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Are the Halcyon Days of Cryptocurrency Over?

  • June 15, 2023
  • Clayton Rice, K.C.

The United States Securities and Exchange Commission has initiated two enforcement actions in two days against major platforms in the cryptocurrency market environment. The two civil cases are another push by the SEC to flex its muscle over crypto markets often described as the Wild West of investing. But the platforms continue to push back claiming the SEC rules are fuzzy and the agency is overreaching.

1. Introduction

On June 5, 2023, the U.S. Securities and Exchange Commission filed a complaint in the United States District Court, District of Columbia, charging Binance Holdings Ltd. with a variety of violations of securities law. (here) Binance operates the largest cryptocurrency trading platform in the world. The complaint also charges U.S.-based affiliate, BAM Trading Services Inc., and their founder Changpeng Zhao. Binance and BAM Trading jointly operate the cryptocurrency trading platform, Binance.US. On June 6, 2023, the next day, the SEC filed a complaint in the United States District Court, Southern District of New York, charging Coinbase, Inc. with operating its cryptocurrency platform as an unregistered national securities exchange, broker and clearing agency. (here) The complaint also charges Coinbase with failing to register the offer and sale of its cryptocurrency staking-as-a-service program. The dual complaints have ratcheted up the heat in the crypto kitchen following the high profile charges initiated last year against FTX and its founder Sam Bankman-Fried that I discussed in a previous post to On The Wire. (here)

2. Background

I will give you some brief background information about the players that will provide backdrop to my observation that the SEC has been steadily increasing its involvement in the cryptocurrency market as the year has been unfolding.

(a) Binance

Binance is a Cayman Islands limited liability company founded and owned by its Chief Executive Officer, Changpeng Zhao. It operates through a web of subordinate or affiliated entities, in multiple jurisdictions, all tied to Mr. Zhao as the beneficial owner. The co-defendant, BAM Management US Holdings Inc., is a Delaware corporation and the parent of the co-defendant BAM Trading services Inc. When the Binance.US platform launched in 2019, BAM Management was wholly owned by BAM Management Company Limited, a Cayman Islands company, which in turn was wholly owned by CPZ Holdings Limited, a British Virgin Islands company that was owned and controlled by Mr. Zhao. BAM Trading is also a Delaware corporation with a principal place of business in Miami, Florida. It is wholly owned by BAM Management.

(b) Changpeng Zhao

Mr. Zhao, commonly known as “CZ”, was born in China’s Jiangsu province and emigrated with his family to Canada in the 1980s settling in Vancouver, British Columbia. He is a Canadian citizen and a graduate of McGill University in Montreal, Quebec, in computer science. He was ranked the 136th richest person in the world by Bloomberg Billionaires Index with a net worth estimated at $13.1 billion as of December 2022. That ranking, however, appears to have bounced up to 50th richest according to a report by the CBC, Canada’s national broadcaster, but then slipped to 69th richest following the announcement of the SEC charges. (here and here) Reputed to have “towering ambitions” Mr. Zhao told staff in a company group chat in 2022 that, “We want to take over the entire market!” (here) The SEC claims that between October 2022 and January 2023, Mr. Zhao personally received $62.5 million from one of the Binance bank accounts.

(c) Coinbase

Coinbase is a Delaware corporation, founded in 2012 by computer science and economics graduates Brian Armstrong and Fred Ehrsam, that operates a cryptocurrency trading platform servicing U.S. customers. In 2014, Coinbase became a wholly owned subsidiary of the co-defendant, Coinbase Global, Inc. Coinbase purports to be a “remote-first company” that maintains no principal executive office. Coinbase Global is also a Delaware corporation founded in 2014 to act as a holding company for Coinbase. It’s principal asset is its equity interest in Coinbase. Like Coinbase, Coinbase Global purports to have no principal place of business and is a “remote-first company.” Coinbase Global filed an effective registration statement with the SEC and, on April 14, 2021, Coinbase Global listed its common stock on the Nasdaq Global Select Market.

3. The Binance Complaint

The SEC alleges that, while Binance and Mr. Zhao publicly claimed that U.S. customers were restricted from transacting on, they subverted their own controls to secretly allow high-value U.S. customers to continue trading on the platform. By exercising control of the customers’ assets, they were able to commingle or divert assets as they pleased, including to an entity owned and controlled by Mr. Zhao called Sigma Chain. The complaint asserts that BAM Trading and BAM Management misled investors about non-existent trading controls over the Binance.US platform, while Sigma Chain engaged in manipulative trading that artificially concealed the fact that it was commingling billions of dollars of investor assets and sending them to a third party, Merit Peak Limited, that is also owned by Mr. Zhao. The complaint also charges violations of registration related provisions of federal securities law that are summarized in a concurrent press release:

  • Binance and BAM Trading with operating unregistered national securities exchanges, broker-dealers and clearing agencies;
  • Binance and BAM Trading with the unregistered offer and sale of Binance’s own crypto assets, including the so-called exchange token, BNB, a so-called stablecoin, Binance USD (BUSD), certain crypto-lending products, and a staking-as-a-service program; and,
  • Mr. Zhao as a control person for Binance’s and BAM Trading’s operation of unregistered national securities exchanges, broker-dealers and clearing agencies.

