This paper written by Winnie Wang, Research Intern at Struck Crypto, deep dives into the recent SEC lawsuits against two of the world’s biggest and most influential cryptocurrency exchanges, Binance and Coinbase. These actions signify increased regulatory scrutiny and potential long-term consequences for the crypto industry. Though the two exchanges face very different accusations, the underlying theme of the SEC’s complaints show that there is need for increased perspective within the Web3 policy field. The paper examines our views of the implications of these lawsuits for investors, digital asset holders, other exchanges, and the overall ecosystem. It emphasizes our opinion that there is a need for clear-cut regulations and collaboration between the crypto community and policymakers to foster growth and financial inclusivity in the evolving Web3 landscape.
Building Background on Binance and Coinbase
The U.S. Securities and Exchange Commission’s (SEC) recent actions against Binance and Coinbase signal a new incoming season for the cryptocurrency ecosystem, one driven by regulatory actions and consequential market responses. On June 5th, the SEC sued Binance over several alleged violations of national security policies, noting “an extensive web of deception” from CEO Changpeng Zhao. The next day, they sued Coinbase. While these recent actions quickly led to a temporary decrease in the price of major cryptocurrencies across all exchanges, they also signify the approach of much longer term consequences that are on the horizon in what is already a bleak crypto winter. This new era of policymaker scrutiny against digital assets will have cascading effects on all parties involved within the ecosystem — investors, builders, asset holders, consumers — which begs the questions: what does this all mean, and what comes next?
Binance + Coinbase … What’s the relevance?
By market cap, Binance and Coinbase are the two largest centralized cryptocurrency exchanges in the world, listing hundreds of digital assets globally. Beyond cryptocurrency trading, they offer several services to consumers and blockchain builders. Though these two exchanges are similar in terms of scale and the large role they play within the greater crypto ecosystem, the two lawsuits differ greatly in terms of what the SEC has alleged against the two companies. For Coinbase, it appears that the suit is largely hinged on ambiguous US securities policy, and a disagreement between the SEC and Coinbase regarding whether some of the cryptocurrencies traded on the platform can qualify as securities, and be regulated as such. In contrast, Binance is facing much heavier, clear-cut allegations: the SEC has a laundry list of accusations against the company and founder Zhao, ranging in nature from securities violations to alleged deceptive practices to commingling consumer funds in offshore accounts.
These allegations have massive implications for the larger cryptocurrency industry as well, and may just be what keeps the ecosystem within the current crypto winter. The authors of the filing provide background information on initial coin offerings, and focus in particular on the issue of exchanges continuing to sell crypto assets after initial offerings — which they believe classifies these as securities offerings. This allegation could have an immensely negative impact on the economy as a whole — we’ll delve into the other exchanges that the SEC had named within their lawsuits as security issuers — but the implication here is that potentially any cryptocurrency could be investigated by the SEC as a security.
Beyond security allegations, the SEC also alleged accusations against the Coinbase Wallets that have been employed by Coinbase since 2017, claiming that they are classified as “non-custodial”. For crypto holders in the US, this could have a concerning impact on crypto wallets as a whole, though the extent of this impact is not yet clear.
The outcome of these lawsuits against Binance and Coinbase are significant not only regarding the scale and influence of the exchanges that are being accused, but rather the crypto market as a whole. If it comes to a ruling where Coinbase is deemed to have violated securities laws, a precedent could be created for future investigation into exchanges and assets. Beyond the investor uncertainty that is sure to arise from regulatory scrutiny and increased legal cases, stricter regulations could drastically alter the way that operations are conducted within the industry. The wide reach of the big cryptocurrencies that the SEC has named as possible securities is sure to send ripples out into the industry, impacting all parties involved in the different niches of the ecosystem.
Current SEC Stance on Web3 Policy
Over the past few years, Congress has introduced multiple bills aiming to create more clarity within the emerging sector. The Responsible Finance Innovation Act, which is in the process of being amended as of July 2023, was designed to create a clear, tailored regulatory framework for digital assets, integrating them into existing banking infrastructure while allowing for continued innovation in the space.
