“Crypto is dead in America.” How FTX’s collapse led to a Biden crackdown on the digital asset sector.

By Chris Matthews

The Treasury Department and the SEC have become more unfriendly to crypto in recent months

Few assets have performed better in 2023 than crypto, but the outlook for the US industry has arguably never looked worse amid a broad regulatory crackdown led by Securities and Exchange Commission Chairman Gary Gensler.

The gravity of the situation is illustrated by cryptocurrency exchange Coinbase’s ( COIN ) Monday decision to take the SEC to court, demanding that the agency respond to a request from last July to issue new rules to regulate digital assets, including a new framework for how the agency will identify which digital assets are securities and therefore which crypto issuers must register with the agency.

“Coinbase does not take any litigation lightly, especially when it relates to one of our regulators,” Paul Grewal, Coinbase’s general counsel, wrote in a blog post announcing the lawsuit.

Financial regulatory expert Todd Phillips argued on Twitter that the lawsuit will not succeed because the first petition was filed just nine months ago — a very short time for the federal regulatory apparatus — and because the best Coinbase can hope for is for the SEC to dismiss the petition.

As a legal strategy, Coinbase’s move may not look particularly convincing, but it may well be an effective strategy to rally demoralized supporters of the cryptocurrency industry.

The lack of morale among crypto boosters was on display over the weekend when longtime bitcoin booster and billionaire investor Chamath Palihapitiya declared that “crypto is dead in America,” in response to a recent spate of regulatory actions against the industry, including the SEC sending Coinbase a “Wells notice ” signaling the agency’s intention to bring enforcement action against it.

Read more: Coinbase shares fall 16% after crypto exchange reveals SEC warning

“The US government has definitely turned its gun on crypto,” said Palihapitiya, who once predicted bitcoin would hit $200,000.

Crypto startups “were probably the ones that were the most threatening to the establishment,” he added during an episode of his podcast. “They were the ones who, in fairness to regulators, pushed the boundaries more than any other sector of the startup economy. So yes, the bill has come for them.”

Greg King, founder and CEO of crypto investment firm Osprey Funds, which manages about $120 million in assets, said in an interview with MarketWatch that the failure of crypto exchange FTX this fall was a watershed that “really cooled a lot of receptivity, especially on the Democratic side of the aisle” for the crypto industry.

Rep. Maxine Waters of California, the top Democrat on the House Financial Services Committee, said in a hearing last week that after the collapse of FTX and other failures in the industry, she has withdrawn her support for a bipartisan bill regulating stablecoins, saying that “we start from scratch,” on the legislation despite feeling that a bill regulating stablecoins is necessary.

Stablecoins are a type of cryptocurrency that peg their value to government-backed currencies such as the US dollar, and are used by crypto traders to store unused assets. The vast majority of trades for cryptocurrencies such as bitcoin and ether involve a stablecoin, according to the Federal Reserve.

As recently as May, the Biden administration was much more balanced in its statements on crypto. The industry cheered an executive order on digital assets that directed federal agencies to “exploit the potential benefits of digital assets and their underlying technology.”

Since then, the Treasury Department has focused mainly on perceived threats that crypto poses to the government’s efforts to stop money laundering and the financing of illegal activities such as terrorism and drug trafficking.

Last August, the Treasury Department sanctioned Tornado Cash, a decentralized finance (DeFi) protocol that enables users to hide transactions on the Ethereum blockchain, for its alleged role in helping North Korean hackers launder illicit proceeds.

The move was criticized by crypto supporters as an abuse of a law that allows the Treasury to block US persons from trading with sanctioned foreigners or foreign entities.

Earlier this month, the Treasury published a 40-page report outlining the threats it sees posed by such DeFi services, and recommended that the US government step up oversight and enforcement against digital asset companies that facilitate money laundering and terrorist financing.

President Joe Biden’s annual Economic Report of the President, released in March, also contained an entire chapter aimed at refuting claims that digital assets have benefited the US economy.

“There was a lot of optimism about what was to come from the executive order and the hope that it served as an indicator that the administration wanted to embrace the technology and establish clear ground rules that would protect investors and consumers,” Brett Quick, head of government affairs for the Crypto Council for Innovation , told MarketWatch. “Unfortunately, that’s not what we’ve seen lately.”

Quick says there are still those in the Biden administration, such as Commodity Futures Trading Commission Chairman Rostin Behnam, who have taken a friendlier approach to the industry, but that those approaches are contentious given SEC Chairman Gensler’s increasingly aggressive stance.

Miller Whitehouse-Levine, executive director of the DeFi Education Fund, a DeFi advocacy organization, sees Gensler’s stance on the sector changing markedly early last year, when he stopped advocating for Congress to pass legislation “to prevent transactions, products and platforms fall between the regulations,” as he did in a speech in August 2021.

To be sure, Gensler’s speech that day was consistent with recent statements that the law is clear on which digital assets are securities and which are not, even as the regulator has grown stronger in its criticism of the crypto industry.

“”I’ve been around finance for 40 years, in one way or another,” Gensler said at a hearing last week. “I’ve never seen a field that is so inconsistent with laws written by Congress and certified if and again. left by the courts.”

Whitehouse-Levine believes Gensler has been emboldened by the failure of FTX and its effect on Democratic lawmakers and administration officials, in light of FTX founder Sam Bankman-Fried’s high-profile donations to Democratic lawmakers. (Bankman-Fried said in an interview after his fall that he gave to both parties, but was not public in his donations to Republicans).

“I don’t think Gensler has been more motivated by the collapse of FTX,” he said. “I think he no longer faces any opposition to his agenda to ban crypto in this country at the level he did before the collapse of FTX.”

Gensler has denied wanting to ban crypto in public hearings with lawmakers, and that he is simply trying to protect investors and create a level playing field between crypto companies and those raising money in traditional financial markets.

“Congress gave the commission a mandate to protect investors, regardless of the labels or technology used,” Gensler told the House Financial Services Committee last week. “Nothing about the crypto markets is inconsistent with the securities laws.”

-Chris Matthews

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04-27-23 1042ET

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