SEC special report: is this the end of cryptos in the US?

What is the SEC accusing Binance and its boss of?

After more than a year of investigation, and twists and turns in the press, the US financial watchdog this week took the world's largest platform to court on the basis of 13 offences.

One of the most damning is the one concerning the mixing of its own funds with those of its clients. According to the SEC, Merit Peak and Sigma Chain, two market makers controlled by Binance founder Changpeng Zhao, known as 'CZ', saw funds from the platform's customers in transit...

Also according to the SEC, Binance allegedly engaged in market manipulation to inflate its trading volumes. CZ and Binance also allegedly targeted US users, knowingly when they did not have the right to do so, depriving users of the "protections afforded to them under the securities laws", the document states.

According to the complaint, Binance executives knew full well that the global entity was operating illegally. "We are a fucking unregulated exchange in the United States," the compliance director allegedly wrote to a group employee at the end of 2018 😅.

The icing on the cake is that Binance's US subsidiary allegedly has very strong operational and capital links with Chengpeng Zhao. This would contradict the founder's claim that Binance's US operations were independent of Binance global and himself.

This complaint follows one filed in March by the CFTC, the other major US financial regulator, which accused Binance of illegally serving US customers. Discussions are currently underway between the Chinese company and the CFTC.

Binance faces an outright ban on its services in the United States, a fine of several billion dollars, and even criminal proceedings concerning Changpeng Zhao.

"Binance will definitely have big problems in the United States," bellows one of its business partners. "Now the question will be whether Washington will go after the global structure or whether the case will remain confined to the US subsidiary," she says. The SEC has already begun requesting a "temporary" freeze on the US subsidiary's funds.

According to manager 21Shares, Binance has recorded $1.4 billion in withdrawals over the past three days 💸.

What about Coinbase?

The SEC has also taken legal action against Coinbase, mainly claiming that the company was operating as an unregistered exchange in the US.

The regulator thus believes that many of the crypto-assets available on Coinbase are "financial securities", which should have required the company to register under this regime. Binance is also being targeted for this offence.

Part of the charge also relates to the staking product offered by Coinbase to its customers. This action, which involves depositing cryptos in order to secure blockchain protocols (such as Ethereum), in exchange for a fee, is perceived by the SEC as a yield product and would therefore be a kind of financial security 🧐.

Coinbase faces significant financial penalties, but also the delisting of tokens targeted by the SEC and the discontinuation of its staking product. This is notably what happened a few months ago to its compatriot Kraken.

The platform run by Brian Armstrong has stated that it wants to defend itself in court and thus avoid any out-of-court settlement (which would be a way of admitting its wrongdoing).

Coinbase has been fighting for many years to have it recognised that cryptocurrencies are not traditional financial securities, and therefore that it does not have to comply with their regulation. The resolution of this case is expected to take, at the very least, several months.

What do the two cases have in common?

The two cases are not of the same seriousness, in particular because Coinbase is not accused of fraud and accounting manipulation. In addition, there are no charges against Coinbase CEO Brian Armstrong, while Chengpeng Zhao is personally targeted.

"The two complaints have quite different grounds, but they also have points in common, namely that the SEC considers many of the digital assets offered by Coinbase and Binance US to be financial securities," explains Morgane Fournel-Reicher, a lawyer at Kramer Levin specialising in US digital asset law.

"According to the regulator's analysis, the two platforms would have had to obtain certain licences in order to operate legally in the United States," she continues. One of these licences is that of a regulated stock exchange.

In the United States, the best known are the NYSE and the Nasdaq, where Apple and Nike, among others, are listed.

Why is Binance so keen on the US market?

This is one of the big questions that arises as the risks taken by Binance and Chengpeng Zhao seem so great. But according to testimony obtained by the SEC, the motivations are above all... financial 💸.

CZ is said to have explained in particular in 2019 to company executives that the United States, and American customers, were important for the platform's volumes.

"We can't lose American customers because they contribute to a large part of the volume. So the ideal would be to help them (...) move their transactions abroad, i.e. by accepting them without them having to be labelled as Americans."

The use of VPN software (allowing customers to mask their real geolocation) would have been encouraged by CZ itself, according to Gary Gensler and his teams. The latter also allegedly promoted techniques to conceal the citizenship of certain American VIP customers.

Officially, Binance's share of the US market is negligible (9% according to Kaiko). However, in light of the documents provided by the SEC, the actual share of US customers could be much higher because it is actually based on biased figures.

How could the SEC allow Coinbase's IPO?