The current focus within the regulatory conversation is whether cryptocurrencies can and should be classified as securities, or as something else, such as a commodity or currency. The federal and state jurisdictions that cryptocurrencies are regulated under hinge under this classification — for example, if crypto is deemed a commodity, then they would abide by regulations imposed by the Commodity Futures Trading Commission (CFTC). However, if the decision is reached that crypto should be treated as a security — think stocks and bonds — the SEC would have jurisdiction over regulation of cryptocurrencies.
In other words, the sale of cryptocurrency will generally only be regulated if the sale falls into one of the following categories:
- Is defined as the sale of a security,
- Is defined as money transmission, which would deem the person a money services business.
The SEC has made it clear throughout the numerous filings of the past year that they believe cryptocurrencies should be treated as securities. In determining whether a digital asset can be classified to include an “investment contract”, the famous Howey precedent is called upon to serve as a four characteristic checklist. The fourth leg of the Howey test, which states that a security is “an investment of money in a common enterprise with expectations of a profit to be derived from the efforts of others” causes much disagreement, given the fluid nature of the “decentralization” and the lack of a common consensus on how to define decentralized networks.
History and Timeline of Major Policy Developments
Let’s dive a little deeper into the timeline of previous SEC crackdowns, to provide a little more context on the gravity of these two cases and explore just how far back the animosity goes. For years now, the SEC has been attempting to exercise an iron grip on perceived illegal activity within the sector, but following FTX and some other major shutdowns in 2022, there’s been much more of a slippery slope. Note that this list is not comprehensive and aims to cover specific events that are important to the development of these writings.
- December 2020: SEC alleges that Ripple Labs and its executives have conducted offerings of unregistered securities, hinging upon the decision of whether XRP is to be classified as a security.
- February 2022: BlockFi concedes to SEC, agreeing to pay $100M in fines to the SEC for lacking registrations for its crypto lending product.
- November 2022: Following the collapse of the FTX exchange, SEC brought several serious accusations against FTX founder Sam Bankman-Fried, claiming that he has participated in severely defrauding investors — we’ll see later on that many of these allegations parallel the ones brought against Zhao earlier this summer.
- March 2023: SEC issues a Wells notice to Coinbase, noting to the exchange that the SEC has investigated and found potential violations of US securities laws.
- March 2023: CFTC sues Binance, alleging that they have knowingly allowed US customers to trade digital assets as unregistered securities.
- April 2023: Coinbase files for a “writ of mandamus”, asking for the SEC to address previous proceedings pushing the SEC to define clearer outlines for how a token can or can not be classified as a security.
- July 2023: SEC charges Quantstamp over a $28 million ICO conducted in 2017
As of July 13th, 2023, a ruling has been reached on the Ripple case — one that could set a massive positive precedent for the community as a whole. The court ruled in favor of Ripple Labs, injecting significance into the allegation that the SEC made stating crypto assets on major exchanges can be classified as unregistered securities. The order decouples the XRP token from any initial investment contract made, citing that XRP does not fully pass the Howey test to be rightfully classified as a security. As of the writing of this piece, the implications of this ruling are not fully clear — though it has the potential to serve as a beacon of hope for the ongoing cases alleging digital assets as securities, the order could also be interpreted more narrowly going forward. The court could possibly see this as the consequence of the specific circumstances of the situation that Ripple found themselves under, but this could say nothing regarding the status of other tokens and their characteristics as securities.
There are also some exciting changes in the policy world as of writing that are notable — on July 26th, 2023, a landmark overhaul bill that will address the regulation of crypto exchanges and stablecoins has advanced past the first committee, and is on its way to reaching the House floor. This bill has the potential to set more concrete guidelines for the regulation of exchanges and tokens going forward, and could also transfer more responsibility over the regulation of tokens to the CFTC, which would represent a huge power dynamic shift for the SEC’s involvement in the crypto world as it currently stands.
As it stands, in our opinion, it’s clear from the ambiguity in the laws regarding cryptocurrency and specific regulations surrounding the trading of tokens that there is no easy way to defend either side — going forward. We believe a strong responsibility lies upon the SEC and Congress as a whole to reach a consensus on how cryptocurrency tokens specifically can be classified as securities and more clear cut regulations on digital assets more broadly.
