updated on 12 September 2023
QuestionWill regulatory involvement lead to viability of cryptocurrency in the financial sector?
This was originally published on 20 June 2023.
On Monday 5 June, the Securities and Exchange Commission (SEC) filed a lawsuit against Binance, one of the largest cryptocurrency exchanges in the world. The following day, the SEC brought a claim against Coinbase, one of the largest cryptocurrency platforms publicly listed in the US.
The changing regulatory landscape in this industry is expected to have significant repercussions on the businesses operating in this space. But it may also provide traditional institutions with the confidence to venture into a sector that’s traditionally been considered the ‘Wild West’ of finance. Once official guidelines are in place to provide more security, many believe this will create a more stable and trustworthy industry, paving the way for a larger – and more regulated – market in crypto assets.
The events in the US
The SEC’s claim accused Binance of operating a “web of deception”, and has charged the exchange, alongside its founder Changpeng Zhao, with 13 offences. SEC Chair Gary Gensler stated that Zhao and Binance have “corrupted trading volumes while actively concealing who was operating the platform, the manipulative trading of its affiliated market maker, and even where and with whom investor funds and crypto assets were custodied”. The main accusations include:
In fact, Binance was accused of offering 12 cryptocurrency coins without registering them as securities. The SEC also filed an emergency order to freeze the assets of Binance’s US subsidiary, known as Binance.US. If granted, the order would require the U.S. subsidiary to send any money back to the US that’s being held offshore for US customers. Binance’s holding company is located in the Cayman Islands.
The SEC’s aggressive approach taken towards Binance was followed in quick succession by another lawsuit, this time filed against Coinbase. The crypto asset trading platform was accused of trading at least 13 assets that are securities and therefore should have been registered.
Securities or not?
The SEC escalated its intervention in the crypto industry following the collapse of Bahamas-based FTX, whose founder Sam Bankman-Fried has been charged with numerous offences, including securities fraud. This highlights one of the main issues that regulators are facing when dealing with crypto currencies, namely the controversial nature of many tokens and assets. In addition to the latest claims, the SEC has been involved in a legal battle with Ripple Labs Inc. since December 2020, arguing that Ripple has been offering its token, known as XRP, as an unregistered security since 2013.
The same question on the definition of crypto assets is also being addressed in other jurisdictions around the world. In South Korea, the trial commencing against Daniel Shin, co-founder of Terraform Labs, to prove that the token Terra Classic is a security, is the latest in a string of cases that hinge on defining the nature of cryptocurrency tokens. The prosecutors in South Korea are arguing that if Terra Classic is recognised as a token, Daniel Shin will have violated the Financial Investment Services and Capital Markets Act. The trial will undoubtedly focus on the difficult question of defining these assets and is likely to encounter a few obstacles, first and foremost the lack of crypto-specific clauses within traditional legislation.
EU and UK
The US isn’t the only jurisdiction cracking down on regulating the cryptocurrency industry. The Markets in Crypto Assets (MiCA legislation was formally adopted by the European Parliament on 20 April 2023. Most of its provisions are expected to come into effect in January 2025, and implementation of MiCA is predicted to result in the EU becoming “the first major jurisdiction with the comprehensive regulatory framework on crypto assets”.
In the UK, the Financial Conduct Authority (FCA) currently has limited powers with regard to cryptocurrency. Its current limited remit involves “making sure that crypto firms that operate in the United Kingdom comply with anti-money laundering and counter-terrorism legislation”. But the FCA published a survey this week showing that crypto ownership had more than doubled in the UK in 2022, demonstrating an appetite for investors, both retail and institutional, to get involved. These numbers may put even more pressure on UK regulators, who’ve already introduced proposals for a new regulatory regime that would impose rules similar to those applying to traditional financial services. For instance, the FCA published policy statement PS22-10 in August 2022, in which it considers strengthening the regime for how high-risk investments (including cryptoassets) can be promoted. Earlier in 2023, HM Treasury amended the Money Laundering Regulations to extend the Financial Action Task Force’s ‘travel rule’ to capture crypto asset activities (Regulation 5, The Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022). This extended information sharing and record-keeping requirements that apply to bank transfers to transfers of crypto assets.
Within this context, the SEC’s most recent lawsuits and the developments across the EU and UK jurisdictions may be well received by more traditional institutions waiting for the sector to become more secure before venturing into this legislative no man’s land.
The crackdown by regulators in the US and Europe is likely to have considerable implications for those already operating in the crypto sector. Exchanges and platforms trading in any kind of crypto asset within the US will face the pressure to ensure their activates comply fully with SEC registration requirements. Despite the ambiguity that exists in determining which tokens represent securities, and therefore fall within the remit of the SEC, companies will want to err on the side of caution, given their largest peers in the industry aren’t immune from regulatory scrutiny.
In Europe, many within the industry have been concerned about the introduction of MiCA, wondering whether the legislation will be able to effectively regulate a sector that’s always thrived on a lack of rules. On the other hand, the imminence of MiCA being brought into force has encouraged many businesses dealing in crypto assets to ensure their compliance with the new regulations and to avoid any future disputes.
The recent scrutiny by regulators could however represent an opportunity for some. In fact, it’s expected that more risk-averse businesses that were previously steering clear of this financial grey area will look to get involved in the crypto sector once a more stable regulatory regime is implemented. The past few years, when Bitcoin and Ethereum prices reached their all-time high, saw large banks such as Goldman Sachs and JP Morgan become involved in transactions with crypto assets, and it may be reasonable to believe that others will follow once the dust settles. However, new ventures within the space will need to account for the cost of ensuring compliance with the new changes that are taking effect, so decisions such as launching one’s own token may come at a higher cost than they have in the past.
However, the new appetite to get involved may also increase the demand for services relating to crypto assets, such as those provided by traditional financial institutions such as banks, or by service providers such as consulting agencies and law firms. These industries will need to be ahead of the curb to keep up with clients increasing their demand for crypto-related products and services. Law firms especially will be involved in advising how best to comply with the latest regulatory developments.
Regulators and courts are currently at the forefront in the effort to bring crypto assets into the mainstream financial industry. The recent lawsuits and trials are in fact helping to shape the industry to be accepted on a wider basis, and to protect consumers from the high volatility and uncertainty that’s traditionally characterised this sector. The ultimate effect may be that of legitimising cryptocurrency’s long-term viability as a financial product.
It'll be interesting to see how the current regulatory vacuum will be handled by the new MiCA legislation, and whether the SEC’s lawsuits will be successful in bringing crypto assets under the definitions of securities laws in the US. This may bolster the confidence of companies looking to get involved in the industry, leading to opportunities for innovation and development across a range of traditional sectors to keep up with the trend.
Camilla Bertocchi is a trainee solicitor in the capital markets team at White & Case LLP.
Any views expressed in this publication are strictly those of the authors and should not be attributed in any way to White & Case.