SEC's Full Attack on Crypto, The Aftermath of Binance and Coinbase Lawsuit | Weekly Digest

June 12, 2023

Welcome to another Crypto Weekly Digest brought to you by VirtualBacon.

This past week brought about seismic shifts in the crypto world, as the U.S. Securities and Exchange Commission (SEC) stepped into the ring, delivering back-to-back lawsuits against heavyweight crypto exchanges - Binance and Coinbase. The industry felt the tremors, and we're all bracing for potential aftershocks.

Following the SEC's decision to sue the two titans of crypto trading, we saw an immediate reaction with Coinbase's U.S. listed shares tumbling by about 15%. The question reverberating in every crypto-enthusiast, trader, and investor's mind: "What does this mean for the global crypto community?" This week, we delve into what these lawsuits mean for crypto owners outside of the U.S. and for the future of the crypto universe.

Why is the SEC doing this?

Why is the SEC putting the crypto industry in its crosshairs? At its core, the SEC aims to protect investors, a mandate that finds itself being tested in the wild frontier of the crypto industry.

In conventional financial markets, the SEC requires trading platforms to register, separating the roles into three distinct entities: the exchange, the broker, and the clearing house. The exchange matches buy and sell orders; the broker executes trades on behalf of clients; the clearing house settles the trade. This separation is vital to maintain impartiality and protect the interests of the investor.

However, the operation of a crypto exchange defies this traditional model. They act as the exchange, broker, and clearing house, all rolled into one. This bundled function poses potential risks for the investor, illustrated by the infamous case of the now-defunct FTX, which owned its own coin, raising potential conflicts of interest.

Navigating these waters is crucial to the development of the crypto industry, and how this battle unfolds could set important precedents for the future of crypto regulation.

SEC vs Binance

The SEC first brought legal action against the titan of the cryptocurrency exchanges, Binance, and its dynamic CEO Changpeng Zhao (CZ). The lawsuit claims that Binance unlawfully solicited U.S. customers to trade on platforms not registered within U.S. jurisdiction, a serious violation in the eyes of the SEC. Furthermore, they argue that despite claims to the contrary, both Binance and Zhao were directly involved in the operations of Binance.US.

However, Binance is not accepting these allegations lying down. In a firm rebuttal, the company stresses that all user assets across Binance and its affiliate platforms, including Binance.US, are safe and secure. The company argues that the SEC's legal pursuit might be less about investor protection and more about establishing jurisdictional control over other regulators.

Zhao has been quick to address the controversy personally, announcing on Twitter that the company will issue an official response once they fully review the SEC complaint.

This development follows a mere month after Binance criticized the U.S. crypto crackdown as overly harsh and detrimental to business.

Notably, Zhao's response to the community reaction echoes his resilient spirit. In a Twitter conversation with @WuBlockchain, he encapsulates Binance's attitude towards this legal storm in two powerful words, "Strong Together."

Bitcoin's price reflected the gravity of this news, rapidly plunging to $25,500 in its aftermath.

In a climate of increasing regulatory scrutiny, Binance's legal battle with the SEC could potentially shape the future of the crypto industry in the US.

SEC vs Coinbase

The SEC then announced legal action against another leading cryptocurrency platform, Coinbase, shortly after initiating a similar lawsuit against Binance. This legal offensive alleges that Coinbase has been operating without the requisite registrations since 2019, in violation of SEC regulations.

The allegations include the operation of Coinbase’s Staking Program, which the SEC deems as an investment contract and thereby classifies it as a security.

SEC Chairman Gary Gensler has criticized Coinbase's operations as a serious deprivation of investor protections, including the necessary guardrails against fraud, manipulative practices, and conflicts of interest.

This legal development has negatively impacted Coinbase's stock $COIN, with a 16% drop recorded in pre-market trading.

Yet, questions have arisen from various stakeholders within the crypto industry about the inconsistency in the SEC's actions, given Coinbase's public listing approval in April 2021.

The timing of the lawsuit, coming just a day after the SEC's legal action against Binance and its CEO Changpeng Zhao, suggests a concerted regulatory crackdown.