SEC vs. Binance Deep Dive
Within the SEC’s 136 page complaint against Binance and Zhao they alleged 13 charges, accusing them of the following amongst others:
- Binance.US operates as an unregistered exchange — Similar to the original accusations from the CFTC earlier this year, the SEC repeated that Binance had begun operating in the US without approval. Receipts from internal communication from Zhao to other top executives have painted the CEO as purposefully operating his exchange as an unregistered securities dealer.
- Binance.US fails to enforce regulation that bars US customers from trading on Binance.com, creating little separation between US and offshore operations — The SEC maintains that a large part of Binance’s strategy was courting US customers while attempting to avoid US laws, by encouraging investors to trade on Binance.com.
- Zhao has misled Binance.US customers about market surveillance measures — Allegedly, the platform has overtly marketed services available only on Binance.com to all customers, even within the US. This does not comply with measures set in place, as there were no imposed controls on how able US investors were to trade on the international exchange.
- Zhao has misdirected funds to separate investment funds — The SEC has claimed that Binance misuses customer funds, alleging specifically that billions of investments were “commingled in an account held by a Zhao-controlled entity”. Binance platforms converged as a Merit Peak account that was then used to purchase BUSD illegally, as well as possible market manipulation purchases.
Note: Binance operates on two platforms domestically and internationally: for their international customers, they use Binance.com, and in the US, they exist as Binance.US. Since the US has differing, and generally stricter regulations on trading compared to other global participants, consumers coming from US traffic are not allowed access to Binance.com. Regarding this, the SEC has alleged that Binance has violated securities laws by allowing US customers loopholes to trade on the international market despite the ban that has been initiated on Binance.com.
These allegations against Binance have an uncanny resemblance to the accusations that the ecosystem saw made against SBF, and in somewhat similar fashion, the SEC has requested that the court immediately freeze Binance’s operations and open verified investigations into the accounting measures within the firm.
Beyond an immense number of references to internal messages between Zhao and his employees, the SEC has also (anonymously, but not really anonymously), garnered testimonies from previous executives who stated that Binance could not operate domestically without access to Zhao’s investment funds, as well as the existence of a concerning level of relation between Binance and BAM Trading, which was the holding company behind Binance.US.
Protesting the response of CEO Zhao to the ongoing federal investigations, sources have cited that many executives have reportedly quit, amongst other scrutiny directed towards the top officials regarding most historical actions by Binance, such as the PopcornSwap rug pull incident from 2021.
Binance has continued to operate and uphold that it is not guilty of the SEC’s accusations, naming a new general counsel as they continuously grapple with the onslaught of legal challenges.
In the month that followed after the initial filing, the BNB token lost more than $10B in market value, and lost a notable percentage of their global market share. For BNB holders, it may be difficult to sell the tokens that they are currently holding, but it’s been clear thus far that the pressures around the downfall of BNB don’t exactly compare to the implications of FTT, which was the FTX token. Given the limited applicability of BNB beyond Binance’s main exchange and platforms, we believe there is unlikely to be a widespread, downstream impact on the rest of the industry. Whatever small blips we saw in prices following directly after the initial ruling have largely recovered since, implying that beyond Binance’s balance sheet, the negative fallout within the industry could be largely contained.
Looking ahead, we believe that it seems very likely that BNB will be able to recover and maintain the current position it holds within the greater market.
SEC vs. Coinbase Deep Dive
While the lawsuit against Binance focused on various alleged violations, the SEC’s case against Coinbase centers around potential breaches of securities laws.
Unlike the SEC’s lawsuit against Binance, which focused largely on a diverse array of violations, the accusations that the SEC has filed against Coinbase is largely focused around the classification of tokens offered on the exchange as possible securities. In fact, the filing names several tokens offered on Coinbase’s exchange as securities — some of the major ones being SOL, ADA, MATIC, FIL, SAND, etc.
