The SEC Is Suing Binance and Coinbase. What’s Next for Crypto?

The U.S. Securities and Exchange Commission (SEC) rocked the crypto landscape this week, further intensifying its regulatory scrutiny on the industry by filing civil lawsuits against two of the world’s largest cryptocurrency exchanges, Binance and Coinbase. Citing a laundry list of accusations ranging from a failure to protect investors to the mismanagement of customer funds, the SEC also identified several well-known crypto tokens (MATIC, SOL, and ALGO among them) as well as those related to gaming and metaverse platforms (SAND, MANA, and AXS), as potential securities.

The lawsuits fall on the week of the 89th anniversary of the SEC, making the already combative discussion surrounding the regulatory body’s attitude toward crypto regulation all the more evocative. It’s precisely the organization’s allegiance to history that its critics point to as its blindspot; to determine whether or not something is a security, the SEC relies on rulings established in the 1930s and 1940s. Proponents of blockchain tech argue that digital assets are simply too new and too unique to be folded into those laws, and at least one SEC Commissioner has expressed frustration with the organization’s “regulation by enforcement” approach. They argue that new laws must be made to avoid stifling innovation and economic development in the industry.

But with the filing of these lawsuits, the SEC has made it crystal clear that it has no intention of considering digital assets in a new regulatory light. SEC Chair Gary Gensler has likewise made it no secret that he finds the very existence of cryptocurrencies little more than a superfluous nuisance.

So, what comes next for the trillion-dollar crypto industry, and what should Web3 organizations (down to the average crypto holder) be on the lookout for as the regulatory landscape shifts? Just as importantly, why does the SEC seem either unwilling or unable to provide clarity regarding legal compliance to the very entities it’s trying to regulate?

The SEC’s crypto rules: Vague by design?

After it was announced that the SEC was suing Binance earlier this week, Changpeng Zhao, the crypto exchange’s founder, took to Twitter to express his frustration with Gensler in no uncertain terms. If Binance has shown a recent willingness to take the SEC to task for what it sees as the body’s failures, then Coinbase can be considered a veteran brawler at this point, taking up the mantle of the cultural leader in the crypto industry’s fight for legal relevance and legitimacy.

As such, Coinbase has been increasingly vocal in the last year regarding the SEC’s seeming unwillingness to cooperate, claiming the organization moves the goalposts each time its team attempts to come into regulatory compliance with it. The exchange even went so far as to release a petition in June 2022 calling for legal clarity from the body. They may be getting some sympathy from the legal system — the U.S. Court of Appeals for the Third Circuit recently gave the SEC seven days to respond to that petition.

Crypto has come a long way.
In America, it still has far to go.
We’re ready. 🛡️ https://t.co/JC0b4WpF5R

— Coinbase 🛡️ (@coinbase) June 6, 2023

But the frustratingly opaque web of legal compliance the SEC has presented crypto exchanges may be by design rather than incompetence, a strategy meant to strong-arm Web3 organizations into fitting into existing legal framework.

“I think that the SEC and the way they approach their enforcement program and the lack of public transparency is by design,” said Jon-Jorge Aras, a partner at Warren Law Group who specializes in representing individuals and businesses in cases involving financial-based investigations and enforcement actions pertaining to the SEC and the Financial Industry Regulatory Authority (FINRA) while speaking to nft now.

Aras believes the SEC views this legal struggle strictly through the lens of the Securities Act of 1933 and the Securities Exchange Act of 1934. For Gensler, the rules to govern securities already exist, and it’s the obligation of anyone dealing with securities to abide by those rules. Any cryptocurrency – even Ethereum, whose status as a security has yet to be addressed by the SEC – is likely to be labeled as such. Expecting anything else from the organization, Aras says, is unwise.

“The public perception that the SEC is lacking transparency is a little bit naive,” Aras elaborated. “The SEC does this by design so they’re able to implement their enforcement program to vet out the bad actors who are not acting in compliance with the rules. That being said, I think there are some legitimate arguments for why crypto assets require their own regulatory framework.”

Crypto proponents face an uphill battle

This framework remains a pipe dream for the time being, however. One reason for this is the fact that the SEC and the Commodity Futures Trading Commission (CFTC) have taken a dual approach to regulating the crypto sphere, partly as a result of Congress’s inaction in crafting new laws or even establishing a dedicated body to address the industry’s unique needs and virtues (despite years of calls from government officials to do so).

