The Token Word #1
Binance and Coinbase vs. the SEC, memecoin overload, FCA oversight, UK parliamentarians’ crypto punt +More
Welcome to issue one of the latest monthly specials from Compliance+More, and we couldn’t have chosen a better week to launch after the headlines were dominated this week by the news of the SEC investigations into both Binance and Coinbase.
Also in this issue, we take a look at the swarm of memecoins and why opposition is building from within the crypto community to a phenomenon that threatens to swamp the ecosystem.
This is followed by developments in the UK where, on the one hand, the Financial Conduct Authority is preparing stringent new rules for crypto products and, on the other, a group of prominent parliamentarians has told the government that crypto should be regulated like gambling.
I can’t get your love, I can get a fraction.
SEC takes aim
A drastically reconfigured market will likely be the result, as the US securities watchdog issues two lawsuits against the two largest crypto exchanges in two days.
The old one-two: On Monday, the Securities and Exchange Commission announced 13 securities law charges against Binance, its US arm, and its founder and CEO Changpeng Zhao. The next day it was Coinbase’s turn to feel the SEC’s wrath in a complaint alleging the company had made billions of dollars since at least 2019 illegally handling crypto “asset securities” transactions.
The charges against Coinbase include:
Operating an unregistered securities exchange, broker or clearing agency, which ducks federally mandated investor protections including record keeping requirements, SEC inspections and conflict of interest rules.
Unlawfully blending and offering exchange, broker-dealer and clearing house functions that are required to be kept separate.
Trading at least 13 crypto assets, including tokens such as Solana, Cardano and Polygon, which the SEC considers securities and should be regulated as such.
Thin disguise: The SEC said Binance and Zhao operated a “web of deception” and accused the business of deliberately plotting to fool regulators. The charges include:
Acting as an unregistered exchange, broker and clearing agency while raking in $11.6bn in revenue.
Unregistered offer and sale of crypto tokens, including its own coins, crypto-lending products and Binance.US’s staking-as-a-service program, through which the company maintains secret control of user funds.
Failure to stop US users from accessing Binance.com, by facilitating and concealing the exchange activity of wealthy US crypto investors.
Lying to exchange customers and company investors about its compliance controls to guard against token price manipulation, while secretly engaging in “wash trading” to pump trading volumes.
With friends like these: Both exchanges went on the offensive, with Binance alleging SEC head honcho Gary Gensler offered to advise the company in 2019, while Coinbase said business will continue as usual.
“The two cases are different, but overlap and point in the same direction: the SEC’s increasingly aggressive campaign to bring cryptocurrencies under the jurisdiction of the federal securities laws,” said former federal prosecutor Kevin O'Brien, partner at Ford O’Brien Landy.
“If the SEC prevails in either case, the cryptocurrency industry will be transformed.”
Also facing lawsuits for failing to register as an exchange, clearing house and broker are crypto hawkers Beaxy Digital and Bittrex Inc.
“The whole business model is built on a non-compliance with the US securities laws and we’re asking them to come into compliance,” Gensler told CNBC.
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Meme swarm
A swarm of memecoins on the Bitcoin blockchain, such as the cartoon frog-themed Pepe and Elon Musk’s beloved Doge, is putting the network under pressure and causing transaction prices to hike.
Stop the madness: Bitcoin’s developers, who maintain the foundation of the rails on which various kinds of tokens operate, want to build in spam blockers to break the logjam and make it harder for coins with little or no value to use the blockchain.
Meme coins are cryptocurrencies with origins in internet humor, built in the most part with a focus on going viral, which makes their price movements highly volatile.
The creators of the coins often hire social media influencers to create buzz and hype, a practice that has attracted the attention of regulators.
Standards built into the Bitcoin blockchain allows large numbers of NFTs, tokens and other digital collectibles to be created and hosted, and over the last year memecoins (and shitcoins, which are cryptocurrencies with little value or clear purpose) have exploded.
The Bitcoin blockchain hosts around 25,000 memecoins with a total market cap of nearly $500m.
10,000 maniacs: Speaking to Bloomberg, Bitcoin developer Ali Sherief said: “I do think the system is being abused. Bitcoin was never intended to serve as a base layer for meme tokens. Worthless tokens threaten the smooth and normal use of the Bitcoin network as a peer-to-peer digital currency.”
The flood of speculative coins jammed up the Bitcoin blockchain in May, triggering a record-breaking number of transactions and an 11-fold leap in processing fees.
NFTs alone accounted for 65% of the total transactions and the average fee per transaction to $30 before cooling off to $4 by the month-end.
This spike proved a boon for Bitcoin miners who raked in $45m from activity.
Critics have suggested a version of the Bitcoin blockchain should be developed, a hard fork, that would only support the standards that allow memecoins to flourish.
Rules is rules
The UK’s Financial Conduct Authority (FCA) is preparing stringent new rules for crypto products, including a cooling-off period for new investors and warnings in advertising.
Clear and present danger: From October 8, firms promoting crypto products or services need to carry a clear risk warning in their adverts such as telling customers they should not expect protection “if something goes wrong”.
Customers should be urged to “take two minutes to learn more”, the FCA added, and be told to prepare “to lose all the money you invest”.
Incentives like “refer a friend” or “new joiner bonuses” are banned.
Companies advertising crypto assets and digital currencies will need to offer a break to new investors requesting to put money in.
Tougher due diligence requirements will be brought in for businesses offering crypto assets, to ensure the underlying asset is legitimate and the promotion is “fair, clear and not misleading”.
Penalties for violation include jail time and fines for non-compliance.
Heads you lose, tails I win: The FCA said crypto uptake doubled among consumers between 2021 and 2022, but the industry remains largely unregulated and the lack of a safety net puts investors at risk of losing all their money.
