At the end of March, a long-lasting and prominent cryptocurrency exchange, Bittrex, announced it would no longer do business with U.S. citizens because “it’s just not economically viable for us to continue to operate in the current U.S. regulatory and economic environment.”
Then on Monday, the Securities and Exchange Commission (SEC) hit Bittrex with a lawsuit in U.S. District Court in the Western District of Washington.
Among the charges: “Bittrex has been operating as an unregistered broker (including by soliciting potential investors, handling customer funds and assets, and charging a fee for these services) and an unregistered clearing agency (including by holding its customers’ assets in Bittrex-controlled wallets and settling its customers’ transactions by debiting and crediting the relevant customer accounts).
The company has “operated the Bittrex Platform as an unregistered exchange by providing a market place that, among other things, brings together orders of multiple buyers and sellers of crypto assets and matches and executes those orders,” the SEC asserts. In doing so, Bittrex has met the demonstrated market needs of thousands of Americans, some of whom, given the rise in some crypto asset values in the past half-decade, have undoubtedly changed their lives enormously for the better.
Bittrex is accused of clearly knowing they might run afoul of the SEC, with the suit citing “Bittrex’s coordinated campaign, going back to 2017, to direct issuers of crypto assets to ‘scrub’ their public statements of any language that could raise questions from the SEC as to whether these crypto assets were offered and sold as securities, while allowing those securities to be traded on its platform….Bittrex knew what statements to ask issuers to ‘scrub’ because it understood the test to determine whether a crypto asset was being offered and sold as a security.”
The SEC wants Bittrex to stop violating the various securities laws it insists it has been breaking, and to “disgorge on a joint and several basis all ill-gotten gains,” with interest.
SEC Chair Gary Gensler has long mocked people in the virtual currency business who complain of lack of regulatory clarity and how the agency practices what many in the field see as arbitrary “regulation through enforcement,” occasionally hitting some market player for some version of dealing in unregistered securities. These have included XRP/Ripple (the subject of a long-ongoing lawsuit), LBRY, Beaxy, Kraken, and Gemini.
The twists and turns and reasonings of how and when one is dealing with a “security” can seem quite opaque. To attempt a simplistic understanding, one needs to go back to the 1946 Supreme Court case SEC v. W.J. Howey.
As explained in an earlier Reason article on the SEC’s threats against leading U.S. market crypto exchange Coinbase:
Whether or not a financial instrument, agreement, or coin in the virtual currency space constitutes a “security” under the reigning “Howey test” … continues to be a matter that courts seem to have to sort out on a case-by-case basis. While complex, as most legal definitional principles are, a central element of Howey is that the buyer and seller of the product are involved in a common enterprise involving a monetary investment in which reasonable expectation of profit is derived from the effort of others. Most argue that most virtual currencies are more like commodities whose values fluctuate based on mass market demand, not based on any effort of the original issuer. As Coin Center Director of Research Peter Van Valkenburgh explained in an interesting article assessing whether ether (the second-highest-market-cap virtual currency) should be legally categorized as a security, there is a meaningful distinction between a virtual object that may at some time have been part of some arrangement or offer that might be reasonably seen as a security and a virtual object that is in and of itself always a security.
A December 2022 article published at the Social Science Research Network, “The Ineluctable Modality of Securities Law: Why Fungible Crypto Assets Are not Securities,” makes a similar argument. The authors, lawyers with a firm called DLx specializing in the blockchain space, insist that while “capital raising from investors, whether involving sales of crypto assets or anything else of value, is incontrovertibly subject to the protections provided by U.S. securities laws….Expanding the reach of federal securities law to characterize fungible crypto assets as securities is both unnecessary and misguided” once the virtual currencies are out in the market being bought, sold, and held by entities with no relation to any original issuers to whom they could be said to be in a common enterprise expecting profit based on the effort of others.
