Compiled by: TaxDAO
The road to compliance for cryptocurrencies has faced challenges, with U.S. lawmakers and judicial authorities stepping up regulation of the industry in March and April of this year.
This is all good from the perspective of the average investor and the economy as a whole. As I’ve written before, the value of crypto tokens, from Bitcoin to the most ridiculous versions like Dogecoin, is so obscure that they can be easily exploited to “separate” unwary or gullible investors from their money.
The term “cryptocurrency” may be recent, but the transactions in question fit neatly into the framework that courts have used to identify securities for nearly eight decades.
The value of cryptocurrencies can be placed anywhere. They do not generate income like bonds, and their prices are not tied to liquid markets like publicly traded securities. To date, no one has explained what cryptocurrencies are useful for, other than paying ransom to fraudsters who hold a database or computer system hostage.
Change Healthcare, a healthcare transaction processor owned by United Health Group, received a second ransom demand in crypto tokens. The company paid $22 million to save information including payment data and medical records of thousands of patients.
That hack of the Change Healthcare database disrupted medical reimbursement payments nationwide and even forced some healthcare providers to lay off staff or close entirely due to a lack of funds.
The new ransom demand apparently comes from a ransomware group that believes it was duped by its partners in the first extortion attempt, and that those partners may have absconded with the initial ransom.
Crypto March Madness
Of course, the most notable blow was the March 28 sentencing of convicted cryptocurrency fraudster Sam Bankman-Fried, who was convicted last October on seven counts of fraud in connection with the collapse of the FTX cryptocurrency exchange.
Federal Judge Lewis Kaplan sentenced Bankman-Fried to 25 years in prison and ordered the forfeiture of more than $11 billion. Kaplan observed that SBF had shown little remorse for his crimes. Kaplan justified the lengthy sentence by saying that without the lengthy sentence, there was "a not insignificant risk that SBF would do something very bad in the future."
Not only that, the day before SBF's sentencing, federal judge Katherine Polk Failla made a ruling that could have a more far-reaching impact on the cryptocurrency industry. Failla approved the SEC to continue its lawsuit, alleging that cryptocurrency broker and exchange giant Coinbase has been conducting securities transactions without permission.
What’s significant about Failla’s ruling is that she immediately rejected Coinbase’s argument that cryptocurrencies are a new type of asset that doesn’t fall under the SEC’s jurisdiction — in short, they are not “securities.”
Crypto promoters have been making the same argument in the courts and in the halls of Congress, urging lawmakers to craft an entirely new regulatory structure for cryptocurrencies — preferably one that’s less restrictive than existing rules and regulations promulgated by the Securities and Exchange Commission and the Commodity Futures Trading Commission.
As it happens, SBF said the same thing during his appearance before a congressional committee, when he was seen as the last seemingly honest cryptocurrency promoter, only to be found out later that he had illegally misappropriated clients’ assets to fund his company.
Failla sees through the debate. “The term ‘cryptocurrency’ may be recent,” she wrote, “but the transactions at issue fit neatly into the framework that courts have used to identify securities for nearly eight decades.”
Failla also blasted the cryptocurrency gang, dismissing Coinbase’s argument that the case falls under the “significant issues doctrine,” an informal rule that requires regulatory initiatives to be explicitly authorized by Congress if they involve “significant economic and political significance.” Coinbase said that because Congress has not enacted regulations specifically targeting cryptocurrencies, the SEC’s lawsuit should be dismissed.
The judge’s take on that argument was disheartening. She noted that “while the cryptocurrency industry is indeed large and important, it is far from being a ‘part of the U.S. economy’ of great economic and political significance.” Cryptocurrency simply “cannot be compared to other industries that the Supreme Court has found raise significant questions of principle,” including the U.S. energy industry and the traditional securities industry itself, she wrote.
Failla’s ruling follows another ruling in a New York federal court in which a judge deemed cryptocurrencies to be securities. In that case, Judge Edgardo Ramos refused to dismiss the SEC’s charges against Gemini Trust Co., a cryptocurrency exchange run by Cameron Winkelvoss and Tyler Winkelvoss, and Genesis Global Capital, a cryptocurrency lender.
