Valmar’s Perspective on Recent SEC Complaints Against Binance & Coinbase
Last week, the Securities and Exchange Commission (SEC) filed complaints against two of the largest cryptocurrency exchanges by volume, Binance and Coinbase. There has been substantial criticism concerning the SEC’s approach to regulating the crypto space, and in this blog, we parse through the potential short-term and long-term implications of these complaints and take stock of where we are in the long road to domestic regulatory clarity, which is crucial for broader institutional adoption.
SEC Lawsuit against Binance
On June 5th, the SEC sued Binance, Binance.US and its founder Changpeng Zhao (CZ). In their complaint, the SEC essentially alleges that Binance:
Operated in the United States as an unregistered exchange, broker-dealer, and clearing agency.
Issued unregistered securities in the form of BNB and BUSD.
Facilitated the trading of “crypto asset securities”, specifically naming SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, and COTI.
Lied, concealed and misrepresented its activities, such as trading against their own customers, inflating exchange volumes, providing false information about internal controls, misappropriating client assets, and misrepresenting the independence of Binance.US.
The first three allegations relate to whether the assets listed or issued by Binance should be classified as securities. Unfortunately, we are no closer to knowing for sure as the SEC continues to regulate by enforcement without providing any clarity with respect to how they make that “security” determination. For example, it is unclear why SOL is specifically named in the complaint while other layer-1 tokens such as AVAX and NEAR are not.
Of note, regardless of the securities classification, it is considered best practice to separate the functions of broker-dealer, exchange, and clearinghouse. These functions are separated in traditional finance to eliminate conflicts of interest and to preserve the safety and custody of client funds. The crypto industry must adopt this principle too. We are already witnessing an increase in the rate at which many crypto exchanges are integrating with leading custody solutions such as Copper’s ClearLoop to enable active trading without holding assets on exchange. We hope this trend of disaggregating functions currently performed by crypto exchanges continues and that true custodial solutions continue to grow.
The allegations related to misappropriated funds and misrepresentations are the most problematic. If proven true, it would be another significant blow to the crypto industry and would prove to be another downward catalyst. There is no sugar coating the turmoil that would be caused by taking down the largest crypto exchange by volume: markets and reputation would be further damaged. However, from a broader and longer-term perspective, such a moment could serve as an opportunity for the industry to become less reliant on opaque and hard-to-trust counterparties and shift towards more transparent and trustworthy ones. The establishment of trusted and compliant counterparties is critical to true institutional adoption.
SEC Lawsuit against Coinbase
The very next day, the SEC filed a lawsuit against Coinbase, alleging that:
Coinbase is operating an unregistered securities exchange, broker, and clearing agency from since at least 2019. The complaint lists the following “crypto asset securities”: SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, ICP, VGX, NEAR, NEXO, FLOW and DASH.
Coinbase’s staking-as-a-service is an unregistered securities offering.
Coinbase Wallet and Coinbase Prime are unregistered brokers because they route orders through 3rd party trading platforms.
Similar to the suit against Binance, the SEC alleges that Coinbase is operating an unregistered exchange, broker, and clearing house. As mentioned above, regardless of whether digital assets are classified as securities, it would be beneficial for the industry to segregate these functions.
The rest of the allegations are frustrating to see. Importantly, Coinbase IPO’ed in 2021, well after the date from which the SEC alleges that it was operating as an unregistered exchange. From Valmar’s vantage point, Coinbase has repeatedly sought meaningful engagement with the SEC for guidance and rulemaking, to no avail. Coinbase even acquired an alternative trading system (ATS) to prepare for trading digital asset securities alongside non-security digital assets. However, without any changes to the current regulatory framework, unregistered digital asset securities cannot be traded on an ATS. The problem lies in the uncertainty surrounding which digital assets are securities and how to register them with the SEC.
As with the Binance complaint, a few digital assets were specifically named as securities in the case against Coinbase, but there seems to be specific reasoning to it. Why are ADA and MATIC mentioned in the Coinbase complaint but not in the Binance complaint, even though Binance also lists them? Without any discernable reasoning, the industry is left with no additional guidance with respect to the question of whether an asset is a security or not.
The allegation that Coinbase Wallet is an unregistered broker also raises concerns. Coinbase Wallet is a self-custodial wallet that allows users to connect to DeFi applications and effect transactions. Such an allegation could be interpreted as a veiled assault on the concept of self-custody and DeFi.
Final Considerations
Valmar is in favor of prudent and common-sense regulation for digital assets. We believe that improving transparency, safety, and security is necessary to bring about institutional adoption and unlock the full potential of blockchain technology.
The Digital Asset Market Structure Proposal (DAMS) drafted by Representative McHenry (Chairman of the House Financial Services Committee) and Representative Thompson (Chairman of the House Committee on Agriculture) offers a potential path forward. The proposal seeks to:
Clarify the roles of the SEC and CFTC with respect to digital assets.
Establish a framework for digital asset securities, digital asset commodities, and stablecoins, so that they can be traded on regulated ATS.
Allow broker-dealers to custody digital assets.
It is worth noting that the collaborators on this proposal are both from the Republican party. Democrat support for some version of the proposal will be needed for it to become law. Additionally, there is an opportunity to include SEC Commissioner Hester Peirce’s “safe harbor” proposal in future drafts of DAMS. This “safe harbor” would provide token projects with a three-year grace period to achieve sufficient decentralization before having to comply with regulatory requirements.
The road to institutional adoption is long and full of bumps. While the recent SEC actions introduce uncertainty, we believe that in the long run, they can lead to a better and safer digital asset ecosystem. Digital asset markets are global, and many credible jurisdictions around the world are finding ways to embrace technological and financial innovation, including the UK, Europe, the Middle East, and Asia.
The below map, produced by Blockchain Coinvestors, illustrates the stark difference between the US and the rest of the world in terms of regulatory approach towards digital assets.
Source: Blockchain Coinvestors
The US may be slower on the uptake, but we have faith that it will eventually get this right. The US cannot afford to miss out on a historic opportunity of innovation and the development of new capital markets.