PIMFA, the trade association for wealth management, investment services and the personal investment and financial advice industry, was one of several bodies to raise concerns.
“Classifying crypto-assets in such a way runs the risk of creating a ‘halo effect’ that may benefit some associated digital assets, leading consumers to assume they are safe assets to invest in or covered by some form of redress if consumers lose money. Neither is true,” said David Ostojitsch, PIMFA government relations and policy director.
“There is a significant danger that consumers will assume crypto-assets are safe because they are being marketed by an FCA-regulated person or firm. Again, we would stress this is not the case.”
Game done changed: “Make no mistake – they are game changing,” said Jake Green, global co-head of financial regulatory practice at law firm Ashurst, of the proposals. They “materially enhance restrictions” around marketing crypto, which Green inferred means “offshore providers will find accessing UK clients more difficult and subject to much higher risk”.
The rules have extra-territorial effect, added George Morris, partner at Simmons & Simmons, meaning anyone publishing invitations or inducements to enter into crypto exchange activity, which is viewable by UK persons, is caught.
“This isn’t just about marketing emails,” he said. “Anything promotional, even statements on a website landing page viewable by UK persons, is covered; it is a criminal offense in the UK if you breach these rules.”
Gambling or finance?
An influential panel of British lawmakers tells the government crypto should be regulated like gambling. While these proposals sparked immediate ridicule, fury, and everything in between, chatter has turned to how workable the Treasury Select Committee’s idea actually is.
Silly punts: Piling money into unbacked crypto should be considered speculative punting, MPs said. The government’s position is that digital currencies are a matter for the financial services regulators, but some believe that may not be the best fit either.
“Gambling is tax-free in the UK, which would potentially attract more speculators and simplify matters for crypto enthusiasts,” said Adam Vaziri, CEO of KYC tech business Blockpass and a seasoned crypto lawyer.
Existing UK laws also tackle offshore access, whereas financial services rules only restrict onshore marketing, he said.
The reclassification would bring crypto onshore, “potentially benefiting the local market and making UK consumer protection more consistent”, he said.
“The levy system imposed on gambling operators finances the social costs, such as problem gambling, which may also be applicable to excessive crypto trading,” he added, noting however that it could also exempt it from financial market regulations that address manipulation and disclosure requirements.
The Financial Times recently reported on the growth of crypto gambling addiction clinics, stating one space had clocked 300 patients since 2018.
Empty spaces: Others pointed out the immediate fallacy, that the existing gambling regulator has not been seen nor heard from in any part of the debate and most other crypto hubs are relying on financial regulators to take on the responsibility.
“The thought of the Gambling Commission regulating this sector, perhaps not the most esteemed regulator, shows how misunderstood crypto really is,” said economic crime expert Howard Rawstron of Lloyds Banking Group.
Putting the UK gambling watchdogs in charge while other jurisdictions look to financial regulators would create arbitrage, inconsistency and do little to protect users, he said.
Nobody beats the biz: “Crypto is simply a headache that no one wants to take responsibility for regulating, because it is designed to be hard to regulate,” added Mark Conway, gambling harm campaigner.
“Labeling it as gambling may have some logical basis, it is risking money on uncertain outcomes, but so is every financial market in the world; commodities… forex, etc.”
He said financial regulators would struggle to rein in misconduct in the market given the borderless nature of the sector and the fluid jurisdictional approach taken by exchanges.
“Who exactly do you [as a regulator] sanction for malfeasance or market manipulation that occurs in a different jurisdiction? Or when Elon Musk crashes the market with a tweet?”
We got this: A separate cross-party parliamentary group dedicated to reviewing matters of digital currencies and assets later published its own paper, also pushing the need for speedy regulation, but adding that existing financial services rules would cover it.
Of the pair, the All-Party Parliamentary Group’s (APPG) recommendations “are more balanced”, said Dion Seymour, crypto director at specialist tax advisory firm Andersen LLP.
“The APPG recognises the reality of crypto assets: that to have consumer protection requires regulatory clarity – something that the industry has been asking for since 2018,” he said.
Further reading: Compliance+More’s coverage of the committee’s probe into the dark side of digital currencies.
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IOSCO standards
Global securities watchdog IOSCO has floated the first international proposals for regulating cryptocurrencies and assets.
There can’t be only one: IOSCO’s standards, published late May, include conflicts of interest and cross-border cooperation guidance, aiming to stop crypto companies “from combining certain functions in a single legal entity or group of affiliated entities,” such as running exchanges, trading firms and custody businesses under the same legal entity (ie, what Coinbase and Binance are accused of above).
The 18-point plan lands at a time when national and other worldwide regulators are forming their own approach to regulating crypto.
IOSCO’s message to governments is to get on with it.
“What we would say to jurisdictions is just push ahead,” IOSCO secretary-general Martin Moloney said in an interview with the Financial Times.
“They’ve all got different legal frameworks, different regulatory frameworks. Just push ahead, do it to this standard as quickly as you can … It’s not helpful for anyone to hold back at this point,” he added.
Willing and stable
US legislators unveil a pair of competing bills to govern stablecoins as part of a recent hearing of the Subcommittee on Digital Assets, Financial Technology and Inclusion.
Two tribes: Stablecoins are cryptocurrencies whose value is pegged to a reference asset, such as either fiat money, exchange-traded commodities like precious or industrial metals, or another cryptocurrency.
The Republican effort by House Financial Services Committee chair Patrick McHenry (R-NC) would put states in charge and give them powers to license stablecoin issuers
The Democrat proposals by committee ranking member Maxine Waters (D-Calif.) would allow the Federal Reserve oversight to deny registration of a stablecoin issuer approved at the state level.
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