“We allege that Zhao and the Binance entities not only knew the rules of the road, but they also consciously chose to evade them and put their customers and investors at risk – all in an effort to maximize their own profits,” said Gubir S. Grewal, Director of the SEC’s Division of Enforcement. “By engaging in multiple unregistered offerings and also failing to register while at the same time combining the functions of exchanges, brokers, dealers, and clearing agencies, the Binance platforms under Zhao’s control imposed outsized risks and conflicts of interest on investors.” (here) In one telling allegation, the SEC asserts that Binance’s Chief Compliance Officer admitted to another Binance compliance officer in 2018, “[W]e are operating as a fking unlicensed securities exchange in the USA bro.”

4. The Coinbase Complaint

The complaint charges Coinbase, Inc. with operating its cryptocurrency platform as an unregistered national securities exchange, broker and clearing agency. It is also charged with failing to register the offer and sale of its crypto asset staking-as-a-service program. The complaint asserts that Coinbase’s holding company, Coinbase Global Inc., controls Coinbase and is liable for certain of Coinbase’s violations. The SEC alleges that Coinbase intertwines the traditional services of an exchange, broker and clearing agency without having registered any of those functions with the Commission. Through these unregistered services, the SEC alleges that Coinbase:

  • provides a marketplace and brings together the orders for securities of multiple buyers and sellers using established, non-discretionary methods under which such orders interact;
  • engages in the business of effecting securities transactions for the accounts of Coinbase customers; and,
  • provides facilities for comparison of data respecting the terms of settlement of crypto asset securities transactions, serves as an intermediary in settling transactions in crypto asset securities by Coinbase customers and acts as a securities depository.

“We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions,” said SEC Chair Gary Gensler. “In other parts of our securities markets, these functions are separate. Coinbase’s alleged failures deprive investors of critical protections, including rulebooks that prevent fraud and manipulation, proper disclosure, safeguards against conflicts of interest, and routine inspection by the SEC.” (here)

5. Previous SEC Complaints

On March 29, 2023, the SEC charged the crypto asset trading platform and its executives for failing to register as a national securities exchange, broker and clearing agency in a complaint filed in the United States District Court, Northern District of Illinois. (here) The SEC also charged the founder of the platform, Artak Hamazaspyan, and a company he controlled, Beaxy Digital, Ltd., with raising $8 million in an unregistered offering of the Beaxy token (BXY) and alleged that Mr. Hamazaspyan misappropriated at least $900,000 for personal use, including gambling. (here) And on April 17, 2023, the SEC charged crypto asset trading platform, Bittrex, Inc., with operating an unregistered national securities exchange, broker and clearing agency in a complaint filed in the United States District Court, Western District of Washington. (here) The SEC asserts that, since 2014, Bittrex facilitated buying and selling of crypto assets that were offered and sold as securities. (here)

The enforcement actions taken against Beaxy and Bittrex this year are two more examples from the larger number of complaints initiated by the SEC dating back through 2022. John Stark, a former senior SEC official and senior lecturing fellow at Duke University, School of Law, in Durham, North Carolina, told The Guardian that the SEC has been “incredibly aggressive” towards the crypto industry recently. More than 30 cryptocurrency related enforcement actions have been taken since 2022. Mr. Stark added that the Binance complaint contains “scathing allegations” including that Binance’s actions were “designed to avoid regulatory scrutiny.” (here)

6. Conclusion

Crypto asset traders have lost boatloads of money in the volatile cryptocurrency market. That, and the continuing instability of the digital asset environment, lie at the heart of the controversy. According to a report by the U.S. Federal Trade Commission last year, traders have lost $1 billion to fraudulent scams since 2021. And that was before the FTX collapse. (here) Reporting for Reuters, opinion columnist Anita Ramaswamy said, “the market now may be mostly made up of diehard crypto believers, and they are more likely to use decentralized alternatives that are not exposed to a single company or regulatory framework. That suggests companies like Binance and Coinbase are fighting for dwindling market share and an increasingly skeptical customer.” (here) The halcyon days of crypto, then, may be in the rear view mirror.

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