Jonathan Raa/NurPhoto via AP
The crypto industry hasn’t had a great year. We’ve seen the epic collapse of FTX, and the prosecution of its boy king Sam Bankman-Fried, followed by the bankruptcies of BlockFi, Voyager Digital, and Celsius. As a result, the value of all the major cryptocurrencies has plummeted from their late-2021 highs. Venture capital investment in the industry has also nearly collapsed, with just half a billion so far this year as against $21.6 billion in 2022.
And now the Securities and Exchange Commission (SEC) has filed lawsuits against the two largest remaining crypto players: Binance and Coinbase. This step is long overdue, but still welcome. Whatever the actual results of the lawsuits, they make clear that the entire business model of crypto was doing an end run around financial regulation, except without the burdensome encumbrance of real businesses.
The two lawsuits are structurally similar. The SEC accuses both companies of conducting three kinds of securities businesses—exchange, broker-dealer, and clearinghouse—without registering for any of them as required by U.S. law. These are bog-standard financial industry activities: An exchange helps clients buy or sell securities to each other; a broker-dealer will buy and sell securities on behalf of itself and its clients; and a clearinghouse nets out securities transactions across a whole marketplace to facilitate trading.
The lawsuit obviously turns on the definition of a security. I’m not a lawyer, but the legal definition of a security is incredibly broad and surely fits with any rational understanding of how crypto assets are supposed to work. The Supreme Court has summarized the definition as “investment of money in a common enterprise with profits to come solely from the efforts of others; and, if that test be satisfied, it is immaterial whether the enterprise is speculative or nonspeculative, or whether there is a sale of property with or without intrinsic value.” The vast majority of people invest in crypto stuff to make money; the companies are advertised as such, and as the SEC points out, both Binance and Coinbase offer “staking” services, which offer profits in return for an investment of coins.
Despite the lawsuits’ similarity, the one against Binance is a lot juicier. The SEC complaint accuses Binance CEO Changpeng Zhao, along with other company executives, of conspiring to escape regulation. Under “Zhao’s control,” it says, they “designed and implemented a multi-step plan to surreptitiously evade U.S. laws.” One way they allegedly did this was by creating two entities, BAM Management and BAM Trading, that supposedly controlled the Binance.US system for American clients. “Behind the scenes, however, Zhao and Binance were intimately involved in directing BAM Trading’s U.S. business operations and providing and maintaining the crypto asset services of the Binance.US Platform.”
Another alleged strategy was simple lies. They “consistently claimed to the public that the Binance.com Platform did not serve U.S. persons, while simultaneously concealing their efforts to ensure that the most valuable U.S. customers continued trading on the platform.” The SEC has communication from the Binance chief compliance officer admitting “[o]n the surface we cannot be seen to have US users[,] but in reality, we should get them through other creative means.”
This COO was apparently particularly indiscreet, elsewhere writing that “we do not want [Binance].com to be regulated ever” and “we are operating as a fking unlicensed securities exchange in the USA bro.” Which is kind of something you don’t want to write down, in case it ever gets used in a federal lawsuit about your unlicensed security exchange.
Finally, Zhao is accused of diverting customer assets to an entity he controlled called Sigma Chain, which also “engaged in wash trading that artificially inflated the trading volume of crypto asset securities on the Binance.US Platform.”
The Coinbase lawsuit doesn’t have nearly so much incriminating drama. Still, the core of the SEC complaint about failing to register securities businesses is more important. Lying to regulators and investors or stealing customers’ money is a crime as old as money itself; it is important to prosecute, but it’s nothing new. Setting up openly unregulated securities businesses, however, strikes at the very heart of the U.S. financial system, and crypto bros have been doing it with reckless abandon.
The point of financial regulation, as set up in the 1930s during the New Deal, was to protect the integrity of financial markets. During the Great Crash of 1929, the country had seen that beneath the gigantic stock market boom of the 1920s was a writhing mass of fraud. Real estate, manufacturing, investment, stock trading—whatever sector of the economy you could name, you could find a major infection of swindling and corruption.
Hence the Securities Act of 1933, which defined and regulated securities, and the Securities Exchange Act of 1934, which set up the SEC and added more controls. The idea was that by mandating that any company that sells, buys, or trades securities register with the SEC and submit public financial disclosures, together with strict oversight and punishment of deception or cheating, people would have the confidence to invest their money through the financial system, and that investment would be channeled toward productive enterprise.
There is no better proof of this than the crypto industry itself. It is simply lousy with scams familiar to any student of 19th-century financial panics—pump-and-dumps, Ponzi schemes, market corners, fake companies, and so on—plus new ones like rug pulls or wash trading. Indeed, one could argue that the entire crypto ecosystem is fraudulent to its core, since the only evidently profitable businesses have been ones that took a cut from people trading crypto magic beans back and forth, or just stole their customers’ money.
Probably one or both of these cases will make it to the Supreme Court eventually, where we’ll all get to learn if its reactionary majority (last seen deciding that water is not, in fact, wet) thinks that crypto assets are securities. I can’t wait for the triumph of logic and reason!
But the Court’s musings aside, we can definitely say for sure that in finance, without disclosure and regulators checking the books, what happens is theft, and lots of it. We also learned this in the 2000s, when New Deal–era regulations were rolled back and Wall Street blew itself up less than a decade later.
For Binance at least, the Court’s decision may come too late. As of early Tuesday morning, customers had pulled some $790 million out of the company, and they probably won’t be the last. Too bad the SEC didn’t get on this problem sooner, but better late than never.