The SEC claims that Coinbase operates functionality akin to those in traditional finance securities markets, yet has never been registered as a broker, securities exchange, nor clearing agency. For example, Coinbase Lend has come under fire for acting as an unregistered securities exchange, and Coinbase Prime and Coinbase Wallet have been defined as unregistered brokers. The SEC believes that in avoiding these labels, Coinbase has purposefully evaded the laws imposed by the SEC on those entities.
Even now, it’s clear that Coinbase has the influence and legal funding to take this case all the way to the Supreme Court — which seems to be the optimal path of action in our opinion. As we’ve now seen, the incumbent court may be more than happy to take this case and rule against the SEC again, and Coinbase is doing everything in its power to accelerate the case to that point. That is, if there is no intervening precedent or if the administration does not change over to less forgiving members, we believe it seems very possible now the Court would rule in favor of Coinbase again.
The former CFTC chair chimed in as well to note that the timing of these charges is malicious and intentional, given that Coinbase Chief Legal Officer Grewal was set to testify just hours later in what would be a court case working on developing a better framework for digital asset regulation. Grewal has also since shared his position on the recent enforcement actions, pointing out holes in the securities claims — you can learn more here.
Since the filing, Coinbase has also bumped the SEC and put forward actions to keep its tokens afloat and relevant as it goes through tumultuous investigations.
For one, they’ve followed up on their SEC lawsuit from earlier this year. Last year, Coinbase requested that the SEC develop a policy that would replace existing requirements, ones that would make it much easier and clear-cut to define tokens. This past April, they sued the SEC for a response. Now, the SEC claims that they will need four months to possibly generate a response, but argues that digital asset rules exist clearly, and just not in favor of Coinbase.
Since the filing, Coinbase has also put forward increased USDC rewards for customers, a rewards service that has intentionally been separated from the services the SEC is currently targeting. Their efforts have been largely effective — even in the week after the SEC lawsuit, their stock closed in the green. We believe Coinbase customers may be in the clear, compared to Binance, who is comparatively facing much more drastic measures.
Conclusions and Key Takeaways for the Ecosystem
We believe that it is clear that the SEC is employing a more forceful approach to cracking down on perceived non-compliance within the cryptocurrency industry, especially given the lacking regulatory framework that currently exists. Despite the criticisms from within the industry and out, who have pointed out the regulatory ambiguities, the SEC is making their position clear in taking legal action against these two leading firms.
As it stands now, there is little way to predict what comes next for the industry. But given what we know, how are the different niches within the ecosystem going to experience the downstream effects of these lawsuits? In this section, we’ll break down the potential implications of these cases on different groups of stakeholders in the community, looking into the long-term impacts that rulings could have.
Given the possibility of a stricter crackdown on cryptocurrencies as alleged securities, investors may be inclined to shift their focus towards projects that are more centralized, building upon tokens that have largely evaded the scrutiny of the SEC. WE believe it seems incredibly feasible that these filings will only drive investor panic, which could lead to ramped intensity of due diligence processes for firms that operate in the space. Compliance with regulatory frameworks and existing securities risks have always been a concern, but has the potential to be a major dealbreaker, or source of consideration. Though we believe it seems unlikely currently, in the event that these tokens are eventually delisted, a decrease in liquidity will could inevitably lead to the decline of investment in many spaces of the industry.
As we see more and more major voices within the industry moving out of the US and into jurisdictions with more favorable, clear-cut regulations (think Europe and Asia), we believe it’s possible that investors will turn their focus out of domestic founders and builders, and towards newer spots with regulatory clarity.
For Digital Asset Holders and Customers
In deciding where to go next, we believe the ruling from the Ripple case might serve as grounds for the SEC to next target the platforms from which digital assets are generated, or take issue with the profits generated from non-custodial wallets, which was implied from the Coinbase case. Lacking greater distinction for non-custodial wallets, this has the potential to be bad news for crypto wallets domestically.
For Other Major Exchanges
Big questions to be asked here — what are the implications for all the other digital tokens mentioned within the Coinbase and Binance cases? What are the implications for all the other digital assets that weren’t mentioned? Coinbase already mentioned earlier this year their plans to move internationally — is moving offshore a feasible option for more exchanges based from within the US?
