Source: Yahoo Finance, compiled by TaxDAO
The road to compliance for cryptocurrencies has been challenging, with U.S. lawmakers and judicial authorities stepping up regulation of the industry in March and April of this year.
From the perspective of ordinary investors and the economy as a whole, this is all good. As written before, from Bitcoin to the most ridiculous versions such as Dogecoin, the value of crypto tokens is so vague that they can be easily exploited to "separate" unwary or gullible investors from their money.
The term "cryptocurrency" may have only recently emerged, but its questionable transactions fit perfectly into the framework that courts have used to identify securities for nearly eight decades.
The value of cryptocurrencies can be placed anywhere. They do not generate income like bonds, and their prices cannot be linked to liquid markets like listed company securities. So far, no one has explained what cryptocurrencies are useful for, except to pay ransoms to fraudsters who hold databases or computer systems hostage.
Recently, Change Healthcare, a medical transaction processor under United Health Group, received a second request to pay a ransom in crypto tokens. The company paid a $22 million ransom to save information including payment data and the medical records of thousands of patients.
That hack of the Change Healthcare database disrupted health reimbursement payments nationwide and even forced some health care providers to lay off staff or close entirely due to a lack of funds.
The new ransom demand apparently comes from a ransomware group that believes it was duped by its partners in the first extortion attempt, who may have absconded with the initial ransom.
Crypto’s March Madness
Of course, the most notable blow was the March 28 sentencing of convicted cryptocurrency fraudster Sam Bankman-Fried, who was convicted last October on seven counts of fraud in connection with the collapse of the FTX cryptocurrency exchange.
Federal Judge Lewis Kaplan sentenced Bankman-Fried to 25 years in prison and ordered him to forfeit more than $11 billion. Kaplan observed that SBF had shown little remorse for his crimes. Kaplan justified the lengthy prison term by saying that without it, there was “a not insignificant risk that SBF would do something very bad in the future.”
Moreover, the day before SBF’s sentencing, federal judge Katherine Polk Failla issued a ruling that could have even more far-reaching implications for the cryptocurrency industry. Failla allowed the SEC to proceed with a lawsuit alleging that cryptocurrency broker and exchange giant Coinbase has been trading securities without a license.
What’s significant about Failla’s ruling is that she immediately rejected Coinbase’s argument that cryptocurrencies are a new type of asset that doesn’t fall under the SEC’s jurisdiction — in short, they are not “securities.”
Crypto promoters have been making the same argument in courts and in the halls of Congress, urging lawmakers to create an entirely new regulatory structure for cryptocurrencies — preferably one that’s less restrictive than the existing rules and regulations promulgated by the SEC and the Commodity Futures Trading Commission.
Coincidentally, SBF said the same thing during his appearance before a congressional committee, when he was seen as the last seemingly honest cryptocurrency promoter before it was discovered that he had illegally misappropriated customers’ assets to fund his company.
Failla saw through the debate. “The term ‘cryptocurrency’ may be recent,” she wrote, “but the transactions at issue fit neatly into the framework that courts have used to identify securities for nearly eight decades.”
Failla also took a swipe at the cryptocurrency gang, rejecting Coinbase’s argument that the case should fall under the “significant issues doctrine,” an informal rule that requires regulatory initiatives to be explicitly authorized by Congress if they involve “significant economic and political significance.” Coinbase said that because Congress has not yet enacted regulations specifically targeting cryptocurrencies, the SEC’s lawsuit should be dismissed.
The judge’s take on that argument was discouraging. She noted that “while the cryptocurrency industry is indeed large and important, it is far from being ‘a part of the U.S. economy’ of great economic and political significance.” Cryptocurrency simply “cannot be compared to other industries that the Supreme Court has found raise significant questions of principle,” she wrote, including the U.S. energy industry and the traditional securities industry itself.
Failla’s ruling follows another ruling in a federal court in New York in which a judge deemed cryptocurrencies to be securities. In that case, Judge Edgardo Ramos declined to dismiss the SEC’s charges against Gemini Trust Co., a cryptocurrency exchange run by Cameron Winkelvoss and Tyler Winkelvoss, and Genesis Global Capital, a cryptocurrency lender.
