The crypto industry began the week preparing for a Congressional hearing that it hoped would pave a path toward new regulatory framework.
The Chairman of the Securities Exchange Commission had other ideas.
On Monday, SEC Chair Gary Gensler dropped a long-awaited lawsuit against Binance, exposing embarrassing details of a campaign by the worlds biggest crypto exchange to evade U.S regulation. The following morning, he dropped a second complaint against Coinbase before embarking on a TV tour that would portray the crypto industry as lawless and out of control. He also questioned the need for crypto, telling Bloomberg, We dont need more digital currencywe already have digital currency, its called the U.S. dollar.
Genslers gambit was an unusually political action by a regulator, but also a successful one. Even his biggest critics in the industry quietly acknowledged to Fortune that the SEC Chair had put them on the defensive, backing Coinbase into a corner during a week when the company had planned to put forward a narrative about working with Congress to create a better regulatory regime.
Gensler may have won the week, but whether he can succeed in his longer term goal of bringing the crypto industry under his thumb is unclear. Figures in crypto are quick to tell you that Genslers aggressive enforcement campaign has put him out over his skis, and predict it is a matter of time until the SEC receives a comeuppance by way of a federal court. Others, however, are less sanguine. According to one legal source, this weeks complaint against Coinbase poses an existential threat to the company, and the broader U.S. crypto industry may be living on borrowed time.
You cant ignore the rules because you dont like them
The substance of the SECs two crypto complaints are very different. In the case of Binance, the agency alleges the company sought to dupe U.S. regulators and engaged in so-called wash tradingtrading with itself to inflate volumeand that it co-mingled customer funds with its own accounts. Its also significant that the SEC filed its complaint in Washington, DCa sign, legal experts say, that criminal charges against Binance are also on the way.
In contrast, the SEC sued Binance in Manhattan, the customary forum for more run-of-the-mill securities litigation. And indeed, the agencys allegations against Coinbase are more pedestrian. Sources close to Coinbase, however, told Fortune they believe Gensler timed the SECs complaint to coincide with the Binance one in order to conflate the companies behavior in the minds of the public and lawmakers.
Meanwhile, the SEC reinforced its efforts to portray Coinbase as a scofflaw on Tuesday, with a senior official declaring You simply cant ignore the rules because you dont like them or because youd prefer different ones.
The federal judge who will hear the case is unlikely to allow the SECs tactical maneuvers to inform any eventual ruling. But this may not matter since the agencys allegationswhile not as dramatic as the ones against Binanceare still serious and, if they stick, will pose a grave threat to Coinbases business model.
The SEC alleges that Coinbase sold 13 tokens that are unregistered securities. Meanwhile, the agency also argues that the company acts as a broker, an exchange and a clearinghouseand did not get permission from the agency to do any of these things.
In the traditional financial world, the SEC requires that these activities be carried out by different entities so as to protect consumers. Coinbase and other crypto companies, however, argue that such divisions are unnecessary because of blockchain technology, and that it makes no sense to cram the square peg of their operations into the round hole of financial regulations designed for another era.
The upshot is that, if the SEC prevails in its lawsuit, Coinbase would emerge badly hobbled. It could be forced to divest some of its core operations, and be limited to selling Bitcoin and Ethereuman activity that has become increasingly low margin and commoditized. Industry experts say this could mean the regulatory environment could become unviable for U.S. crypto companies.
Theres a 33% chance Coinbase wont exist in the U.S. in five years, says Preston Byrne, a longtime crypto lawyer who is partner at Brown Rudnick.
Byrne predicts that, if Coinbase faces setbacks in the SEC case, it will accelerate its international expansion strategy. He added that aggressive enforcement actions by the SEC would likely have spelled the death knell for the entire crypto industry a decade ago, but that the U.S. market is now dwarfed by overseas onesa trend he says will continue as countries such as Nigeria, whose population will surpass the U.S. in coming years, embrace crypto.
Byrnes view of the robustness of the global crypto economy is borne out by current crypto prices. While Bitcoin and Ethereum dropped around 6% following news of the SECs Binance complaint, they have since recovered with Bitcoin trading over $27,000 as of Wednesday morning.
Genslers campaign against Coinbase, meanwhile, does not mean there is no place for a U.S.-based crypto industry. The Financial Times reported last week that traditional Wall Street names like Charles Schwab and Fidelity are preparing to move into the sector by offering services like custodythe industry term for storing cryptoand seeking to challenge crypto-native firms.
