Hello and welcome to the latest edition of the FT’s Cryptofinance newsletter, where we digest the set menu of regulatory clarity served up by the SEC.
What a week. In the space of 24 hours the US Securities and Exchange Commission filed lawsuits against Binance and Coinbase, alleging swaths of securities law violations against two of the industry’s biggest names.
SEC chair Gary Gensler has been increasingly strident in his view that most cryptos are securities and the exchanges offering them are therefore unlicensed. Now he has let rip.
“When crypto asset market participants go on Twitter or TV and say they lacked ‘fair notice’ that their conduct could be illegal, don’t believe it,” he said.
Both exchanges have dug their heels in. Binance’s Changpeng Zhao, known as CZ, has probably set a record for the amount of times he’s tweeted “FUD” in a single week, and Coinbase’s chief legal officer Paul Grewal told me the San Francisco-based exchange had no plans to de-list tokens in the wake of the SEC’s suit.
As Rajeev Bamra of credit rating agency Moody’s said earlier this week, the charges carried “the potential to have far-reaching implications for the cryptofinance sector”.
Both Binance and Coinbase were accused of running unregulated securities exchanges—allegations both businesses deny—but the SEC went in harder on Binance, alleging Zhao’s empire misused customer funds and misrepresented trading controls.
The latter is particularly noteworthy as it targets an issue that has dogged the crypto market for years — allegations of wash trading, and how much of trading is truly genuine.
Wash trading occurs when the same institution takes both sides of the trade, meaning there’s no change in beneficial ownership of the asset. The trade carries minimal risk or economic purpose but can generate extra fees for the broker and gives the impression of more market activity than is actually the case. In most countries it is illegal.
According to the SEC, a Zhao-controlled entity incorporated in Switzerland named Sigma Chain engaged in wash trading that artificially inflated the trading volume on Binance US, which shares the same ultimate beneficial owner as Binance.com but which is allegedly independent, according to said ultimate beneficial owner.
This was especially so when things needed a push, the SEC alleged. Sigma engaged in wash trading in 48 of 51 crypto assets that had been newly listed between January 1 and June 23 last year, to boost the appearance of activity, the SEC said. The day after Binance US opened for trading, the SEC believed Sigma Chain accounts owned by Zhao, or associated with Binance senior employees, constituted more than 99 per cent of the initial hour of reported volume for at least one crypto asset.
Part of it is down to the opacity of many exchanges and their multi-headed roles of acting as exchanges, market makers and custodians, among other things.
“Wash trading on these [crypto] exchanges is definitely more involved than say, in equities markets,” Will Cong, associate professor of finance at Cornell University, told me. “Not only can exchanges wash trade, but exchanges can provide tokens and incentives for individuals to wash trade.”
How can this happen? After all, we’re repeatedly told that the beauty of transactions on the blockchain is that anyone can see the movement of payments and money.
But as a default, you have literally no idea who is behind a transaction unless you happen to know someone’s wallet address. In essence, imagine if you could see physical dollar bills flying out of Building A and making their way into Building B. You can see a transaction taking place, you can even see how much money is being moved: but you don’t know who controls the lease to either building.
American prosecutors are already on the prowl for evidence of market abuse. In May a former Coinbase employee was sentenced to two years in prison in the first ever insider trading involving cryptocurrencies. In the same month, a former OpenSea employee was convicted in the first ever NFT insider trading case.
But the allegations around Sigma go to the heart of the industry. Volume and liquidity is everything; the more you have, the more likely people will come to you to trade.
“In terms of magnitude and impact . . . this is going to be very big, it’s going to shape the industry going forward,” Cong added.
The specifics of what comes next for the industry remain to be seen. But it’s a very safe bet to suggest the future of crypto as we know it hinges on the two newest lawsuits filed by America’s hard-charging regulator.
“I don’t think that the threat posed by the complaints is limited to just Binance and Coinbase,” Peter Fox, partner at Scoolidge, Peters, Russotti & Fox, told me.
The SEC thinks more than a dozen unlicensed crypto tokens are securities; the regulator is likely to consider more exchanges falling foul of the same registration requirements as Binance and Coinbase, he said.
But this week may also mark a turning point in the personal lives of CZ and Coinbase chief executive Brian Armstrong, as the weight and breadth of the cases devour time and attention.
“The big decision any leader has to take in times like this is whether they should step down so as not to create a distraction for the business,” added one fund manager who lists Binance as a counterparty.
That may be some time away; for the exchanges these cases may be existential threats that their founders cannot walk away from. Even so, cases like these and their fallouts are rarely contained and controlled.
What are your thoughts on this week’s SEC suits? As always, email me at scott.chipolina@ft.com.
Weekly highlights
We dive into how the Binance and Coinbase lawsuits represent the most aggressive legal assault yet on the digital assets market. Heard of Merit Peak and Sigma Chain, the two secretive offshore companies behind Zhao’s empire? Read about them both here.
The UK’s Financial Conduct Authority found crypto ownership more than doubled last year, despite repeated warnings that buyers should be prepared to lose all their money. The majority of those surveyed said buying crypto was “a gamble”. That gives me a chance to highlight last weekend’s harrowing deep dive into crypto gambling addiction, which I wrote with my colleague Oliver Barnes.
Robert Armstrong had an engaging take on crypto as securities: “The SEC is wrong about crypto exchanges . . . but not for the reasons the exchanges might think,” he said.
Last weekend reports surfaced about an alleged $35mn hack targeting Atomic Wallet, which describes itself as a “decentralised wallet trusted by 5 million+ users” (it’s not clear how many still trust the platform today). Analytics company Elliptic has suggested North Korean state-backed hackers Lazarus Group is responsible for the theft.
Soundbite of the week: Plain talking
Binance and regulators rarely see eye to eye but the SEC seemed to agree with this former Binance chief compliance officer, since revealed as Samuel Lim.
“We are operating as a fking unlicensed securities exchange in the USA bro.”
Even the SEC couldn’t help but tweet it.
Data mining: A parched landscape
Last month centralised exchanges’ collective monthly spot trading volume dropped to $495bn, the lowest since March 2019. According to data provider CCData, that’s a near-22 per cent fall on April.
Remarkably, it’s been on the decline since the peak of the meme stock frenzy on equity markets in early 2021. That encompasses the all-time high of bitcoin and the ad-fueled hype of the Super Bowl in early 2022. After the SEC’s lawsuits this week, it’s hard to see June reversing the trend.
Cryptofinance is edited by Philip Stafford. Please send any thoughts and feedback to cryptofinance@ft.com.
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