The SEC alleges that Gemini’s scheme to pool customers’ crypto assets, lend them to Genesis and promise customers high returns was an unregistered security. As with the case against Coinbase, the SEC’s case will proceed to trial.
Both rulings tend to overturn a 2023 ruling by New York federal judge Analisa Torres in the SEC’s enforcement action against Ripple, the developer of the XRP crypto token. Torres argued that the token might not be a security in certain circumstances. But her ruling was overshadowed by a series of rulings by her colleagues that held that cryptocurrency marketers and exchanges were engaging in unregistered securities transactions, which is illegal.
April in Crypto
The fallout from March continued into April. On April 5, a New York federal jury found Terraform Labs and its CEO and majority shareholder Do Kwon liable in what the SEC called a “massive cryptocurrency fraud.” The case involved Terraform’s so-called stablecoin UST, a crypto token pegged 1:1 to the U.S. dollar. Do Kwon was not in court to hear the verdict. He is detained in Montenegro while U.S. and South Korean authorities fight for his extradition.
Terraform claimed that if the value of the UST coin fell below $1, it would automatically "self-heal" through software algorithms. This happened in May 2021. When the token did recover to a value of $1, Terraform and Kwon boasted that the price recovery was a victory over "decision-making by human agents during periods of market volatility," the SEC said.
In fact, the algorithm had nothing to do with it. According to trial testimony that began in late March, Terraform was secretly bailed out by trading firm Jump Trading, which may have invested tens of millions of dollars to prop up UST and may have made more than $1 billion in profits from the trade. The SEC said that failure to disclose the arrangement to investors violated the law.
The SEC said Kwon and Terraform also lied to the public by saying that Chai, a South Korean financial company similar to Venmo, was using Terraform to process transactions, when in fact Chai stopped using Terraform in 2020.
The agency claims that these deceptions painted a picture of robustness within Terraform, but that picture fell apart in May 2022 when UST again decoupled from the dollar and could not recover. The SEC said UST’s value effectively fell to zero, “losing more than $40 billion in total market value… and sending shockwaves through the cryptoasset community.”
Terraform, now bankrupt, has not yet filed any charges against Jump Trading.
Tighter Regulation?
These events should give U.S. lawmakers pause to think about how cryptocurrencies should be regulated. At a hearing before the Senate Banking, Housing, and Urban Affairs Committee, Senator Sherrod Brown, the committee’s chairman, warned that cryptocurrencies pose a potential threat to national security.
“Bad actors are turning to cryptocurrency not because they saw an ad and believed the hype,” Brown said. “They’re using it because they know it’s a workaround. They know it’s easier to move money in the dark without safeguards like know-your-customer rules or suspicious transaction reports, and we have to ensure that cryptocurrency platforms are subject to the same rules as other financial institutions.”
Adding to Brown’s words, Treasury Undersecretary Wally Adeyemo urged Congress to enact Treasury’s proposed reforms to strengthen sanctions against “foreign digital asset providers that facilitate illicit finance.”
Meanwhile, Massachusetts Democratic Senator Elizabeth Warren — perhaps the most intransigent voice on Capitol Hill about cryptocurrencies — took aim at stablecoins, urging the House Financial Services Committee to avoid trying to enact rules that “embed stablecoins more deeply into the banking industry.”
Given the potential for stablecoins and their ilk to “undermine consumer protection and the safety and soundness of the banking system,” she warned, any so-called reforms “could amplify and entrench those risks rather than mitigate them.”
What’s driving politicians’ enthusiasm for promoting an asset class that has no value other than when it involves fraud or theft? As is often the case, it’s money — the green, foldable kind.
Crypto promoters have been ramping up their lobbying in Washington, with crypto firms spending nearly $20 million on lobbying in the first nine months of 2023, according to data from watchdog group Open Secrets.
With the push for new regulatory approaches, especially from House Republicans, and the fact that this is an election year, more spending looks to be on the horizon. It’s a win-lose situation, with politicians and crypto promoters poised to win, and regular investors, and the economy as a whole, likely to lose.