Before there was crypto, there was just bitcoin. During bitcoin’s earliest days, around 2008 and 2009, one of its core features was how difficult and annoying it was to actually get — it was worth hardly anything, traded only by a handful of hard-core superfans. One of the earliest markets was just a guy you’d email before paying him through PayPal. But then the exchanges came, making trading easy. Japan-based Mt. Gox was the first major one — it ruled the market until it was annihilated by a massive hack. Others emerged to fill the void. Soon there was a huge business in making bitcoin not difficult and not annoying to buy. By the time the boom of 2021 peaked, bitcoin was worth more than a trillion dollars, and a lot of exchange owners — but also a whole lot of exchange users — had gotten really rich, really quick. (Many others lost their shirts, of course.)
Along with the cryptocurrency exchanges, thousands of new digital currencies popped into existence and flourished (and/or crashed), filling every conceivable niche in the weirdness that was the emerging world of crypto. There was the global-computer-on-a-blockchain ethereum; the Wall Street favorite ripple; the dumb dogecoin and the dumber Shiba Inu coin. Before Sam Bankman-Fried was indicted for billions of dollars in fraud, he wanted to make trading all of them as easy as buying a banana. Unconstrained by old rules, this was the blueprint for the nothing less ambitious than the future of the financial system — perhaps the entire global economy.
But there was a big problem. As cryptocurrency technology got more mature and complex, as a whole industry formed around it and billions of dollars flowed into it, it started to resemble the old financial system (“tradfi” in cryptospeak) — at least minus all the laws and regulations governing how money can be invested and how financial instruments can be created. Over time, that imbalance became more and more glaring to regulators.
This week, the federal government sued two of the world’s largest exchanges to tell them that the new system needs to operate under the same rules as the old one. The first suit, filed Monday, is against offshore exchange Binance. (I wrote about the five key things to know about that case.) The second, filed Tuesday, targets Coinbase, the largest U.S. crypto exchange — and arguably the most respected and respectable firm in the industry; the one that, by most accounts, had gone out of its way to try to play by the rules and operate inside the law (while accounting for the fact that there has been a lot of ambiguity around what, exactly, is legal and what is not in the cryptosphere). Still, the government is accusing the company of selling unregistered securities to the public. The complaint is not remotely as damning as the one against its larger rival (which quotes an executive as saying “we are operating as a fking unlicensed securities exchange in the USA bro”), but it is still quite a big deal for both Coinbase and for the crypto industry in the U.S. Both of these suits target the financial plumbing of the crypto industry, including the very companies that made it easy to buy and sell. These actions by the Security and Exchange Commission are likely to remake how the industry operates from here on out.
In the universe of crypto prosecutions — there have been many at this point — the Coinbase suit is pretty prosaic in its details. There are no yachts. There is no fraud, no embezzlement. The CEO, Brian Armstrong, isn’t named as a defendant. The crux of it is that Coinbase is not just an exchange — it’s also acting as a broker, buying and selling securities on its customers’ behalf, as well as a clearing and settlement agent. The problem, though, is that it’s not registered as a broker, or any of those other things, and the securities it is trading are also not approved by the federal government to be sold. Essentially, they’re saying that some portion of its business model is not legal. Since 2019, the SEC alleges, Coinbase has “defied the regulatory structures and evaded the disclosure requirements that Congress and the SEC have constructed for the protection of the national securities markets and investors.”
On the surface, this would seem to be a lawsuit about paperwork — Coinbase needs to fill out some forms and be a certain kind of business, which it has failed to do. There are some parts that look kind of incriminating, like when Coinbase suggests that other crypto companies, hoping to list their coins on the platform, should “remove any existing problematic statements” (those that might make the cryptocurrency look like a security). Its crypto “staking” service — essentially a lending program — is also targeted for registration violations.
But in reality, this suit is the culmination of years of acrimony around how the SEC has been regulating the crypto industry. Armstrong has been outspoken about how aggressive the regulator has been, at one point calling the SEC “sketchy” back in 2021:
They company and the industry argue that they have been put in an impossible position. In a March blog post previewing this lawsuit, Paul Grewal, Coinbase’s chief legal officer, said that the company had, in fact, tried to register. “The SEC asked us to provide our views on what a registration path for Coinbase could look like — because there is no existing way for a crypto exchange to register,” he wrote. “We developed and proposed two different registration models. We spent millions of dollars on legal support to build these proposals and repeatedly asked for the SEC’s feedback. We got none.” Then there’s the fact that the agency allowed the company to go public in April 2021, even though its core business would have presumably been illegal then, too:
There is no denying that the last two years have been a period of limbo for the crypto industry. Gary Gensler, the SEC chair, hasn’t been subtle on his thoughts about most cryptocurrencies — which is that most of them are currently offered illegally. And though the SEC has powers of enforcement, it is by and large an agency whose mission is about disclosure to the least-sophisticated investors. When Coinbase went public, for instance, it warned investors that much of its business model could be upended by changes at the SEC. “The SEC’s views in this area have evolved over time and it is difficult to predict the direction or timing of any continuing evolution,” the company said. For its part, the regulatory agency has said that just because it allows a company to go public, it “does not constitute an SEC or staff opinion on, or endorsement of, the legality of an issuer’s underlying business.” While it’s not likely that the SEC would approve of an IPO for, say, the Sinaloa cartel, they have allowed cannabis companies to go public after disclosing that their business model could fall apart if the laws don’t go their way. It is their way of saying “Buyer, beware.”
There will probably be more lawsuits. Both the Binance and Coinbase suits mention specific cryptocurrency companies that the SEC alleges are offering illegal securities — tokens like solana, cardano, and polygon. The SEC has been suing crypto companies for all kinds of reasons going back to 2012, not least of which is selling things that they shouldn’t. But none of these cases have been as big as the ones filed against Coinbase and Binance.
So what kinds of changes to the U.S. crypto industry might come out of these cases? That’s a live question, but the future could look a lot smaller. One reason the SEC didn’t approve Coinbase’s registration is because, under existing securities laws, a company can’t do all the things that it currently does, said Tyler Gellasch, a former senior attorney for the SEC. “One of the great lessons from the Great Depression is you can’t have a single entity performing as all the entities in the capital markets,” said Gellasch, who’s now the CEO of advisory Healthy Markets Association. “Brokers, exchanges, and clearing agencies have distinct laws and rules — not just about disclosures but about what they can and can’t do. The crypto industry has generally disregarded all of it.”
Weirdly enough, Armstrong seemed to be the most sanguine about the whole thing when he responded to the suit, saying, “We’ll get the job done. In the meantime, let’s all keep moving forward and building as an industry. America will get this right in the end.”