It’s clear in our opinion that the SEC has no plans of stopping at Coinbase and Binance — crypto companies still operating in the space under riskier approaches may face substantial repercussions in the upcoming months.
For various other tokens at differing levels of decentralization, it would take a while to reach individual judgements on each token unless more rigorous regulation takes place. If a ruling happens such that the SEC’s definition of securities will expand to include a wider range of crypto, operational dynamics could shift significantly within the industry. This would require issuers designated as securities to register as such, potentially creating decreased liquidity and investor panic. The Ripple case will hopefully serve as an important precedent here.
For the Ecosystem — What Comes Next?
Going forward, we believe the outcomes for these cases will certainly provide valuable insights into the SEC’s plans for regulating cryptocurrencies. Beyond the future of Coinbase and Binance, these court outcomes have the potential of shaping the industry as a whole.
In terms of good news, the ecosystem continues to innovate. Even though Web3 adoption in the US will likely be stunted as these two cases come to term, we believe the rest of the world is still pushing into space even despite the crypto winter.
A Picture of Collaboration Between the Ecosystem and Policymakers
We believe that it is crucial for US policymakers to acknowledge both the unique challenges and opportunities that Web3 presents for not just the US, but the global community as a whole. As such, we feel Congress would benefit to prioritize these issues at the forefront of driving innovation and technology domestically. New laws that would offer a more holistic policy response, tackle emerging concerns, fill regulatory gaps, all while stimulating compliant and safe innovation within the ecosystem is a dire need at this time, as proven by the consequences of ambiguous legislation. By adopting a more balanced strategy, we believe the risks of the crypto ecosystem can be better addressed by stakeholders in the space while also seeking to safeguard consumer interests and promote financial inclusivity .
We believe US policymakers may be interested in considering the possibility of implementing clear cut regulations based on specific verticals within the ecosystem, which is ideal in preventing lack of understanding of policy. The current SEC regime was developed not for decentralized finance, but rather for securities that are issued by centralized firms.
Just as it’s difficult to use traditional finance policies regarding traditional securities and communities to classify and police digital assets that are fundamentally different in nature, it seems impossible to create a “one size fits all” narrative for regulation within the landscape. For DeFi in particular, a correct approach would address the specific niches within the field, such as Web3 specific zero-knowledge KYC and identification functionalities. This provides an option for spurring continued innovation, but in a way that clearly supports founders by offering detailed guidelines while protecting greater consumer interests.
Is increased regulation a double-edged sword? Though many believe that more defined regulations could force operational changes and deplete innovation, we believe clear-cut policy will actually drive growth the opposite (positive) way — effects that we’ve seen go into place in Singapore, Hong Kong, and many other hubs of innovation that crypto creators flock to. With less uncertainty from founders, funders, and participants in the ecosystem, a much more bullish market could emerge, one unclouded by the legal ambiguity of existing operations and development.
As for Web3 entrepreneurs and enthusiasts, these cases have ushered in a new era of the industry, one that defines it less as an emerging field and more as a maturing one. We believe the future of Web3 is one that will inevitably make collaboration with policymakers necessary, in order to fully fulfill the visions shared by the ecosystem — one that bolsters financial inclusivity and operates fairly. As such, there need to be pioneers in the policymaking field, ones that will interact directly with representatives and regulators on developing the policies that will shape the upcoming generations of Web3 innovation. Whether this means creating a consensus definition of decentralization or differentiating between buyers and sellers going forward, there is a dire need for advocates that will help to clear the ambiguity in existing regulations as representatives of the ecosystem as a whole.
The information provided in this blog post is for educational and informational purposes only and is not intended to be investment advice or a recommendation. Struck has no obligation to update, modify, or amend the contents of this blog post nor to notify readers in the event that any information, opinion, forecast or estimate changes or subsequently becomes inaccurate or outdated. In addition, certain information contained herein has been obtained from third party sources and has not been independently verified by Struck. While such sources are believed to be reliable, Struck does not assume any responsibility for the accuracy or completeness of such information. Struck does not undertake any obligation to update the information contained herein as of any future date.
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