Gensler’s SEC Drops the Ultimate Bomb on Cryptocurrencies – Will Your Wallet Survive?

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. Within 24 hours, the US Securities and Exchange Commission filed a lawsuit against Binance and Coinbase, alleging a series of securities law violations against two of the biggest names in the industry.

SEC Chairman Gary Gensler has been increasingly strident that most cryptocurrencies are securities and the exchanges that offer them are therefore unlicensed. He now he let rip.

“When cryptocurrency market participants take to Twitter or TV and claim they don’t have ‘fair notice’ that their conduct may be illegal, don’t believe it,” he said.

Both exchanges put their foot down. Binance’s Changpeng Zhao, known as CZ, likely set a record for the number of times he tweeted “FUD” in just one week, and Coinbase’s chief legal officer Paul Grewal told me that the exchange in San Francisco the exchange had no plans to delist the tokens from the list in the wake of the SEC lawsuit.

As Rajeev Bamra of credit rating agency Moody’s said earlier this week, the allegations had “the potential to have far-reaching implications for the cryptofinance industry.”

Both Binance and Coinbase have been accused of operating unregulated securities exchanges — allegations both firms deny — but the SEC went harder on Binance, alleging that Zhao’s empire misused client funds and misrepresented trading controls.

The latter is particularly notable as it takes aim at an issue that has dogged the cryptocurrency market for years: allegations of wash trading and how much of the trading is truly genuine.

Wash trading occurs when the same institution takes both sides of the trade, meaning there is no change in beneficial ownership of the asset. The trade carries little risk or economic purpose, but can generate extra fees for the broker and gives the impression of more market activity than it actually is. In most countries it is illegal.

According to the SEC, a Swiss-incorporated entity controlled by Zhao named Sigma Chain engaged in wash trading that artificially inflated trading volume on Binance US, which shares the same ultimate beneficiary as Binance.com but is allegedly independent, according to said ultimate beneficial owner.

This was especially true when things needed a boost, the SEC said. Sigma engaged in wash trading of 48 of 51 cryptocurrencies that were recently listed between January 1 and June 23 of last year, to boost the face of activity, the SEC said. The day after Binance US opened for trading, the SEC found that Sigma Chain accounts owned by Zhao, or associated with senior Binance employees, constituted more than 99% of the initial hour of reported volume for at least one crypto assets.

Part of that is due 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] Exchange is definitely more involved than let’s say, in stock markets,” Will Cong, an associate professor of finance at Cornell University told me. “Not only can exchanges wash trade, but exchanges can provide tokens and incentives for people to wash the Commerce”.

How can this happen? After all, we are repeatedly told that the beauty of blockchain transactions is that anyone can see the movement of payments and money.

But by default, you literally have no idea who is behind a transaction unless you know someone’s wallet address. Essentially, imagine you can see physical dollar bills flying out of Building A and making their way into Building B. You can see a transaction in progress, you can even see how much money is being moved: but you don’t know who controls the contract lease of both buildings.

US prosecutors are already looking for evidence of market abuse. A former Coinbase employee was sentenced to two years in prison in May first ever insider trading involving cryptocurrencies. In the same month, a former OpenSea employee was convicted in first ever NFT insider trading case.

But the allegations about Sigma go to the heart of the industry. Volume and liquidity are everything; the more you have, the more likely people are to come to you to trade.

“In terms of scale and impact . . . this will be very big, it will shape the industry in the future,” added Cong.

The details of what comes next for the industry remain to be seen. But it is a very safe bet to hint at the future of cryptocurrencies as we know it hinges on the two most recent lawsuits filed by the US regulator.

“I don’t think the threat posed by complaints is limited to Binance and Coinbase,” Peter Fox, a partner at Scolidge, Peters, Russotti & Fox, told me.

The SEC believes more than a dozen unlicensed crypto tokens are securities; the regulator is likely to consider more exchanges that don’t meet the same registration requirements as Binance and Coinbase, he said.

But this week could also mark a turning point in the personal life of Brian Armstrong, chief executive of CZ and Coinbase, as the weight and breadth of cases eat up time and attention.

“The big decision any leader has to make in times like this is whether or not they should step down or create a distraction to the business,” added a fund manager who lists Binance as a counterparty.

It may take some time; for exchanges these cases can be existential threats from which their founders cannot walk away. Even so, cases like these and their fallout are rarely contained and controlled.

What do you think of this week’s SEC suits? As always, write me at scott.chipolina@ft.com.

Weekly highlights

• We dive into how the lawsuits by Binance and Coinbase represent the most aggressive legal assault yet on the digital assets market. Have you ever heard of Merit Peak and Sigma Chain, the two secret offshore companies behind Zhao’s empire? Read about both Here.

• The UK’s Financial Conduct Authority found ownership of cryptocurrencies more than doubled last year, despite repeated warnings that buyers should be prepared to lose all their money. Most respondents said that buying cryptocurrencies was “a gamble”. This gives me a chance to highlight the one from last weekend excruciating deep dive in Crypto Gambling Addiction, which I wrote with my colleague Oliver Barnes.

• Robert Armstrong had an involvement Take on cryptocurrencies as securities: “The SEC is wrong about cryptocurrency exchanges. . . but not for the reasons that trades might think,” he said.

• Reports surfaced last weekend about an alleged $35 million hack against Atomic Wallet, which describes itself as a “decentralized wallet trusted by more than 5 million users” (it’s unclear how many still trust the platform today). Analyst firm Elliptic has suggested that North Korean state-backed hackers Lazarus Group are responsible for the theft.

Bite of the week: speak clearly

Binance and regulators rarely agree, but the SEC has since seemed to agree with this former Binance chief compliance officer revealed as Samuel Lim.

“We’re operating like a fucking unlicensed stock exchange in the United States, bro.”

Even the SEC could not do without tweets It.

Mining: a barren landscape

Collective monthly spot trading volume of centralized exchanges fell to $495 billion last month, the lowest since March 2019. According to data provider CCData, this is a drop of nearly 22% from April.

Surprisingly, it has been in decline since the peak of the stock market meme frenzy in early 2021. This includes bitcoin’s all-time high and Super Bowl ad-fueled hype in early 2022. After SEC lawsuits this week, it’s hard to see June reverse the trend.

Cryptofinance is edited by Philip Stafford. Please send any thoughts and feedback to cryptofinance@ft.com.