Crypto's insecurity complex
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In March 2021, when Gary Gensler was nominated to lead the US Securities and Exchange Commission (SEC), Quartz watched his confirmation hearing mainly to see what he would have to say about cryptocurrencies. It was the very thick of a crypto boom: The price of bitcoin rose 30% that month, ending at nearly $59,000, as part of a ride so wild that it seemed to be begging for some kind of oversight.
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Gensler indicated back then that, under his tenure, the oversight would come. While he wanted to encourage blockchain technology, he noted that any kind of trading involving securities would fall under the purview of the SEC, which would “ want to ensure that there’s appropriate investor protection.”
One year into the crypto winter—a industrywide downturn exacerbated by the collapse of the popular exchange FTX and, yes, rising interest rates—Gensler has taken his biggest shots yet at crypto by suing two of the sector’s biggest brands.
I’ve been around finance for four decades. I’ve never seen so much just noncompliance and hype masquerading as reality as I’ve seen in this field.
—SEC chair Gary Gensler, in an interview on June 6
This past week, the SEC filed lawsuits against Binance and Coinbase, the largest cryptocurrency exchanges in the world by volume. In considerable part, the SEC’s actions against Coinbase hinge what on cryptocurrencies actually are. Gensler has frequently said that the vast majority of cryptocurrencies are, in fact, unregulated securities that his agency should have authority over. Accordingly, the SEC has accused Binance and Coinbase of operating illegally as unregistered brokers, exchanges, and clearinghouses for securities.
Coinbase’s top lawyer told Quartz that the SEC was pursuing an “enforcement only” strategy for crypto regulation and called for Congress to pass new legislation. But the SEC has long maintained that the government doesn’t need new laws to govern crypto because, well, they’re securities, plain and simple. Which prompts the question: What is this distinction in nomenclature that Gensler and the crypto companies are tussling over?
THE HOWEY TEST
To define a security, regulators look back to a time before crypto was a gleam in anyone’s eye. In 1946, a US Supreme Court ruling laid down the substance of the Howey test, which uses four criteria to determine if an investment contract should be considered a security.
Is there an investment of money?
Is there an expectation of profits from the investment?
Is the money invested in a common enterprise?
Do any profits accrue from the efforts of a promoter or third party?
If the answers to all these questions are “Yes,” the transaction is likely to involve a security, the Supreme Court decided.
Gensler concedes that bitcoin is likely a commodity, not a security, and should thus be regulated by the US Commodity Futures Trading Commission (CFTC). But the SEC insists that some crypto tokens, such as Solana and Polygon, as well as tokens of some gaming platforms, are securities, and thus should be registered and regulated by the SEC.
Since Coinbase traded several of the tokens classified as securities by the SEC, the agency deemed the platform an unregistered broker. The SEC also described Coinbase’s staking program, which lets users earn interest on their tokens, as a security. Binance, meanwhile, faces accusations of misusing customer funds. But the SEC’s lawsuit also argues that some of Binance’s products, such as BNB and BUSD, ought to have offered investors the same kind of protections that registered securities do.
QUOTABLE
“[W]e are operating as a fking unlicensed securities exchange in the USA bro”
—Binance’s chief compliance officer, in a message to a colleague in 2018, as quoted in the SEC’s lawsuit
WHAT’S IN A NAME
The crypto industry purports to be decentralized. That word implies many things, including the idea that cryptocurrencies are financial instruments free from the control of governments or central banks.
Anything defined as a security, on the other hand, is tightly regulated, especially in the US. Security exchanges must follow transparency rules, so that the public knows who owns and runs these businesses; they must make mandatory financial disclosures, so that investors know how securities are performing. The SEC imposes severe penalties for lying, and limits what businesses and insiders can say publicly.
All of these rules would surely lead to serious compliance costs and bellyaches for crypto companies. And in some ways, true regulation would end the illusion of decentralization. People who buy into crypto as a vision may not be able to willfully suspend their disbelief when their favorite crypto companies have to answer directly to the US government.
ONE ⚖️ THING
Many SEC suits end in companies settling quietly and agreeing to change how they run. Coinbase, though, has said it has no such plans. “We’re going to continue to operate business as usual, and those assets are going to continue to trade until the court makes a determination,” Coinbase CEO Brian Armstrong told Axios.
Taking the case to court is a high-risk, high-reward strategy. The court might side with the SEC, which would prevent the tokens under questions from trading on exchanges like Coinbase. But if the court decides that the SEC is wrong about what constitutes a security, it would be a huge win for Coinbase.
The case ought to be straightforward because it deals with basic statutory interpretations and not constitutional issues. But it’s difficult to tell what the partisan justices on today’s Supreme Court will do, said Tyler Gellasch, the president of Healthy Markets Association, a Washington–based think tank.
“It’s a reasonable thing for the industry to argue that the SEC let all this stuff go for years, and had plenty of opportunities to stop it,” Gellasch told Quartz. “But traditionally, that’s not how laws work. You might be able to speed every day on the same road for 10 years, and all of a sudden a cop pulls you over. You can say, ‘I’ve been speeding on this road for 10 years!’ But it’s not a great defense.”
Thanks for reading! And don’t hesitate to reach out with comments, questions, or topics you want to know more about.
Have a secure weekend,
—Scott Nover, reporter; Samanth Subramanian, global news editor
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