Gensler thinks it’s simple: with bitcoin an exception (roughly, since it never involved any single entity raising money from the public), and ether maybe as well, pretty much every other virtual currency is to him a security; anyone dealing in them without registering with his agency is a criminal. And he will, maybe, probably, eventually, get around to tossing you against the wall. This week it’s Bittrex’s turn. The suit against them lists several virtual currencies Bittrex facilitated trading in that the agency asserts are securities, including Dash, Algo, and NCC.
Just yesterday, before the House Financial Services Committee, as the Wall Street Journal reported, Gensler again repeated that “I’ve never seen a field that is so noncompliant with laws written by Congress and confirmed over and over again by the courts….It’s not a matter of lack of clarity,” insisting crypto market players should understand “that they are providing exchange services, broker-dealer services, clearing services of crypto security tokens.”
Kristin Smith of the Blockchain Association told the committee in a statement that “Gensler’s testimony perfectly reflects the SEC’s approach to the crypto economy: confusing, unclear, opaque, and ultimately blind to the harm its regulation by enforcement strategy is doing to lawful companies in this country.”
Gensler’s SEC also this week announced it believed most decentralized finance (DeFi) platforms using virtual currencies and contracts should also be considered “exchanges” regulatable by them. SEC Commissioner Hester Peirce, far softer on crypto than Gensler, said, as Coindesk reported, that the SEC’s new scheme regarding DeFi “‘articulates confusing and unworkable standards.’ Noting last year’s destruction of so much of the centralized crypto industry, she added that ‘it seems perverse to me that we would be encouraging centralization.'”
Gensler has been known to suggest it’s a mystery to him why exchanges don’t just step right up and register with the SEC, implying that the legal fact they must is obvious and that doing so is straightforward and easy.
It is, for one thing, remarkably complicated and expensive, though surely Gensler would think that isn’t his problem. But as a detailed essay published by crypto investment firm Paradigm explains, the crypto business has qualities that pre-21st century dealers in items that the SEC might consider securities do not:
[Gensler’s] suggestion that crypto companies can register by “filling out a form online” fails for a … straightforward reason: until the SEC adapts the registration framework to the unique aspects of digital assets, it is impossible to “come in and register.” The current registration forms rely on a set of disclosures that are inadequate for crypto’s unique aspects and leave investors vulnerable. Registration also entails a host of additional regulations for the token, the reporting company, and other participants in the ecosystem that makes the functioning of most crypto protocols impossible.
Indeed, the reason there are virtually no registered token offerings in the US is because the SEC has failed to provide any actionable guidance, issue a single rule or constructively engage with anyone in the crypto industry to provide a workable regulatory framework for security tokens.
In another essay from Paradigm explaining exactly how complicated both in application and later functioning it is to simply register with the SEC, for token issuers or exchanges, it is pointed out “tokens that register as securities would not be tradeable on existing crypto exchanges, none of which are registered as a national securities exchange. But there are also no registered national securities exchanges that can trade tokens. … But more fundamentally, the current regulations are incompatible with disintermediated trading.” Paradigm gives historical case studies about how tokens that have tried to play ball with the SEC all signed their own death warrants by doing so.
Gensler likely thinks the incompatibility of crypto markets—or the very existence of virtual currency—and existing securities law is appropriate, that in fact none of them should exist.
Some in the crypto space see a set of government actions lately, including the SEC’s recent muscle-flexing against exchanges, the closing amid various varieties of government pressure of two banks that were big deals in the crypto space, Silvergate and Signature, denying crypto bank Custodia out of Wyoming membership in the Federal Reserve system, and many other pressures on banks that deal with crypto, as constituting a clear and present conspiracy to just squeeze the entire industry out of existence. Some are calling the situation “Chokepoint 2.0” after last decade’s “Operation Chokepoint” aimed at harming various state-disfavored businesses from porn to guns.
Coinbase’s CEO Brian Armstrong said this week that bugging out from U.S. jurisdiction is a possibility for his company as well. Many in the crypto-watching space seem resigned that, at least under this administration, the U.S. government actively wants almost no virtual currency business to occur under its jurisdiction or involving its citizens.