The SEC is not the law
In interviews with Fortune, industry executives were surprisingly upbeat about the chances for Coinbase and other crypto firms to prevail against Genslerthough its not certain whether that sentiment was expressed sincerely or strategically.
An executive at a prominent venture capital firm, who asked not to be identified, said the firm had sent out letters to its limited partners reassuring them the SECs actions did not represent a long term threat to crypto. She also suggested that lawyers at the firm and at crypto companiesmany of whom have experiences at top levels of the US governmentbelieve Gensler, who is not an attorney, has overplayed his hand.
The SEC is not the law, said the executive, saying the agencys enforcement campaign has been based around interpretations of existing securities rules that have rarely been applied in the context of federal courts.
While those with a stake in lawsuits typically view their chances in a rosy light, the outcome of several high profile cases involving crypto and the SEC is genuinely up in the air. These include the closely watched SEC v. Ripple, which turns on whether the agency correctly designated the XRP token, which launched in 2013, to be a security. And in another case involving the trust company Grayscale, Bloomberg Intelligence recently upgraded the firms chances for success from 40% to 70% following a hearing in which a three-judge panel suggested the SEC had behaved in a high-handed and arbitrary manner in denying an application for a Bitcoin ETF.
A loss for the SEC in one of those cases would likely lead the agency to adopt a less aggressive approach to crypto enforcement, and could lead it to drop charges or agree to a settlement with Coinbase. For now, though, the market does not appear bullish on Coinbases prospects, as shares of Coinbase on Wednesday were down 15% from the start of the week.
A person close to Coinbase leadership, meanwhile, told Fortune the company doesnt believe that Gensler wants to drive crypto from American shores, and that crypto is simply going through a period of regulatory uncertainty similar to other upstart industries before it.
Like Uber or Airbnb, this a natural process for any regulated utility, said the Coinbase source.
This a common sentiment across the industryone that implies the crypto industry will catch a break, either in the courts or in Congress, that will release them from Genslers grip. But the industry also acknowledges that, for now, the worst is likely yet to come.
Other shoes to drop
The SECs lawsuits against Binance and Coinbase this week garnered attention because the two companies are the biggest names in the industry, but the agency is actively pursuing numerous other cases against crypto firms. And in interviews with Fortune, crypto insiders predicted more cases are on the wayincluding legal actions from the Justice Department, which has the power to bring criminal charges. Several people said they expect Justice to announce such charges against Binance imminently.
If multiple federal agencies are pursuing a company, the charges they bring typically drop in tandem, but that has not been the case with Binance. Roughly two months before the SECs complaint, the smaller Commodities and Futures Trading Commission sued the company in federal court, which has raised questions about the staggered nature of the charges.
One industry source told Fortune that the agencies are indeed coordinating, and that the delay in the Justice Department bringing charges against Binance is likely because the agency is in ongoing settlement talks with the company, or because it needs more time given the complexity of the case. Several people speculated that Binance will also face charges from the Office of Foreign Assets Control, a Treasury Department agency tasked with overseeing sanctions violations.
Two crypto industry figures in Washington, DC, however, suggested that a rivalry between the SEC and other agencies has undermined customary cooperation, and that Genslers personal ambitions and taste for swashbuckling politics has made him unpopular.
Hes pissed off people at the Fed, Treasury and the Justice Department, said a former Capitol Hill staffer and veteran crypto lobbyist.
Meanwhile, many in Washington, DC are suspicious of Genslers motives. Critics suspect his recent hardline against the crypto industry is intended to make Democrats forget that he failed to spot massive frauds at the stablecoin project Terra and at FTX, and about his personal and professional connections to FTXs disgraced founder Sam Bankman-Fried.
This view was shared by the venture capital executive, who said that the political winds could shift against Gensler in the coming months, providing an opening for legislation that would remove the SEC from oversight of certain elements of the crypto industry.
The likelihood of this transpiring is unclear and may reflect wishful thinking on the part of the crypto industry. As for Gensler, who has declined repeated requests to speak with Fortune, he has proved adaptable and morally fluid in the eyes of his criticswho point to a career arc that has seen him evolve from a Goldman Sachs banker to CFO for Hillary Clintons Presidential campaign to his current role as a close ally of Sen. Elizabeth Warren and other progressives who abhor crypto.
Whatever Genslers motivations, he appears to have the upper hand on the crypto industry for the moment. While Coinbase and other crypto companies will likely survive his rein one way or another, they may have to find their way forward far from U.S. jurisdiction.