The SEC alleges that Gemini’s scheme to pool customers’ crypto assets, lend them to Genesis and promise customers high returns was an unregistered security. As with the case against Coinbase, the SEC’s case will proceed to trial.
Both rulings tend to overturn a 2023 ruling by New York federal judge Analisa Torres in the SEC's enforcement action against Ripple, the developer of the XRP crypto token. Torres argued that the tokens might not be securities in some cases. But her ruling was overshadowed by a series of rulings by her colleagues that found that cryptocurrency marketers and exchanges were engaging in unregistered securities transactions, which is illegal.
April in Cryptocurrency
The fallout from March continued into April. On April 5, a New York federal jury found Terraform Labs and its CEO and majority shareholder, Do Kwon, liable in what the SEC called a “massive cryptocurrency fraud.” The case involved Terraform’s so-called stablecoin, UST, a crypto token pegged 1:1 to the U.S. dollar. Do Kwon was not in court to hear the verdict. He is being detained in Montenegro while U.S. and South Korean authorities battle for his extradition.
Terraform claimed that if the value of the UST coin fell below $1, it would automatically "self-heal" through software algorithms. This happened in May 2021. When the token did recover to a value of $1, Terraform and Kwon boasted that the price recovery was a victory over "decision-making by human agents during periods of market volatility," the SEC said.
In fact, the algorithms had nothing to do with it. According to trial testimony that began in late March, Terraform was secretly bailed out by trading firm Jump Trading, which may have invested tens of millions of dollars to prop up UST and may have made more than $1 billion in profits from the trades. The SEC said it violated the law by failing to disclose the arrangement to investors.
The SEC said Kwon and Terraform also lied to the public by claiming that Chai, a South Korean financial company similar to Venmo, was using Terraform to process transactions, when in fact Chai stopped using Terraform in 2020.
The agency claims that these deceptions painted a picture of robustness within Terraform, but that picture fell apart in May 2022 when UST once again decoupled from the dollar and could not recover. The SEC said UST’s value effectively fell to zero, “losing more than $40 billion in total market value… and sending shockwaves through the cryptoasset community.”
Terraform, which is now bankrupt, has not yet filed any charges against Jump Trading.
Tighter regulation?
These events should give U.S. lawmakers pause to think about how cryptocurrencies should be regulated. During a hearing held by the Senate Banking, Housing, and Urban Affairs Committee, committee chairman Senator Sherrod Brown warned that cryptocurrencies pose a potential threat to national security.
“Bad actors aren’t turning to cryptocurrency because they saw an ad and believed the hype,” Brown said. “They’re using it because they know it’s a workaround. They know it’s easier to move money in the dark without safeguards like know-your-customer rules or suspicious transaction reports. We have to make sure cryptocurrency platforms play by the same rules as other financial institutions.”
Brown’s words were complemented by Treasury Undersecretary Wally Adeyemo, who urged Congress to enact Treasury’s proposed reforms to strengthen sanctions against “foreign digital asset providers that facilitate illicit finance.”
Meanwhile, Massachusetts Democratic Senator Elizabeth Warren — perhaps the most uncompromising voice on Capitol Hill toward cryptocurrencies — has taken aim at stablecoins, urging the House Financial Services Committee to avoid trying to enact rules that would “embed stablecoins more deeply into the banking industry.”
She warned that given the potential for stablecoins and their ilk to “undermine consumer protection and the safety and soundness of the banking system,” any so-called reforms “could amplify and entrench these risks rather than mitigate them.”
What motivates politicians to promote an asset class that has no value except insofar as it involves fraud or theft? As is often the case, it’s money — the green, foldable kind.
Cryptocurrency promoters have been stepping up their lobbying efforts in Washington, with cryptocurrency companies spending nearly $20 million on lobbying in the first nine months of 2023, according to data from the watchdog group Open Secrets.
With new regulatory approaches being pushed, especially by House Republicans, and this being an election year, more spending seems to be on the horizon. It’s a win-lose situation where politicians and cryptocurrency promoters stand to win, while regular investors and the economy as a whole stand to lose.
