Crypto On Trial

Hey everyone,

For weeks, the crypto world has been languishing in noteworthy-news purgatory. 

Prices have meandered sideways, consolidating with an almost eerie calm. The breakneck volatility that once kept every crypto investor glued to their screen, frantically refreshing their memecoin portfolio, had taken a back seat, replaced by quiet, restive anticipation. 

It’s felt like we’ve all been holding our breath, waiting for anything to break the silence.

Well, this week, the silence has been shattered thanks to crypto’s favourite regulatory watchdog.

It started on Monday, the 5th of June, when news broke of the US Securities and Exchange Commission (SEC) lawsuit against Binance, the world’s largest crypto exchange.

Unsurprisingly, the regulatory snipe sent shockwaves through the industry.

And if that wasn’t enough, hardly a day had passed before the SEC completed their crypto double jab. Following up on their Wells Notice issued in March, they landed a brutal right-hook, suing Coinbase on Tuesday, the 6th of June.

Within 24 hours, the SEC had mounted its biggest offensive on crypto yet. This time, it potentially threatens the industry’s future.

The lawsuits issued to Binance and Coinbase follow a long line of skirmishes that US regulators have had with crypto. From the SEC shutting down Kraken’s staking-as-a-service in February to the CFTC suing Binance in March, these look like another battle in the larger regulatory war.

However, the longer we look at it, it becomes evident that the SEC has launched their all-out assault. They’ve gone all-in and thrown their hail mary.

Crypto is well and truly under attack, and the SEC won’t stop until it’s choked out for good.

So, let’s get into the allegations, break down what they mean for crypto and figure out whether regulation could throttle the future of our beloved industry once and for all...

Crypto On Trial

Binance

The SEC crafted an eloquent 136-page document outlining their case against Binance. From reading and analysing (almost) every page of the legal novel, we managed to dig out the five main allegations cast against the opaque exchange:

1) Binance offered the sale of securities without a license

Basically, companies that want to sell securities (stocks or bonds, etc.) must register with the SEC to conduct their business. Plain and simple.

2) Binance knew they were selling securities illegally

This comment from Binance’s Chief Compliance Officer back in 2018 is a stunner.

You’d think the largest crypto exchange under constant regulatory scrutiny would keep their incriminating thoughts off their email, right?

3) Many high-ranking tokens were named as securities...

... including (unsurprisingly) Binance’s native tokens BNB and BUSD, amongst other fan favourites like Solana, Cardano and Polygon.

Interestingly, Ethereum was a notable exclusion…

This is where we find ourselves in an amusing paradox. 

The SEC uses the Howey Test, put into law in 1946, to determine whether a financial instrument qualifies as a security. This law protects people from fraudulent investments by requiring all securities to be registered and governed by the SEC.

Applying this to digital assets feels like fitting a square peg into a round hole. The idea that tokens like Solana or Polygon could be considered securities is a testament to the law’s outdatedness.

Who in 1946 could’ve ever anticipated crypto to come along? Imagine explaining blockchain to someone in 1946 — the confusion would likely be palpable.

All that said, when strictly applying the rules of the Howey Test to particular tokens and ignoring the context of the 21st century, one could argue that they do meet the definition of a security. But it’s still unreasonable to expect these antiquated laws to govern such a novel financial landscape efficiently.

And this is why there’s a collective cry from key players, like Coinbase, to “update the system.” They recognise the futility of using rules designed for a horse carriage era to navigate the equivalent of a Formula 1 race. 

Our challenge? Navigate these regulations while lobbying for laws that reflect the innovation and uniqueness of the crypto world.

Luckily for us, some politicians in the US, like Senator Cynthia Lummis are showing thoughtfulness around this issue and calling for an update to the legal framework:

The more regulatory clarity we can gain, the more secure the future growth of crypto becomes. We need clear guidelines around how crypto fits into the financial system.

If we can’t get that in the US, don’t be surprised to see other countries extend the regulatory olive branch to the crypto industry.

4) Binance intermingled funds

This is by far the most concerning allegation made against Binance and its owner, CZ.

The SEC has accused them of mixing “billions of dollars” in customer funds and secretly sending them to a separate company controlled by CZ called:

Merit Peak Limited.

And that’s not all; CZ allegedly:

• Transferred those assets from Merit Peak to third parties

• and personally received $62.5 million from a Binance bank account between October 2022 and January 2023.

Sound familiar?

SBF pulled the same stunts with his customer funds, causing FTX’s implosion. While Binance is far more robust than FTX ever was, if allegations like this were true, then US regulators could bring CZ (and, in turn, Binance) down in a big way.

But the reality is that these legal matters have as many interpretations as chameleons have colours and will be drawn out over multiple years. If CZ really did intermingle customer funds, you can be sure he’d have covered his tracks.

5) Binance.US inflated trading volume through wash trading

The elaborate scheme was designed using another company called Sigma Chain.

Interestingly, Sigma Chain accounted for ~35% of all trading volume in the first 11 days that a token ($COTI) was listed on Binance.US.

And at least $190 million was transferred from two Binance entities to Sigma Chain in 2021. The company then used $11 million of the funds received to buy a yacht.

Told you CZ would cover his tracks.

Retaliation

In the face of a formidable opponent like the SEC, Binance didn’t try to hide its reaction. 

The company officially responded to the lawsuit in a detailed statement, defending its commitment to user safety and compliance with regulatory requirements. At the same time, CZ tweeted his signature “4”, calling the SEC’s allegations out as FUD.

