It appears that the SEC is finally getting started after numerous requests to clean up the crypto industry’s Wild West.
Using regulations on unregistered securities as its main weapon, it has targeted household brands like Gemini and Kraken.
We describe them and the reactions of the industry to the regulatory onslaught.
What is the target?
The SEC has moved quickly in recent weeks to punish cryptocurrency offerings it believes are in violation of the law, relying on the justification that they are unregistered securities.
The Winklevoss twins’ Gemini and cryptocurrency giant Genesis were the targets of the most high-profile legal action in January after the SEC claimed that their failed “Gemini Earn” scheme offered unregistered securities.
Then, last week, Kraken, the third-largest cryptocurrency exchange in the world, agreed to end its “staking” service, in which investors lock in their holdings of digital assets in exchange for an interest-based payout, and paid a $30 million settlement to the SEC.
In addition, this week, the New York Department of Financial Services (NYDFS) ordered the cryptocurrency company Paxos to cease production of its stablecoin bearing the Binance name due to an impending SEC lawsuit regarding the sale of unregistered securities. From earlier staking outfits, this is different.
According to a spokeswoman, it strongly disagrees with SEC employees and maintains that its BUSD coin is not a security.
Why now?
Undoubtedly, the collapse of FTX in November, which resulted in the lockout of billions of dollars in customer deposits, as well as the ripple effects of that event on Genesis and Gemini, have intensified the desire to limit potentially dangerous offerings.
Regulators’ unease about cryptocurrencies, however, has existed for as long as the asset has been widely used. SEC Chair Gary Gensler described the cryptocurrency industry as “a little of the Wild West” in October 2021.
A growing body of evidence reveals that methods like staking are now being used by cryptocurrency companies to artificially boost the value of their assets with consumer money.
An examination into the now-bankrupt cryptocurrency behemoth Celsius revealed that the company had utilized customer funds to support the value of its own coin in an effort to give investors large rewards.
Unregistered securities: what are they?
A financial product that is traded for profit is, most simply put, a security. They provide as the foundation for investment agreements for things like derivatives, debt, and stocks.
To establish whether an asset qualifies as a security, the SEC uses the Howey Test. Four prongs make up this test, and each one must be passed for a security to be declared: 1. An investment of money 2. in a group endeavour 3. with hopes of a return 5. from the efforts of others
Registration of securities is necessary since it provides the issuing business with the necessary shareholder information for dividend payments and stock-related communications. By maintaining a record of the legitimate owner of the security, it also aids in reducing fraud.
The SEC defines an unregistered security as one that hasn’t received the regulator’s seal of approval.
The SEC notes that unregistered securities have been the target of numerous frauds, which are characterised by the use of aggressive sales techniques, the promise of huge payouts with little risk, and the support of unqualified investing professionals. Their application is so restricted.
The majority of ordinary investors are effectively shut out of unregistered securities trading since only accredited investors, who are individuals with a net worth of at least $1 million or an annual income of at least $200,000, are permitted to do so. The threshold is used as a metric for financial sophistication and acts as a safety net for qualified investors.
But in the cryptosphere, the argument is less on whether the assets should be registered or not and more on whether they really belong in the category of securities.
Then why the confusion?
The question of whether a digital asset, which is essentially software, is a security like an ETF or a commodity like gold has been up for debate for a while. In order to accomplish this, cryptocurrency is frequently governed by the Commodities and Futures Trade Commission (CFTC), demonstrating its status as a commodity.
Nonetheless, Gensler has maintained that the majority of cryptocurrencies should be registered with the SEC since they fall under the legal definition of a security.
But, as the cryptocurrency industry develops, particularly through initiatives like staking and initial coin offers (ICOs), the distinctions are becoming more hazy, giving the SEC reason to pursue a crackdown.
The emphasis of the investigation is on companies that promised clients returns, whether in exchange for staking their cryptocurrency for a blockchain or lending it out with a certain percentage return, as with Kraken and Gemini’s Earn programs, respectively. One can consider these to be investment contracts.
Because cryptocurrencies don’t create value through the work of others, proponents of the technology frequently claim that the asset fails to meet all four criteria of the Howey test to qualify as a security or investment contract.
Paul Grewal, chief legal officer at Coinbase, similarly rejected the notion that staking qualifies as a security last week. He said in a note that staking violated not just the fourth prong of value generation but all four of the Howey Test’s criteria.
Consumers aren’t at all helped by attempts to put securities law on a procedure like staking, Grewal wrote. Instead, unreasonably strict regulations would drive users to unregulated, offshore platforms and prevent US consumers from getting fundamental crypto services in the US.
More significantly, the leaders of the cryptocurrency sector, like Brian Armstrong and Anthony Scaramucci, have weighed in on the SEC’s decision on Kraken’s “staking” scheme and have called it an attack on economic liberty.
Next, what?
To establish a precedent, cryptocurrency companies and the SEC must wait for the results of numerous lawsuits. The result could force cryptocurrency companies to register their assets and offerings as securities, but some claim this has put them in an ambiguous position.
To set a precedent, cryptocurrency businesses and the SEC will need to wait for the results of several litigation. In the end, crypto companies could have to register their assets and offerings as securities, but some claim this has put them in an ambiguous position.
A digital asset exchange called Globalblock Crypto wrote in a note that “regulation through enforcement is perplexing for crypto aficionados.”
All cryptocurrency projects need to do, according to the SEC, is “come in and register,” yet when they do, they are simply told “no.” Individuals are frantically attempting to understand how to lawfully offer a product while receiving no assistance.”
The crypto trader Scott Melker, dubbed “The Wolf of All Streets,” used additional foul words.
He tweeted, It is evident that the US is at war with the cryptocurrency sector.
“If it’s war they want, it’s war they’ll get.”
