearer rules for the operation of cryptocurrencies and related businesses in the United States. This clarity is likely to spur further growth and innovation in the industry. A draft legislation in the House Financial Services Committee co-sponsored by Reps. Patrick McHenry and Glenn Thompson is considered the most feasible. The legislation seeks to clarify agencies’ jurisdiction over certain digital assets and “strike the right balance” between protecting consumers and encouraging responsible innovation.
The 162-page draft, published in early June, argued that digital assets that began as securities could eventually be regulated as commodities. Whether it is a security or a commodity depends largely on the degree of decentralization of the underlying blockchain network.
It proposes that if a network meets certain requirements, the network will be considered decentralized and commodity-eligible tokens will be regulated by the Commodity Futures Trading Commission (CFTC).
Specific determinations include that no one has unilaterally had the authority to “control or materially change” the functions or operations of the network in the past 12 months, and no token issuer or related person holds more than 20% of the tokens.
However, the draft bill is expected to face substantial opposition from congressional Democrats. SEC Chairman Gary Gensler and some Democrats believe that most digital assets should be classified as securities and that existing regulations are sufficient.
It’s unclear when the bill might reach a congressional vote, but the bill is an important step in the ongoing discussion of digital asset regulation.
Crypto Case Precedent
Ripple (XRP): In 2020, the SEC filed a lawsuit against Ripple Labs Inc. and two of its executives, accusing them of conducting an unregistered securities offering worth $1.3 billion through a digital asset known as XRP. The SEC’s contention is that although Ripple positions XRP as a cryptocurrency, its issuance process is closer to a traditional securities issuance and therefore should be subject to securities laws. This is the largest cryptocurrency-related lawsuit filed by the SEC to date. As of the update of my knowledge base (September 2021), this case is still ongoing and there is no final decision.
Block.one (EOS): In 2019, the SEC announced a settlement with Block.one, which agreed to pay a $24 million fine to resolve the SEC’s allegations that Block.one conducted EOS fraud between 2017 and 2018. Initial coin offerings (ICOs) violate securities laws. This is an important case because it demonstrates the potential for the SEC to impose substantial fines on ICOs that violate securities laws.
Telegram (Grams): In 2020, the SEC successfully blocked Telegram’s Grams token issuance. The SEC’s assertion in this case is that Grams tokens are unregistered securities and therefore their issuance violated securities laws. Eventually, Telegram agreed to pay the fine and refund investors' money.
Kik (Kin): In 2020, the SEC successfully filed a lawsuit against Kik Interactive Inc. for conducting an unregistered securities offering through a digital asset known as Kin. Kik ultimately agreed to pay a $5 million fine to resolve the SEC's charges.
BlockFi: The SEC believes that investors lending crypto assets to BlockFi in exchange for the promise of variable monthly interest payments provided by the company are securities under applicable law; in addition, the SEC believes that BlockFi issued securities and included in its total assets (excluding Cash) held more than 40% of its investment securities and failed to register as an investment company in violation of the registration requirements of the Investment Company Act of 1940. BlockFi will ultimately pay a $50 million fine directly to the SEC and an additional $50 million in fines to 32 U.S. states to settle similar charges. The settlement represented the largest recorded fine ever imposed on a crypto company at the time.
NEXO: The SEC charged Nexo Capital with issuing and selling an unregistered retail crypto-asset lending product, Earn Interest Product (EIP). On January 20, 2023, the crypto lending platform Nexo reached a settlement with the SEC and state regulators and will pay a total of $45 million in fines and stop providing lending products. The SEC agreed to settle with Nexo after taking into account the company's prompt remedial actions and the company's cooperation with Commission staff.
Kraken: The SEC filed securities violation charges against the cryptocurrency exchange Kraken in February 2023, raising concerns about opacity due to its interest-earning business on pledged tokens. That month, the SEC reached a $30 million settlement with Kraken, and Kraken would cancel its “crypto staking” program that provided investment returns.
Crypto Interest-Earning Business
U.S. regulation not only targets areas related to the issuance and trading of security tokens, but also involves financial management businesses, such as BlockFi and NEXO mentioned above.
If a company provides a platform that allows users to store funds and pay a certain amount of interest, then this business model is closer to the deposit business of a bank or financial institution. In this case, the company will need to be registered and licensed as a bank or financial institution in accordance with the laws and regulations of the location.
In the United States, such a company may need to obtain a license from the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), or a state bank regulator. These agencies oversee banks and financial institutions and ensure that their operations comply with legal and regulatory requirements.
In other countries and regions, the Company may need to obtain licenses from the appropriate banking and financial services regulators. In Europe, for example, this might include the European Central Bank and each country's national banking supervisors.
It should be noted that this kind of license usually needs to meet a series of requirements, including capital requirements, risk management requirements, corporate governance requirements, etc. Additionally, companies need to comply with regulations such as anti-money laundering (AML) and customer identity verification (KYC).
Is regulation obsolete?
Proponents of more regulation argue that the designation of securities will bring more information and transparency to investors due to applicable SEC disclosure requirements. But crypto-loving proponents say their projects are decentralized in a way that makes the old rules inappropriate, with crypto trading platforms arguing that the assets they list should be treated as commodities rather than securities. In the United States, rules governing trading in commodities and their derivatives are more focused on ensuring that companies, producers and farmers can effectively hedge against the risk of commodity price fluctuations.
Despite increased scrutiny from regulators, the crypto industry is looking forward to Congress finally passing new laws to legalize the industry. Last year, Democrats and Republicans introduced several bills that would bring cryptocurrencies under the jurisdiction of the Commodity Futures Trading Commission and make other products, including stablecoins, more legal by regulating the assets those products can hold.
Due to the unique properties of crypto-assets, which can contain multiple sources of value beyond traditional securities, it may no longer be appropriate to regulate them solely with the securities regulatory framework of 90 years ago.
Table 2: Classification of value sources of encrypted digital assets
Table 3: Cryptoassets previously defined as securities by the SEC in various lawsuits, June lawsuit filing
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