Insiders and experts are suggesting that big crypto exchanges would have to face-off with the US government, saying that this week’s action against Kraken is just the beginning.
After FTX propelled the crypto industry into the viewfinder of many regulators, major exchanges like Kraken, Coinbase, and Binance have been hit – with the US government keeping a close eye on them.
San Francisco-based crypto exchange Kraken just entered into a settlement with the US Securities and Exchange Commission on February 9th, where Kraken agreed to shut down its US staking services and to pay a $30 million fine upon accusations that its services are facilitating the sale of securities.
According to industry lawyers, consultants, and former regulators, this enforcement action is likely to be the first in a wave of putting big crypto exchanges under the SEC’s – and the government’s eye.
The current chairman of the US SEC, Gary Gensler, has been clear about his stance on crypto – and it isn’t a friendly one. Gensler has been issuing schedule after schedule of enforcement actions against the crypto industry – especially its giants.
Meanwhile, pressure is also being felt at the Commodity Futures Trading Commission (CFTC), and the Department of Justice (DOJ), where new laws are to be drafted and enacted very soon in order to regulate the industry.
“We’re in the early days of some major upheaval,” said Mick Mulvaney, a former acting White House chief of staff under former President Donald Trump, who is now advising a company in the digital assets sector. “The industry is giving people that hate it a lot of ammunition.”
Cowen analyst Jaret Seiberg sees developments in a similar light: “We expect the SEC to rely on enforcement over the upcoming year to shape the crypto sector. We see the greatest threat to trading platforms, which we suspect the agency will contend are illegal exchanges.”
With recent bad press, the crypto industry is bracing itself, as anything may come any time soon to bigger industry players.
Last month, the US Justice Department prepared for a ‘major criminal announcement’, only to reveal (to much relief for the industry) that small crypto exchange Bitzlato was charged with money laundering and ‘catering to criminals’. A few of Hong Kong-based Bitzlato’s major counterparties include Binance, and LocalBitcoins, which just announced that it would close up operations this week.
What’s up with investigations from the US government?
Reports have been circulating saying that the US DoJ is investigating Binance and its execs for potential money laundering charges.
Some experts predict that the SEC may be involved in Binance investigations sooner or later, pointing out that they may declare Binance’s native token BNB as a security – which has happened with FTX’s native token, FTT.
Not to mention, Binance had revealed that it accidentally kept some of the platform’s own funds in the same wallet as assets from its users. “Collateral assets have previously been moved into this wallet in error and referenced accordingly on the B-Token Proof of Collateral page, said a Binance spokesperson.
This sort of error usually occurs in severe sanctions for regulated companies, even if a company has confessed to the breach.
Such high-profile errors continue to be a driving force for lawmakers seeking to add rules and regulations in and around crypto, as they view a need to segregate platform assets and customer assets.
The SEC has been diving deep into Coinbase’s business practices, including staking. Coinbase views that certain tokens are not securities, and is exempt from the SEC’s sweeping declaration that all tokens are securities, or a yield product. Other crypto exchanges offering common services like staking may also be targeted by the SEC.
Coinbase argued that rival exchange Kraken’s staking services are offering a yield product, while Coinbase’s staking services are not. “Coinbase’s staking services are fundamentally different and are not securities,” said Paul Grewal, chief legal officer.
Amongst ongoing SEC investigation into a number of its services, Coinbase has also seen similar woes to Binance where the maintenance of customer assets have been questioned.
Last year, the crypto exchange released a statement disclosing that investor money can be tied up in a hypothetical bankruptcy, creating huge uproar. Coinbase then accused SEC guidance for forcing the company to make the statement.
Not to mention, Coinbase has ongoing tension with the SEC – as it hasn’t registered as an exchange that lists securities. As SEC Chair Gensler calls the “vast majority” of crypto tokens securities, the SEC would consider the listing of such tokens as breaking securities laws. On top of Coinbase already trading tokens that are also unregistered, there’s plenty to unpack.
Coinbase has also come into hot fire with US regulators beyond debates of asset classification. Last year, the SEC pursued an insider-trading case against a Coinbase ex-manager, and in the process identified nine tokens as securities, most of which were traded at Coinbase. In this case, the SEC hasn’t come after Coinbase with enforcement action, but the accusation has Coinbase flagged as a platform that trades unregistered securities, and may go to federal court any time soon.