SEC vs Coinbase: The Timeline

September 2021 marked the beginning, with SEC threatening a lawsuit over Coinbase's "Lend" product. The regulator deemed it a security, which Coinbase contested, leading to the program's shelving amidst an SEC investigation.

March 2022, the SEC accused Coinbase of facilitating trades for 79 unregistered cryptocurrencies, including XRP, Shiba Inu, and Dogecoin. The claim was later dismissed by a U.S. judge in February 2023, citing Coinbase's indirect role in the trade.

July 2022, A significant escalation occurred, as Coinbase filed a "petition for rulemaking" to the SEC, seeking clear regulations for digital asset securities. Despite a lack of response from the SEC, the petition coincided with intensified enforcement on crypto exchanges.

March 2023, the SEC issued a Wells Notice to Coinbase, signaling potential enforcement action. In response, Coinbase stated they do not engage in securities trading. Simultaneously, the SEC initiated a lawsuit against Coinbase in April 2023, prompting the exchange to seek a writ of mandamus to enforce a response to their 2022 petition.

May 2023 saw the SEC responding to the request, advising that rulemaking could take years and that the petition should be denied. Yet, Coinbase challenged the SEC, accusing it of intentionally disregarding their call for clear regulations. Concurrently, Coinbase launched a subscription service, "Coinbase One," in 35 countries, driving a significant increase in Q1 revenue despite the ongoing legal tussle.

The outcome of this confrontation remains uncertain, creating an intense drama of regulatory power-play in the crypto space. The resolution, whatever it may be, will undoubtedly leave a lasting imprint on the crypto landscape.

Large Altcoins Named as Potential Unregistered Securities

The recent lawsuits by the SEC have brought 19 digital tokens into the spotlight. As part of these legal actions, the SEC has asserted that these tokens—$ATOM, $BNB, $BUSD, $COTI, $CHZ, $NEAR, $FLOW, $ICP, $VGX, $DASH, $NEXO, $SOL, $ADA, $MATIC, $FIL, $SAND, $MANA, $ALGO, and $AXS—are securities, thereby requiring compliance with the same regulations as traditional financial assets. Notably, Ethereum's $ETH was excluded from this list.

The listed tokens share three commonalities: – An initial sale/fundraising event– A pledge of ongoing protocol development– Active use of social media for promotion.

The SEC argues these factors imply an "expectation of profit," bringing the tokens within the purview of the Howey Test's criteria for an "investment contract" (security). To understand the implications of this designation, it is crucial to delve into the cornerstone of US securities regulation: the Howey Test. Established by a landmark 1946 Supreme Court case, the Howey Test provides a framework to determine if an asset qualifies as an "investment contract," and therefore a security.

The test has four criteria: – An investment of money– In a common enterprise– With the expectation of profit– Derived from the efforts of others.

This designation carries significant potential consequences. If these tokens are officially deemed securities, they could face restrictions or even prohibition from being traded on U.S. exchanges. In the short term, they are also starting to be delisted from major platforms, including Coinbase and Robinhood, setting a disconcerting precedent for the industry.

The undeniable necessity for the crypto industry today is clear, future-proof regulatory guidelines. This will determine how seamlessly cryptocurrencies can integrate into the broader financial ecosystem. While we navigate these uncertain waters, all stakeholders must brace for some turbulence. It's essential to remember that these unfolding regulatory scenarios will undeniably shape the future of crypto.

The Aftermath

Binance.US's BTC Price Surge and High Outflows

Reflecting on the fallout of the SEC lawsuits, Bitcoin's value on Binance.US soared with a nearly $400 premium compared to other exchanges. Post-lawsuit, Bitcoin traded around $27,190 on Binance.US while standing at roughly $26,800 on Coinbase.

This trend suggested a rush by users to convert assets into Bitcoin for swift withdrawal, potentially circumventing longer fiat withdrawal times. This phenomenon, interestingly, was not the first instance of Bitcoin premium on Binance.US, as a similar situation unfolded last month due to the exchange's banking partner challenges.

The lawsuit against Binance and its founder Changpeng "CZ" Zhao led to considerable turmoil in the crypto markets. Data from revealed that there was a substantial outflow from Binance across all protocols, reaching $719 million within a 24-hour span.

