Explained | Why is the U.S. SEC cracking down on crypto exchanges?

The story so far: The U.S. Securities and Exchange Commission (SEC) is cracking down on cryptocurrency exchanges. On Monday, the SEC filed over a dozen charges against Binance, alleging the exchange commingled billions of dollars of investors’ funds and routed them to a company in Europe owned by CEO Changpeng Zhao. A day later, on June 6, the securities regulator slapped a lawsuit against another major crypto exchange. It sued Coinbase for evading disclosure requirements.

What happened to Binance?

Crypto exchange Binance handles tens of billions of dollars in trading volumes every day. Due to trading controls in the U.S., strict oversight, and registration procedures for crypto businesses, Binance did not allow U.S. customers to trade on Binance.com. But it offered the Binance.US trading platform to the U.S.-based users. The regulator alleged that Binance worked to let “high-value U.S. customers” access the international Binance platform. Binance.US is operated by Binance and BAM Trading Services Inc.

The regulator alleged that BAM Trading and BAM Management US Holdings, Inc. misled investors about trading controls that did not exist on Binance.US. The regulator also stated that Binance and its CEO commingled and diverted customer funds while Zhao was controlling the operations of Binance.US in secret.

The SEC has filed 13 charges against Binance entities and Zhao, alleging that they were “engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law.”

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What happened to Coinbase?

The regulator alleged that Coinbase evaded disclosure requirements that were put in place to safeguard investors. The lawsuit charged that the exchange traded at least 13 crypto tokens that should have been registered. Coinbase said in a statement that it will continue its regular operations.

The lawsuit against Coinbase follows a Wells notice sent by the regulator to the crypto exchange in March. A Wells notice is a letter sent by the SEC to a firm or individual after it concludes an investigation that could lead to an enforcement action.

Coinbase went public in 2021 during the crypto boom, and opened at $381 a share on its first trading day. On Tuesday, the company’s shares were down to $51.61 a piece.

What will be the impact of the SEC’s action against Binance?

At the basic level, the regulator’s actions will spook U.S.-based crypto traders who use Binance’s services but wish to invest in crypto assets legally. The SEC’s message has made it clear that U.S. traders using both Binance.com and Binance.US are in danger of violating the law. The SEC also questioned the ability of Binance and its entities to keep its customers’ funds safe.

“Defendants’ purposeful efforts to evade U.S. regulatory oversight while simultaneously providing securities-related services to U.S. customers put the safety of billions of dollars of U.S. investor capital at risk and at Binance’s and Zhao’s mercy,” said the SEC’s legal filing dated June 5.

SEC Chair Gary Gensler warned that the “public should beware of investing any of their hard-earned assets with or on these unlawful platforms.”

How has Binance responded to the allegations?

Binance issued a statement on Monday, saying that it was disappointed with the SEC and that it had previously cooperated with the regulator’s investigations. The crypto exchange also accused the SEC of trying to make headlines rather than protecting investors. Binance stressed its intention to defend itself “vigorously.” It pointed out that as a U.S. regulator, the SEC’s control over the trading platform was limited because Binance was not a U.S. company.

“Any allegations that user assets on the Binance.US platform have ever been at risk are simply wrong, and there is zero justification for the Staff’s action in light of the ample time the Staff has had to conduct their investigation,” said Binance, insisting that all user assets on Binance and affiliate platforms were “safe and secure.”

Zhao, meanwhile, used the number ‘4’ to signal his Twitter followers to not give in to “FUD” – a crypto slang acronym referring to fear, uncertainty, or doubt – and said that the media had received the SEC complaint before he did.

“Our team is all standing by, ensuring systems are stable, including withdrawals, and deposits,” he tweeted on Monday.

What does the U.S. SEC want?

The U.S. SEC has strongly pushed crypto businesses and trading platforms to register themselves with the regulator, claiming this will ensure investor protections and greater transparency. However, major crypto company heads have been wary of the SEC’s invitations for negotiation, especially in light of the SEC’s history of taking legal action against cryptocurrency companies it claims are breaching U.S. securities laws.

Coinbase’s legal head Paul Grewal noted in a tweet that the U.S. is falling behind and this absence is enabling other markets to frame rules and regulations that can enable crypto to thrive in their jurisdictions. In a detailed response to the Wells notice sent by the regulator in March, Grewal pointed out that the SEC, instead of developing a regulatory framework for crypto, is “continuing to regulate by enforcement only.”

While the Binance and Coinbase lawsuits are different in their charges, they seem to have one common goal: the SEC’s intention to bring crypto exchanges under the U.S. securities law. The SEC has long held the view that tokens constitute securities, and has asserted control over crypto assets. And more recently, the agency has taken aim at unregistered crypto exchanges.

Earlier this year, SEC Chair Gary Gensler commented that all crypto assets except Bitcoin are securities. He singled out Bitcoin as a commodity, and hence it must be regulated by the Commodity Futures Trading Commission (CFTC).

The SEC’s definition of a security is broad, and it includes any investment contract in which an individual invests in a common enterprise for the only purpose of making profit from the effort of others. And based on the regulator’s view, tokens traded on crypto exchanges could come under the SEC’s purview.

How will these events affect the cryptocurrency market?

The cryptocurrency market is small and extremely susceptible to shocks and spooks when compared to more mainstream finance sectors. After the SEC’s lawsuit against Binance, the price of Bitcoin (BTC), the largest cryptocurrency by market capitalisation, fell around 3.90% in a day to retail at under $26,000. The second largest coin, Ether (ETH), fell by 2.96% in the same interval to trade at below $1,900.

However, the Binance-created BNB (BNB) cryptocurrency took a harder hit, dropping by around 7.95% on Tuesday and plunging under the $300 mark to trade at around $277. Meanwhile, the BinanceUSD (BUSD) stablecoin that is pegged to the value of the U.S. Dollar dipped slightly before recovering.

Experienced investors may have already taken into account Binance’s legal tangles with regulators worldwide, and the Wells notice SEC served to Coinbase. But new investors may panic and sell their tokens. Others may wait to see how the regulatory landscape changes for the volatile crypto industry.



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