This is one of the points that has caused the most misunderstanding: why did the SEC give the go-ahead for Coinbase's IPO in April 2021, when it has accused it of being an illegal exchange platform since at least 2019? 🤨

"When a company goes public, we don't look at its business, only whether it meets the criteria to be listed. And that was the case with Coinbase," says Morgane Fournel-Reicher of Kramer Levin.

It should also be pointed out that at the time Coinbase listed just fifty or so digital assets on its platform, whereas today it has more than... 300!

Why are exchange platforms refusing to become regulated exchanges?

At this level, there is no shortage of "arguments".

"There is obviously the cost," stresses Anne-Sophie Cissey, in charge of compliance for market maker Flowdesk 🇫🇷 , which operates in Europe, the United States and Singapore. For players such as Binance or Coinbase, this could be at least around twenty million dollars, according to Anne-Sophie Cissey.

This status also implies having a legal team representing at least 10% of its workforce. This can represent considerable human investment for companies with thousands of employees (Between 6,000 and 8,000 for Binance, around 3,000 for Coinbase).

This status also implies putting in place a whole particularly strict compliance system. Not to mention the processes for monitoring listed assets. "Today, the listing of cryptos and tokens is done in a quasi-discretionary way", explains a good connoisseur of the sector.

"Overall there is not enough transparency on prices", adds Anne-Sophie Cissey. "When there are large brokerage orders, some platforms sometimes deal for their own account, for clients, on the market... We have no idea if there are conflicts of interest," she warns.

Are other cryptocurrency exchange platforms at risk of being attacked by the SEC?

"Everyone is in the crosshairs," says Morgane Fournel-Reicher. "The fact that they're going after Binance and Coinbase means that they're probably going to go after the others," she points out.

Among the major platforms that cater to US customers are Kraken, Bitstamp and Gemini, among others.

"The SEC officially considers SOL, ADA, MATIC, FIL, SAND or ATOM to be financial securities, so as they are listed on almost all exchange platforms, this means that everyone could be declared illegal in the United States," insists Morgane Fournel-Reicher.

So far, only Bitcoin (BTC) is guaranteed not to qualify as a financial security, not least because it was not the subject of an ICO (a cryptocurrency fundraiser to finance a project) when it was created 💡.

Potentially, ether (ETH) could qualify as a financial security by the SEC, but it is not listed in the SEC's court papers.

"The ETH case is rather complex because Gary Gensler's predecessor at the SEC had established that it was not a financial security, without relying on federal regulation," says Morgane Fournel-Reicher.

Still, since the 2022 "Merge" (read our dossier), the SEC has taken a renewed interest in Ethereum and is beginning to consider that, given the number of nodes on US soil, and therefore Ethereum's concentration, ether could be a financial security.

Is the SEC's fight political?

The wave of complaints filed by the SEC comes against a backdrop in which it has been widely criticised for failing to see the FTX scandal coming.

The SEC chairman is regularly the subject of accusations of all kinds over FTX. Being tough on the crypto industry could thus allow him to wipe the slate clean and keep his chances of remaining at the helm of one of the most powerful institutions on the planet.

Whatever happens, beyond the choice of SEC boss, the problem is that the US has no crypto regulations and the sector sails on a case-by-case basis.

"There are no guidelines, so any crypto could be considered by the SEC as a financial security," points out a French investor. "It's totally arbitrary," he adds.

What does this mean for Europe?

The absence of US regulation and its consequences are tremendous publicity for European MiCA regulation, which is far from perfect, but at least has the merit of existing 🤓.

The MiCA regulation, recently adopted by the European Parliament, provides a clear framework for exchange platforms and proposes a legal definition of crypto-assets (different from financial securities).

The SEC's attitude could drive many American projects to the Old Continent, or even to other jurisdictions such as the United Arab Emirates and Singapore, which have also adopted legislation on the subject.

In recent months, France has been chosen by giants such as Cryptocom, Circle and OKX, which have set up their European headquarters here. This is also the case for Binance (read the interview with its boss in France).

"This scenario is likely, but I do see two big limits to it," moderates Arnaud Touati, a partner at Hashtag, a law firm specialising in start-ups and new technologies.

"Firstly, there is Europe's propensity to follow the United States by mimicry, particularly when it comes to the all-out qualification of financial products, and secondly the attractiveness of third-party jurisdictions, particularly tax havens, which allow derivatives transactions to be carried out much more flexibly than in Europe and the United States."

The next few weeks are shaping up to be particularly intense 👀.