Crypto exchanges are fighting the “gravitational pull” to delete assets considered securities

Much of the cryptocurrency world is still expecting fallout over the US Securities and Exchange Commission’s claims in a civil lawsuit that nine crypto assets involved in an insider trading case are securities. The designation comes as the regulator is reported to be investigating the largest US crypto exchange, San Francisco-based CoinbaseCOIN
, offered unregistered securities. Hundreds of other exchanges around the world trade the nine assets named in the insider trading case, forcing a tough decision: ignore the allegations and wait for an official ruling or preemptively appease the SEC and stop listing the assets now to avoid a Coinbase -style suit

With more than 100 exchanges globally trading at least one of the nine tokens named in the SEC complaint, according to CoinMarketCap.com data, the fallout could be widespread. Among the exchanges are centralized giants such as Coinbase, Binance in the Cayman Islands and Seychelles-based KuCoin. Decentralized platforms like Uniswap, which also lists some of its tokens, are much easier for investors and developers building their own trading services to access and may prove more difficult to regulate.

Jason Gottlieb, a partner at the New York law firm Morrison Cohen, known for its crypto litigants, says that while much of the focus since the insider trading lawsuit was filed has been on Coinbase, the “cyclical effects” will go far beyond the $12 billion public exchange . How other exchanges react could affect not only the wealth of current owners, but the very process by which new assets in the nearly $1 trillion crypto market are created and traded.

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“Exchanges need to carefully consider whether they want to continue listing these tokens, now that the SEC has declared, at least in its view, that the tokens are securities,” says Cohen. “But there’s obviously a pretty heavy gravitational pull against doing what the SEC wants you to do, so that you stay out of trouble with the SEC. I imagine that at least the US exchanges would have to think carefully about whether to list these the tokens.”

Coinbase in particular has spoken out against the SEC’s action. Paul Grewal, chief legal officer at the exchange, posted one Twitter thread earlier this week stated that the company disagrees with the SEC action and accused the agency of regulation by enforcement. “We are confident that our rigorous due diligence process — a process the SEC has already undergone — keeps securities off our platform, and we look forward to working with the SEC on the matter,” Grewal said in a statement to Forbes. New York-based Gemini, which also trades some of the assets, declined to comment. Binance, Kraken, KuCoin and Uniswap did not respond in time to requests for comment.

The first domino fell last week, when the SEC demanded a jury trial for its complaint against former Coinbase employee Ishan Wahi, whom the regulator accuses of leaking information about when tokens would be listed on the exchange to his brother Nikhil and a friend, Sameer Ramani . The SEC claims the recipients of the insider information bought Amp (AMP), RallyRLY
(RLY), DerivaDao (DDX), XYO (XYO), Rari (RGTGT
), LCX (LCX), Powerledger (POWR), DFX Finance (DFX) and Kromatika (KROM) tokens in front of their Coinbase listings, selling them to collect more than $1 million in profits. The Wahi brothers’ lawyers denied the SEC claims in statements provided to Reuters.

The SEC’s jurisdiction over the matter depends on the nine listed tokens passing the Howey test, established after a US Supreme Court case outlined what constitutes an investment contract. According to the test, an investment contract exists if money is added to a joint venture with a reasonable expectation of profit from the efforts of others. In the insider trading filing, the SEC outlines how the nine tokens meet these requirements. Interestingly, each and every one of the symbols is of EtherETH
eum blockchain.

Typically, tokens see a 91% price jump after a listing on Coinbase, according to research firm Messari, which gives insiders the chance to make millions by buying them up front, the SEC claimed. Lewis Cohen, a lawyer who specializes in blockchain and tokenization for DLX Law, says that if the exchanges don’t remove the assets, it could be a signal that they are ready to go head-to-head with regulators.

“You can understand an exchange that says, look, it’s just not worth it for me to pick a fight with the SEC on this,” Cohen says. – It will be very interesting to see. If we don’t see these assets delisted on other US exchanges, I think that will be a pretty clear sign that the industry is ready to formally address this.”

Criminal charges by the Justice Department, which do not rely on the assets being classified as securities, against the Wahi brothers and Ramani charge the trio with wire fraud conspiracy and wire fraud. In June, the DOJ filed a similar case against Nathaniel Chastain, a former employee of NFT (non-fungible token) marketplace OpenSea. Chastain allegedly bought NFTs he knew through his position were scheduled to appear on the OpenSea website, which typically increases their value. Chastain’s attorney, David Miller, maintained his innocence in a statement sent to multiple outlets, “Mr. Chastain is not guilty of the charges. When all the facts are known, we are confident that he will be exonerated.”

When the DOJ and SEC both litigate a case, the SEC action typically does not go to trial while the DOJ case proceeds, according to Gottlieb, who says he is not involved with either party in the Coinbase actions. “The overwhelming likelihood here is that the SEC case will not go to trial,” Gottlieb said. “What you’re left with is the SEC coming out with this big, big legal statement that tokens are securities in a way that the projects themselves don’t have a good way to defend.”

If the SEC case does not go to trial, the companies behind the tokens mentioned in the complaint will likely not have the same opportunity Ripple Labs has had to defend its token XRPXRP
. In December 2020, the SEC reviewed this cryptocurrency a security and charged the company and two executives with $1.3 billion in unregistered offerings. Shortly after the SEC charges were announced, Ripple filed a motion rejecting the claim that XRP is a securities or investment contract. The case is ongoing. In the wake of the allegations, a number of exchanges removed XRP, including Coinbase and Kraken. The Coinbase insider trading case could similarly lead to exchanges with the nine specified tokens to re-evaluate their entries.

“It’s always appropriate for companies in this space to reevaluate what they’re doing to make sure they stay consistent with what the SEC’s latest interpretation or opinion or litigation reflects,” Gottlieb said. “To the extent that there is information to be gleaned from the SEC’s allegations in this Coinbase insider trading case, it makes sense for companies to reevaluate their protocols and procedures to see if there is anything they can do better to comply with the SEC’s view of what the securities laws require. “

What happens now? Gottlieb says the “legally mandated” next step is for those accused of insider trading to file a motion to dismiss or an answer with the SEC. “But in a case like this, where there are parallel criminal charges, it’s unclear that there will ever be much of a next step in the case. I would say the next most likely step is a motion to stay. Because otherwise, they make statements that can be used against them in a criminal case.”