The US Securities and Exchange Commission’s scrutiny of digital currencies that are listed on Coinbase Global Inc. is igniting concerns that a major crackdown for the rest of the industry is imminent.
Digital coins are headed for a losing week, dragged down by the revelation that the SEC has been investigating whether Coinbase shirked regulations by offering trading in certain tokens. Anxieties were already running high after the regulator took the unusual step of identifying several crypto assets that it considered to be securities as part of an insider trading case.
The SEC lawsuit against a former Coinbase manager and two others, coupled with the probe into the platform’s listings, signal that after more than a year of warnings by Chair Gary Gensler the regulator’s stance appears to be hardening. Meanwhile, the agency’s assertion last week that nine tokens fall under its jurisdiction is drawing pushback inside the Commodity Futures Trading Commission, the US derivatives watchdog that also oversees crypto.
“This is a shot across the bow of the industry, not just across one boat within that armada,” said James Cox, a professor specializing in securities law at Duke University School of Law.
The SEC on July 21 accused one of Coinbase’s former employees of violating its insider-trading rules by leaking information to help his brother and a friend buy tokens just before they were listed on the platform. The regulator said it was its first for crypto insider trading.
Federal prosecutors in Manhattan also charged the three men with wire fraud conspiracy and wire fraud. Neither the SEC nor Justice Department accused Coinbase of wrongdoing.
Bitcoin advanced 2.3% and Coinbase rose 7.2% on Wednesday at 10:28 a.m. in New York, rebounding from declines on Tuesday. Bitcoin tumbled more than 5% and Coinbase plunged 21% Tuesday after Bloomberg News reported that the firm was facing a US probe into whether it improperly let Americans trade digital assets that should have been registered as securities.
A more aggressive approach by the SEC in asserting that specific tokens are securities would be problematic for the industry because such a label triggers strict investor-protection requirements. Crypto enthusiasts say many of those strictures are incompatible with digital assets. A previous move by the regulator’s enforcement division to crack down on initial coin offerings resulted in a sharp decrease in that corner of the crypto market.
Regulators at the CFTC, which was also looking into the insider trading allegations, were put off by the SEC’s move last Thursday to declare that nine tokens — including seven that trade on Coinbase — were securities and under its purview, according to two people familiar with the matter, who asked not to be named to discuss internal discussions.
CFTC officials have said that Bitcoin, the largest cryptocurrency, and Ether, the second biggest, are commodities and under its jurisdiction. However, the legal status of thousands of other tokens — including those named last week in the SEC’s lawsuit — has remained more murky.
To decide if a digital asset is a security, the SEC applies a legal test, which comes from a 1946 US Supreme Court decision. Under that framework, the agency considers a token generally to be under SEC purview when it involves investors kicking in money to fund a company with the intention of profiting from the efforts of the organization’s leadership.
CFTC staff have argued internally that some of the tokens the SEC identified in its complaint as securities could just as easily be considered commodities. Some have expressed concerns that the SEC case could set a precedent that the derivatives regulator needs permission to pursue digital-asset cases, one of the people said.
“If you’re trying to say that virtually every token, except Bitcoin, is a security, that raises an existential threat to Coinbase and the whole crypto economy,” said Aitan Goelman, a partner at Zuckerman Spaeder and previously a director of enforcement at the CFTC.
Representatives for the CFTC and SEC declined to comment.
In a sign of the tension at the CFTC, Republican Commissioner Caroline Pham broke with typical Washington protocol by issuing a statement on the SEC’s insider trading case critiquing the agency’s move as “regulation by enforcement” with “broad implications beyond this single case.”
Kristin Johnson, a Democratic commissioner at the derivatives watchdog, said people should be focused on protecting investors and not over any brewing turf battles. “Policing markets is a shared priority,” she said in an interview.
For its part, the SEC has long said many coins are subject to its investor-protection strictures and that trading platforms should register with the agency, though none of them have.
As the CFTC and SEC jostle over which tokens are securities, several bills have been proposed in Congress to sort out the confusion.
One highly-watched piece of legislation from Cynthia Lummis, a Republican senator from Wyoming, and Kirsten Gillibrand, a Democratic senator from New York, would significantly expand the CFTC’s role. On Tuesday, Pat Toomey, the highest-ranking GOP member of the Senate Banking Committee, sent a letter to Gensler criticizing the SEC’s approach on crypto.
Beyond Gensler, and his predecessor Jay Clayton, suggesting that the vast majority of tokens are securities, the regulator has mostly avoided weighing in on specific coins. The lack of specificity has prompted calls in the industry for more clarity — including last week from Coinbase itself.
Meanwhile, an SEC enforcement action against the platform or a potential court ruling over whether certain tokens are securities, could call into question many digital exchanges’ business operations.
“The uncertainties and competing visions about crypto regulation are coming to a head,” said Andrew Verstein, a professor of law at the University of California, Los Angeles.
With its latest moves, the SEC is showing it’s willing to bet–potentially in court–on its vision of how the space should be regulated, he said.