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The Scoop

Securities law professor analyzes the SEC’s crypto crackdown: Part 1

Mon Jun 19 2023

Impact of Crypto on Corporate Securities Banking Law and Forensic Accounting

00:16 - 07:02

  • JW Varad, a law professor at George Mason and former SEC advisory committee member, discusses the impact of crypto on corporate securities banking law and forensic accounting.
  • Crypto changes business entity law by wrapping an LLC around a DAO and figuring out managed liability for DAO members.
  • Crypto challenges the precepts of how we test and what it means to be in exchange when you're just publishing code.
  • Crypto changes banking law by allowing banks to over collateralize lending and auto liquidate in a way that limits systemic risk.
  • Privacy tools like Zcash change forensic accounting as they make it impossible to track financial transactions on chain.

SEC Allegations and Integrated Model of Exchanges

00:16 - 07:02

  • The SEC alleges that finance and Coinbase both trade unregistered or illegal securities, but also calls out the integrated model where exchanges operate as custodians and prime brokers.
  • There are legitimate questions about segregation of function in centralized exchanges, but enforcement cases are not the right place to address them. They should be addressed via rulemaking requests or legislative arenas.
  • It's hard to separate allegations about operating an integrated business from operating an unregistered exchange.

Potential Outcomes of Ripple, Coinbase, and BitMEX Cases

06:42 - 13:18

  • The SEC can get to the market questions without winning on at least one of those tokens.
  • Running the wallet is an unlicensed function and ties into the SEC's proposed ATS reforms.
  • Congress may provide a third way out for exchanges by carving out crypto outside of the SEC's jurisdiction.
  • Ripple, Coinbase, and BitMEX cases could go long term up to SCOTUS and reshape administrative authority.
  • The most probable outcome of a Ripple win would be something based on issues specific to Ripple probably.
  • Coinbase is probably the test case for what happens. The SEC has asserted that they only need to win on one alleged token being a security.
  • There might be an outcome of settlement if the SEC allows a path for tokens to register as special purpose broker dealers or ATSs.
  • Legislation passing this Congress is unlikely but might pass in future Congresses with regime change towards a more crypto-friendly regime.

Difficulties in Registering Crypto Tokens as Securities

13:03 - 19:44

  • Crypto tokens are difficult to register as securities due to complications such as who would be the registrant if Ethereum or Solana were registered.
  • The SEC has created hybrid regimes for financing modes like asset-backed securities, master limited partnerships, and real estate investment trusts before and can do so again for cryptocurrencies.
  • Coinbase likely wanted a similar third way solution like Carbat but the politics of FDX's donations shut that window up for now.

Political Influence on Crypto Regulation

19:14 - 25:56

  • The SEC's 10th floor is more political and probably doesn't care much about crypto.
  • The majority of commissioners would be fine with the crypto industry going away.
  • Pressure from the Coinbase case and SCOTUS could put pressure on the SEC to open up a constructive regulatory path.
  • There are smart people at the staff level who know a lot about DeFi, tokens, and decentralization.
  • The major questions doctrine requires authorization from Congress before an agency can regulate something involving a major question of national economic or political importance.
  • This doctrine has been used in cases where agencies sought to regulate things beyond their authority, such as cigarettes and assisted suicide.
  • This doctrine may apply to digital assets that live entirely on a decentralized blockchain.
  • Coinbase, Ripple, and Binance may use this argument in their defense against the SEC's enforcement actions.

Challenges and Uncertainties in Crypto Regulation

31:02 - 43:11

  • Registration A filings are difficult and have limitations on the amount of money that can be raised.
  • The PCOB is behind on understanding smart contracts and their benefits for auditability.
  • There are proposals for an exempt offering with a disclosure framework, such as the LexPunks RegEx proposal.
  • DeFi lawyers who used to work at the SEC want to help with this effort.
  • It is unclear why Gensler has not engaged in discussions about these issues.
  • The COO of Binance admitted they were an unregistered securities exchange.
  • Hot docs are common in law, but sometimes they are just someone mouthing off who doesn't actually understand what they're talking about.
  • The LIBOR scandal was overblown and none of the prosecutions were successful post-Gensler's term.
  • The Binance case came from CFTC and SEC, and there might be a question of jurisdiction that could come up.
  • It will be hard to claim lack of jurisdiction for Binance since they have raised money from VCs within the US.
  • There is greater uncertainty now with Coinbase and Binance, which may cause people to pull back.
  • Winter is coming for crypto trading platforms due to the dual Bruhaha continuing to unfold.
  • The speaker will continue to trade on Coinbase despite new regulations.
  • The future of regulation is bleak and major legislative reform in the near term is down.
  • The fight against regulation is in court, with a focus on defensive current cases outstanding and industry challenges to new SEC rules, custody rules, and reg ATS reform.
  • There is hope that some of these challenges may win.