Why is the US SEC so obsessed with the crypto industry?

Author: Huo Huo, Plain Language Blockchain

Recently, there has been a lot of regulatory and negative news. On June 28, the U.S. Securities and Exchange Commission (SEC) filed a lawsuit against Consensys, accusing it of failing to register as a broker through the MetaMask swap service, and it was only two weeks after the SEC notified Consensys that it had ended its investigation into Ethereum 2.0.

According to relevant information, the SEC's first crackdown on encryption began in 2017, when the Network Department was established to deal with a decentralized autonomous organization called The DAO. Later, the department was renamed the Crypto Assets and Network Department, and the SEC increased its supervision of the cryptocurrency market and launched a series of law enforcement actions against unregistered securities issuance, fraud, and market manipulation.

In 2023, the SEC enforced the law more vigorously, taking a record 46 actions, an increase of 53% over 2022, especially the $4.3 billion fine on the head trading platform BN and the resignation of its CEO Zhao Changpeng CZ, which caused a sensation inside and outside the circle.

In total, by 2024, it will be the seventh year that the SEC has cracked down on encryption, and the two sides are still in the game. So, what actions has the SEC taken recently? What impact does it have on the development of encryption?

01 SEC's recent entanglement with encryption

The SEC (Securities and Exchange Commission) is an agency under the US government that regulates the stock market to maintain the transparency of transactions, combat fraudulent schemes, and protect investors' confidence in the stock market. To this end, the SEC has formulated securities registration rules and supervised their implementation.

Image source: Internet

Regarding the crypto industry, in fact, it has been regulated since the development of crypto in 2013.It’s just that many small actions are not noticed by the public. In June this year, the media in the industry wrote an article "SEC's Encryption Enforcement Action: A List of 20 Major Charges Initiated by the SEC", which listed 20 major regulatory projects since the SEC began to regulate crypto, including the collapse of FTX and the fine of BN.

Image source: SEC official website

In 2024, in addition to the prosecution of Consensys mentioned at the beginning of the article, the SEC also carried out a number of activities and updates in the fields of encryption and DeFi.Let's take a look:

1) Approval of Bitcoin ETF

On January 11, 2024,the SEC approved the Bitcoin ETF, which is an important regulatory milestone. This key decision paves the way for mainstream investors to participate in the Bitcoin market, which is known for its high volatility and innovation.

The crypto community is delighted because it is a major step forward in legalizing cryptocurrency as an investment option available to the general public.

2) SEC Redefines "Dealer"

On February 6, 2024, the SEC adopted new crypto regulatory rules. These rules require a wider range of market participants to register with the SEC, join self-regulatory organizations, and comply with existing securities laws and regulations.

This document details terms such as "dealer" and "government securities dealer" and clarifies what constitutes participation "as part of normal business," thereby expanding regulatory oversight of the cryptocurrency and DeFi sectors.
However, these regulations require that entities must manage or control at least $50 million worth of assets.

The crypto community reacted negatively to this update:

The DeFi Education Fund criticized the SEC's new rules as misleading, emphasizing the lack of viable compliance paths for DeFi participants, and calling this approach impractical and stifling innovation.

Marisa Coppel, legal director of the Blockchain Association, believes that the revised definition of "dealer" sets unrealistic standards for DeFi projects and lacks clarity.

3) Suing Uniswap

On April 10, Uniswap Labs posted a news on Twitter, saying: "We received a Wells Notice from the SEC."

What does "Wells Notice" mean? Simply put:

Wells Notice = SEC's declaration of war to you, which means: "We are going to sue you, see you in court."

SEC's main accusations against Uniswap are the following three things:

A. Uniswap Labs provides trading broker services through the wallet app;

B. UNI Token is an "unregistered security";

C. Uniswap Labs operates a trading platform that sells "unregistered securities."

Then in May, Uniswap submitted a 40-page document to the SEC, which gave a detailed counterattack on the allegations, which will be updated later.

4) Suing Robinhood

Robinhood is a financial services company in the United States. On May 4, the company also received a Wells Notice from the SEC.

Dan Gallagher, head of legal, compliance and business at Robinhood, said in a statement that the company has been in direct communication and cooperation with the SEC on its crypto products for many years, including the well-known "come in and register" attempt, but was disappointed that the SEC still sent them a Wells Notice.

However, it is not clear from previous letters which tokens the SEC has determined to be securities, but it is worth noting that Robinhood has proactively removed some tokens from the list - including Solana (SOL), Polygon (MATIC) and Cardano (ADA) - in response to previous SEC lawsuits against rival trading companies.

5) Approval of Ethereum ETH

On April 26, 2024, Consensys Software Inc., a software developer for the Ethereum blockchain, sued the SEC in a federal court in Texas over Ethereum regulation. The approval of the Ethereum ETF undoubtedly indicates that the SEC will officially abandon its position that ETH is a security.