Clarification: this could only affects https://t.co/hSHrrlF7o7, IF granted by the court.

It does NOT affect https://t.co/9rMMAmc1G9. Funds are #SAFU https://t.co/Xedzc0tyuM

— CZ 🔶 Binance (@cz_binance) June 6, 2023

Aras believes that the crypto space will continue to see these types of enforcement actions from the SEC. And while it may seem outdated, it’s not a bad idea for individuals and organizations operating in Web3 to go back to the Howey Test and focus on the nature of their crypto-related investments and what people expect from those investments.

Litigating a securities case in court, however, is far more difficult, especially in the current environment in which the pejorative public perception of crypto extends to individuals operating in the legal system. Coinbase and Binance are likely to find their most solid legal footing by arguing the case that the SEC’s view of crypto is simply inaccurate and outdated, but that may not be enough.

“I do think that the federal bench is going to side, more often than not, with the Securities and Exchange Commission when it comes to these enforcement actions,” Aras said. “They are the U.S. government, they have a lot of power, and their view of the world dictates a lot. Given the aggressive position that [the SEC] has taken, I think Coinbase and Binance will have a difficult time litigating these matters.”

Degen if you do, degen if you don’t

What likely bothers the SEC the most about the nature of the crypto industry (and the tokens with which it’s powered) is its very decentralized nature (nft now reached out to the SEC for comment but did not hear back). While the average crypto user can find out information about the price of a particular token like Ethereum or its new usages and updates, there’s relatively little information coming from the decentralized organizations that start them or from the exchanges that host the tokens to the public. In contrast, consumers can go to the SEC’s website and find public filings of non-crypto-native companies and learn where that company stands in terms of its balance sheet.

“I think the SEC views that as powerful information for an investment-based decision,” Aras offered as a potential window into the regulatory body’s thought process. “Now, it’s very difficult for [the SEC] to go against individual tokens because they are decentralized. It’s hard to go to the individuals [behind them]. It’s much easier for them to go after the exchanges that are promoting and giving access to what the SEC views as securities.”

Ironically, the more an exchange attempts to get ahead of legal action by providing clear paperwork to the SEC about its operations, the more at risk it is for being labeled as a company that offers securities and needs to be registered. While such robust disclosure could potentially ameliorate future enforcement actions, it’s far from a guarantee.

What the SEC can and can’t do

One of the things that often gets lost in the discussion regarding the SEC’s enforcement powers is the fact that it only has civil enforcement powers; neither lawsuit against Binance or Coinbase is criminal in nature. The regulatory body has three main tools at its disposal for going after exchanges.

The first is discouragement, which is obtaining ill-gotten gains made from violating securities laws. The second is causing a business to cease its operations through an injunction. Finally, the third includes civil penalties that are calculated on top of discouragement, usually as a multiplier of the aforementioned ill-gotten gains.

Regarding the litigation of cases involving crypto exchanges, Aras thinks that Coinbase and Binance are likely to put up a solid fight, but ultimately the SEC will argue that a long legal precedent exists for these matters.

“The SEC’s position is going to be, ‘Guys, this is very well-worn territory. This is really nothing new here. People have been involved in unregistered securities and operating unregistered exchanges as a broker dealer for a long time, and we’re going to rely on that precedent.’ The average crypto holder should be concerned that if they hold their crypto on an exchange, it may be difficult for them to liquidate it and get their money back.”

How regulation could make the crypto industry safer

It’s not a stretch to say that, as long as Gensler remains the head of the SEC, this kind of aggressive enforcement action is likely to continue in the crypto world. Regarding the possibility of the United States’ approach to crypto pushing its innovation overseas, Aras says that the hurdles to a flourishing U.S.-based crypto industry are likely to be overcome with time.

For now, any exchange that will affect U.S.-based customers would be wise to ensure it complies with U.S. rules and regulations to the best of its ability.

“I do think that it will push some business offshore, but the greatest capital markets are still in the United States, and these companies that are involved in crypto exchanges are still going to want to tap into that market,” Aras observed. “So, this is really going to set the tone for being able to do that. And it sounds cliche, but find a securities attorney early on before you get things started so you can mitigate this before it’s too late.”