Brushing off the legal scrutiny, CZ gave a well-timed and cheeky middle finger to the SEC by adding Bitcoin NFTs to Binance’s marketplace a day after being sued.

The SEC retaliated by filing an emergency motion later that day to freeze all of Binance.US’ assets to stop CZ from moving any other customer funds around.

It’s all-out war, folks.

Coinbase

Speaking of all-out war, the SEC’s second target didn’t escape the firing line either. As the leading player in the US crypto arena, Coinbase was on the receiving end of similar allegations to Binance. 

They were slammed for trading without registering with the SEC, a grave offence regarding securities trading in the US.

SEC chairman Gary Gensler pointed the finger, chastising Coinbase’s failure to give investors the protection they deserved. But unlike Binance, Coinbase dodged allegations of commingling customer funds.

The spotlight instead was cast on Coinbase’s staking products. These offerings, where users stake tokens for rewards, were labelled as unregistered securities as far back as March this year. 

The lawsuit was a sucker punch for Coinbase, with their shares plummeting ~17% in pre-market trading on Tuesday.

Despite the SEC’s aggressive approach, Coinbase remained stoic. 

Chief Legal Officer, Paul Grewal, painted a picture of the SEC playing dirty, foregoing clear rules for litigation tactics. It’s hard not to feel the irony - a regulatory body creating an environment of regulatory uncertainty. 

Even Coinbase’s CEO, Brian Armstrong, joined the fray, voicing his frustration on Twitter and emphasising the lack of a “come in and register” option for their business.

He listed their efforts to clarify the securities vs commodities debate, pointing out the glaring conflicts between the SEC and CFTC statements.

Armstrong also stressed Congress’s upcoming legislation to streamline this regulatory labyrinth.

Outflows

While the legal drama unfolds, the two exchanges have been seeing outflows. Blockchain data from Nansen shows that both Binance and Coinbase experienced over $1 billion in negative net inflows in the 24 hours following the lawsuit. 

At the time of writing, Binance has had negative net inflows of ~$2.5 billion in the last seven days.

However, this doesn’t look like another FTX waiting to happen - Both companies are well capitalised, with Binance having over $50 billion in clean assets and Coinbase hoarding over $5 billion of cash. 

Market panic

Unfortunately, the robust exchange balance sheets couldn’t save the crypto market from dumping. 

When the news broke, Bitcoin plummeted by nearly 8% in a day.

Amazingly though, it managed a full recovery within the next 24 hours, returning to pre-drop levels.

The market shrugged off the lawsuits as a non-event, with investors understanding that any legal proceedings would likely take years to conclude and the initial allegations could merely be a smokescreen. 

So the technical landscape remains unchanged, with Bitcoin continuing its trajectory within the range set by the highs and lows of May.

Despite the initial jitters, this SEC action could actually be bullish for crypto.

Regardless of the outcome, clear regulatory guidance (whether in the US or elsewhere) will dispel the clouds of uncertainty for major investors on the fence about the legitimacy of the crypto industry.

Additionally, the resilience of the crypto industry has been tested repeatedly over the past 18-24 months, overcoming numerous controversies and challenges. 

A great example of this was China’s crackdown on Bitcoin mining in 2021.

Instead of causing lasting damage, this demonstrated the industry’s capacity for self-correction and redistribution. 

Just as crypto mining operations found new homes after China’s ban, the crypto market will reorientate itself in response to this regulatory attack. 

After all, resilience is a fundamental characteristic of the crypto world. 

Crypto may be dead in America…

...but that doesn’t mean it’s dead everywhere else. 

This week has shown us the resilience and relentless innovation of crypto. Despite US regulators’ eagerness to tighten their reins, the long-term implications for the fledgling asset class are far from catastrophic.

The regulatory squeeze will undoubtedly drive crypto innovators out of the US to friendlier environments like Europe, Dubai, and Singapore.

This potential exodus only reinforces crypto’s adaptive and survivalist nature as a global, decentralised phenomenon. 

To be honest, crypto doesn’t need America to succeed. America needs crypto to solve its productivity problems.

The loss for America could be a substantial gain for the rest of the world. Brian Armstrong has even alluded to Coinbase relocating if the country’s regulatory climate doesn’t improve.

While the SEC’s tactics have been criticised for their ambiguity - crypto, in its quintessential decentralised spirit, will adapt and persist, regardless of any single nation’s stance. 

These lawsuits are just the growing pains of a fledgling industry navigating a regulatory framework constructed for a different era. 

But as history teaches us, technological innovation has a knack for weathering regulatory storms and emerging stronger.

Ignore the noise

Renowned global macro investor Raoul Pal dismissed the recent lawsuits as mere “noise” this week. He’s doubled down on his long-term bullishness for ETH and SOL. 

Pal’s position highlights the conviction of seasoned investors despite the volatility and unpredictability inherent to crypto.

I echo Pal’s sentiments. 

These legal skirmishes are nothing more than transient noise, and we continue to stack ETH and invest in this burgeoning frontier market for the long term. 

And so, as these regulatory battles unfold, we urge you to focus on what’s within your control, sticking to a long-term investment strategy that filters out the noise.

Building on Pal’s sentiment, something small he said this week resonated with us: 

So, brace yourself, explorers. We are in for an exciting journey. The fate of crypto lies not only in the courtroom verdicts but in the industry’s continual innovation and inevitable adaptation. 

Crypto isn’t dead. It’s just getting started.

Thanks for reading. Share this post with a friend if you found it insightful.

— Luca