On May 23, 2024, the SEC approved the sale of the spot Ethereum ETF, the second landmark decision made by the SEC in five months after the Bitcoin ETF, which also surprised the crypto community.

ETH, the native token of the Ethereum blockchain, is the second largest cryptocurrency in terms of market value after Bitcoin. Naturally, after the approval of the Bitcoin ETF, a large number of applications for ETH ETFs have also come in and have been submitted to the SEC.

In this event, the SEC approved multiple ETH ETF applications under Form 19b-4.

Unlike the Bitcoin ETF, which started trading the day after it was approved, Ethereum's approval is not all documents approved. Therefore, before the Ethereum ETF starts trading, the fund also needs to obtain S-1 document disclosure approval, which will include detailed information about the fund, such as fees and how the product works. The SEC does not set a specific deadline for approving the S-1 document, so it may take some time before the Ethereum ETF can be traded.

However, the Ethereum ETF is about to be approved, and the community is looking forward to which cryptocurrency may become the next ETF candidate.

6) FIT 21 Act

As the election year approaches, cryptocurrency has become an important voting group. Trump accepted cryptocurrency donations and criticized the Biden administration's cryptocurrency policy. The Biden administration's future response to cryptocurrencies may also turn soft.

On May 24, the U.S. House of Representatives officially passed the 21st Century Financial Innovation and Technology Act (FIT 21). The bill was led by the Republicans, supported by many Democratic members, and was eventually approved.

The main task of the FIT 21 proposal is to define which aspects of cryptocurrency regulation fall under the jurisdiction of the U.S. Securities and Exchange Commission (SEC) and which fall under the jurisdiction of the Commodity Futures Trading Commission (CFTC). In the past, the dual regulation of cryptocurrencies by the SEC and CFTC has always been a pain point in the United States. The two departments have very strict supervision and there is obvious competition for regulatory power.

This approval marks an important milestone in the cryptocurrency industry. Although it will take time for formal implementation, it provides new opportunities for investors and indicates that the regulatory environment may improve further in the coming months.

7) Suing Coinbase

On June 6, the SEC sued Coinbase, accusing it of illegally operating a crypto asset securities business without registration.

The SEC wrote in a complaint filed in the Manhattan Federal Court that since at least 2019, Coinbase has earned billions of dollars by operating as an intermediary for crypto asset transactions while evading disclosure requirements designed to protect investors.

The SEC said that Coinbase traded at least 13 cryptocurrency assets that are securities that should be registered, including tokens such as Solana, Cardano and Polygon.

Image source: SEC official website

This is another major trading platform sued by the SEC after the head trading platform BN was sued last year.

8) Suing Crypto Bank

On July 1, Reuters reported that the SEC sued the crypto bank Silvergate Capital in a federal court, accusing it of securities fraud.

The SEC said that after the collapse of FTX in 2022, Silvergate misled investors about its bank confidentiality system, anti-Money Laundering (AML) compliance program and poor financial condition. At the same time, the bank failed to monitor nearly $9 billion in suspicious transfers from FTX and its affiliated entities.

On July 2, Silvergate agreed to pay $63 million to settle charges by U.S. and California regulators for internal management failures and disclosure of bad information to investors.

02 Why is the SEC so obsessed with the crypto industry?

There are varying degrees of crypto regulation in various countries around the world. Due to the special status of the United States, the market size and the degree of perfection of relevant laws and regulations, the SEC has to choose to strictly regulate cryptocurrencies through legal provisions. The apparent starting point is to: investor protection, market stability maintenance, AML and other legal provisions, but from the launch of Bitcoin and Ethereum spot ETFs and past legal action targets, other clues can be seen: 1) The game behind the US election Due to the large number of crypto enthusiasts in the United States, it is no longer a small group. Trump's previous goodwill towards the crypto industry has attracted Biden and his party to control the SEC to relax its attitude, allowing the Ethereum spot ETF, which had no hope of passing, to go through the process one after another. For details, see the previous article: Trump and Biden compete to "win over Bitcoin", is the US crypto regulation going to turn? Trump and Biden compete to "win over Bitcoin", is the US crypto regulation going to turn?

2) Consideration of the status of the US dollar

Although encryption and Web3 innovation are there, financial innovation is also accompanied by certain risks.The rise of Bitcoin has challenged the status of the US dollar hegemony to a certain extent, and crypto assets led by Bitcoin have become a tool to bypass the US dollar's crypto hegemony. At the same time, due to its decentralized nature, the United States, which advocates free values, knows that it is almost impossible to eliminate it. Therefore, "blocking is worse than unblocking", guiding or even controlling this powerful tool to form a situation that is favorable to the future status of the US dollar is the only feasible way.