This surge in withdrawals was most pronounced during U.S. trading hours, when net outflows hit $230 million following the SEC's announcement. Despite this sizable outflow that shows no signs of slowing down, Binance's stablecoin balance remains healthy. The exchange currently holds just over $8 billion in stablecoins, with a seven-day outflow of $519 million, approximately 6% of its total holdings.

Binance.US Suspends Numerous USDT, BTC, BUSD Trading Pairs

Binance.US suspended over 100 trading pairs, including 90 Tether (USDT), eight Bitcoin (BTC), and two Binance USD (BUSD) pairs. This decision was perceived as a proactive measure for non-USDT tokens that might have been regarded as securities by the SEC.

In addition to this, the platform reduced the number of supported convert trading pairs. Consequently, only a select few coins including USDT, USD Coin (USDC), BNB, Ether (ETH), and BTC, among others, were available for buying, selling, and converting on the platform.

SEC Proposes Asset Freeze on Cryptocurrency Owned by Binance.US

The SEC sought court approval to freeze assets tied to Binance.US. The motion followed the SEC's lawsuit against Binance and pertained to assets linked to Binance.US's holding and operating entities, BAM Management US Holdings and BAM Trading Services. If approved, the court order would have compelled Binance to transfer all customer assets to new wallets accessible only by Binance.US within 30 days.

Binance.US Temporarily Halts USD Inflows

Binance.US suspended USD deposits and hinted at an impending halt to fiat withdrawal channels. This maneuver followed the SEC's intense tactics, prompting Binance.US to protect its platform and users by transitioning to a crypto-only exchange.

However, the company reassured customers of maintaining a 1:1 asset ratio. Despite potential withdrawal processing downtime due to increased volumes and bank closures, crypto trading, staking, deposits, and withdrawals stayed operational. The firm experienced difficulties with banking partners due to the SEC's strict stance, leading to the discontinuation of USD deposits and delisting of USD trading pairs.

Ten U.S. States Issue 'Show Cause' Order to Coinbase

Following regulatory action by the SEC, Coinbase received a 'show cause' notice from ten U.S. states: Alabama, California, Illinois, Kentucky, Maryland, New Jersey, South Carolina, Vermont, Washington, and Wisconsin.

These states collectively gave Coinbase a 28-day period to explain why it should not be handed a cease-and-desist order for allegedly selling unregistered securities. The ripple effects of this situation were felt on Coinbase's stock, which fell by 17% since the SEC's initial lawsuit. This scenario underscores the increasing regulatory scrutiny crypto exchanges face on multiple fronts.

US Legal Authorities Serve Summons to Binance CEO

The U.S. District Court for Washington, D.C. served a summons to Binance CEO, Changpeng Zhao. Zhao was granted a 21-day window to respond. The summons pertains to the SEC's allegations of Binance's violation of U.S. securities laws and mishandling of customer funds. While the service status of the summons remains unconfirmed, a failure to respond from Zhao could result in a default judgment in favor of the SEC.

Robinhood Discontinues Trading of Tokens Identified as Securities

Robinhood discontinued support for Cardano (ADA), Polygon (MATIC), and Solana (SOL) - three tokens named as securities. Robinhood users are permitted to continue trading these tokens until June 27, after which any remaining tokens will be automatically sold. The decision followed Robinhood's routine review of cryptocurrencies. Despite the firm's attempts to achieve crypto compliance with the SEC, the registration process was abruptly halted in March.

As we witness the initial shockwaves of these SEC lawsuits ripple across the crypto landscape, it's clear we are only at the dawn of a defining period. These recent events have stirred the waters, prompting significant action from major players like Robinhood, Binance.US, and Coinbase.

However, the full magnitude of these lawsuits' implications is yet to be revealed. Pay attention to these specific outcomes in the next few weeks:

  • Will Binance.US and Coinbase be allowed to continue operating in US?
  • Will Binance.US assets be frozen?
  • If the lawsuits do not go to trial, the Altcoins will not have official rulings for their security status.
  • If the lawsuits do go to trial, each of the named Altcoins could face a decision to be classified as security or not.
  • Will other centralized USD stablecoins receive pressure after BUSD? Think USDT, USDC, TUSD
  • Where will the large number of US crypto traders go for crypto services? New exchanges? DeFi? Potential waves of profitability there.

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