Meanwhile, Coinbase CEO Brian Armstrong has been vocal on Twitter, raising awareness on how the SEC may be targeting retail staking and the crypto platforms that offer them.
1/ We're hearing rumors that the SEC would like to get rid of crypto staking in the U.S. for retail customers. I hope that's not the case as I believe it would be a terrible path for the U.S. if that was allowed to happen.
— Brian Armstrong (@brian_armstrong) February 8, 2023
Recent headlines have shown that Kraken has come into hot fire from the SEC. But what led up to Kraken paying $30 million in settlement charges to the SEC?
On Thursday 9th February 2023, the SEC announced charges against the crypto exchange that its crypto-staking-as-a-service platform equates to offering unregistered securities products in the US.
As these charges happen, staking can be at risk – and can potentially destroy a large portion of the crypto industry.
After Kraken’s settlement announcement, an SEC official speaking at a media briefing says that the regulatory agency views Kraken’s offering of staking services as not any different than any other security offering.
As such, according to the SEC, platforms hoping to offer crypto staking services would have to register and get approved with SEC Division of Corporation Finance as a platform that offers securities in order to offer such products, services, and to file appropriate regular disclosures.
In the SEC’s words, the security that’s much being debated about is how Kraken is offering its product to its users, and the service agreement it enters into with its users. However, there’s much work to be done to properly handle compliance for a happy ending.
A race against time?
The US government’s executive branch is in the midst of a massive standoff to draft up regulations that will apply to the crypto industry. Beyond the Treasury, the DoJ, financial regulators, and federal lawmakers, Congress will have larger power in creating the rules that can shape crypto’s future in the country.
If the US government is to wage a legal war against how crypto platforms do business and offer services, crypto may change forever.
“The risk is that Congress goes so slowly that the administration is able to do things that impact the basic fabric of the industry,” said Mulvaney, who once served in the House of Representatives and now advises Swiss crypto startup Astra Protocol.
As the industry is already suffering, coming in and out of crypto winter on top of a barrage of bad press, a lot of elements are at odds – including the biggest fallacy in the crypto industry: while crypto prides itself on decentralisation, a majority of its users prefer to have their assets handled by others. Putting the regulator dilemma into the mix, few options are left.
CFTC Chair Rostin Behnam highlights that 2023 will be a “strong year of precedent-setting cases”, and it’s all up to Congress to decide the fate of how the industry operates in the US.
Meanwhile, many industry players are frustrated with how the SEC is treating the entire process. “The SEC has never said what a compliant crypto exchange would look like under a securities regulatory regime,” says TuongVy Le, regulatory strategy at Bain Capital Crypto.
Others have complained about a lack of clarity from the SEC, including lawyer Patrick Daugherty, who has formerly worked at the SEC but now represents crypto firms and exchanges: “There is no path available under current law for a crypto exchange to register with the SEC,” he said, citing a registered exchange’s requirements to maintain an audit trail, have only brokerages as members and trade only securities and nothing else. “There is no crypto exchange in existence that can comply.”
And the lack of clarity can be attributed to who’s preferring to use enforcement action over anything else. “I don’t think it’s the staff; I think it’s the chairman,” Daugherty said. “This is how Gensler chooses to do things”
While other private negotiations like Kraken’s settlement may be happening, it isn’t a good sign in developing proper crypto policy. The industry in the US is now being steered by punishments rather than guidelines – a rather ugly way of setting industry precedents.
Meanwhile, there’s a bit of hope: Rep. Patrick McHenry, (R-NC), chairman of the House Financial Services Committee, is in the midst of building a case against Gensler, saying that the SEC Chair is a major player in the industry’s missteps.
“Gary Gensler’s regulation through enforcement isn’t protecting consumers,” McHenry said as his committee got to work last week. “Americans have lost billions of dollars in digital assets to bad actors on his watch.”
As Gensler relies on the so-called Howey Test in his campaign to just simply blanket all crypto tokens as securities, the industry is fighting against all odds to refute that things are not how Gensler sees them.