The current task of the SEC is to suppress and prevent crypto financial companies from getting out of control in a timely manner. Crypto platforms and some mainstream projects with excessive market power have regulated their behavior in their legal actions again and again, and ultimately led to the development of crypto financial innovation, the status of the US dollar, and the digital dollar market in the United States.

In general, every crypto regulatory event of the SEC is very eye-catching, and behind it is the consideration of the balance between innovation and risk and the maintenance of the US dollar strategy.

03 Will SEC regulation be good or bad for the crypto industry?

SEC regulation has played a key role in ensuring market fairness, transparency and stability, and has promoted financial innovation and investor protection to a certain extent. But at the same time, regulatory measures have also brought some compliance costs, which have curbed the development of the market to a certain extent.

1) Positive impact

To be fair, the SEC is not trying to be a villain. The original vision is to protect American investors involved in risky assets, promote fair practices and enhance market integrity by curbing price manipulation and vigilant supervision.With the strengthening of law enforcement actions, fraud prevention can be effectively prevented, and investors can be protected from the traps that have appeared in the collapse of platforms such as FTX and Terra (LUNA).

By approving the establishment of a Bitcoin ETF in the United States, the SEC has opened the door to broader investment in cryptocurrencies, which is likely to stabilize and enhance market confidence in these assets.

In addition, the SEC's focused disclosure standards ensure transparency, thereby helping investors make more informed investment decisions. As the SEC's regulatory umbrella becomes more attractive to traditional investors and institutions, more legal and compliant developments will attract a wider range of adopters. In addition, the SEC's involvement in addressing issues of global concern helps reduce cross-border cooperation in crypto-related crimes.

2) Negative impact

In the short term, it has suppressed the development of the market, with the most obvious consequence being the large-scale withdrawal of cryptocurrency companies and projects from the United States. For example, most initial Token Offerings (ICOs) today are not open to US citizens. And several trading platforms, such as Poloniex and Bittrex, have also chosen to withdraw from the US market after paying millions of dollars in fines. In addition, the SEC's determination that certain tokens are securities will cause trading platforms to delist these tokens, which in turn affects investors.

And the strict cryptocurrency rules implemented by the SEC have not only affected many cryptocurrency investors in the United States, but also hit cryptocurrency investors abroad. Other jurisdictions around the world may want to imitate these rules, resulting in damage to innovation and reducing the adoption of cryptocurrencies by the sectors that need it most, such as the unbanked population.

The SEC has expanded the definition of “dealer,” which has raised concerns among DeFi participants and the broader crypto community. On the one hand, this new definition could impose a considerable regulatory burden on entities within the crypto space, potentially slowing innovation and complicating compliance efforts; on the other hand, for crypto companies, they need to follow complex rules, audits, and daunting numbers because they need to pay compliance costs if they want to enter the U.S. market. Refer to the example of BN, whose CEO Changpeng Zhao pleaded guilty in November 2023 to violating U.S. anti-money laundering restrictions, prompting a $4.3 billion settlement between the platform and the U.S. government.

04 Summary

There is no doubt that the SEC's crypto regulatory landscape will continue to evolve in 2024. According to relevant reports, the SEC has actually been cautious in formulating new specific rules for cryptocurrencies. To address violations, the commission currently focuses on applying and interpreting existing securities laws, such as:

Securities Act of 1933

Securities Exchange Act of 1934

Investment Company Act of 1940

Investment Advisers Act of 1940

Sarbanes-Oxley Act of 2002M

Dodd-Frank Wall Street Reform and Consumer Protection Act

The core issue of SEC crypto regulation is whether crypto can be classified as securities. The SEC has not yet provided a clear classification for all cryptocurrencies.

SEC Commissioner Hester Peirce said at the ETHDenver conference on February 29 this year that the current position of the US investment regulator on the cryptocurrency industry is "enforcement mode only, and mainly follows a court-first approach". In her view, only with clearer regulations can the industry focus on innovation.

In any case, achieving the right regulatory balance is a prerequisite for effectively promoting development. Crypto regulation aims to protect investors from fraudulent schemes and ensure market integrity. For example, by enforcing KYC and AML Guidelines, authorities can prevent the abuse of crypto platforms for illegal activities. These initiatives are generally welcomed as they increase the security and attractiveness of cryptocurrencies as an investment option, potentially attracting more participants and enhancing market robustness.

However, excessive regulation may undermine the fundamental principle of cryptocurrency: decentralization. Cryptocurrencies were designed to operate without central supervision, but if only large, resource-rich companies can comply with complex regulations, the cryptocurrency ecosystem may tend toward centralization.

It can only be said that now, both the crypto industry and regulators are facing complex challenges. When formulating laws, regulators must preserve the value of cryptocurrencies, retain their ability to innovate and decentralize, and reduce potential risks to the market; the crypto industry needs to promote market innovation and development without violating the principles of legal compliance.