The scrutiny of major crypto institutions is intensifying
Tthe crypto audience is hardly known to underestimate his own importance. Its members called the implosion of ftx, the crypto exchange that collapsed spectacularly in November, the industry’s “Lehman Brothers moment,” a nod to the massive consequences of the investment bank’s downfall. Now they say the industry is going through its “Dodd-Frank moment,” a reference to the sweeping financial regulations put in place after Lehman’s collapse.
In America, if crypto firms are regulated at all, they fall under various agencies – from the Securities and Exchange Commission (Sec), a market regulator, and cftc, which oversees raw materials, to a number of government bodies. All increased enforcement actions against crypto companies in 2022, after the go-go years of 2020 and 2021 pushed crypto products into the mainstream. But moves to curb various crypto activities have now begun to reach a frenetic pace.
On the 9th of February Sec reached a settlement with Kraken, a crypto exchange. The company agreed to pay a $30 million fine and stop offering its staking-as-a-service business, where customers deposit crypto tokens and the exchange “stakes” them on their behalf, in exchange for a reward (in a way that doesn’t is different from a bank that offers interest). February 13 New York State Department of Financial Services (newfds), a government financial regulator, ordered Paxos, a firm that issues stablecoins (tokens backed by dollars), to stop issuing a stablecoin it had created for Binance, the largest crypto exchange.
These actions add to a growing list of enforcement actions against, or investigations into, crypto firms. In July Sec launched an investigation into Coinbase, a publicly traded exchange, to investigate whether the listed crypto tokens were actually securities – a notion the exchange denied. And in August, America’s Treasury imposed sanctions on Tornado Cash, software that runs on the Ethereum blockchain and mixes individuals’ crypto deposits into a pool before redistributing them, making it difficult to track ownership.
To many in the crypto industry, these actions are an affront, nothing less than an attempt to stifle a source of financial innovation. But the sum total of the authorities’ actions is revealing. First, their priorities have become much clearer. Secondly, the agencies have developed methods that they can use to enforce laws or regulations in very unfamiliar terrain.
A priority is to sniff out instruments that can be used against economic crime. Tornado Cash was allegedly hired by North Korean hackers to launder $450 million in stolen crypto. newfds‘s action against Paxos, a firm based in America, also appears to have been motivated by concerns about potential wrongdoing. Binance, which claims it has no headquarters, has been under investigation since 2018 for possible non-compliance with US money laundering and sanctions rules. Paxos was not required to stop issuing its own stablecoin, the Pax Dollar – only the one it created for Binance. In response, Changpeng Zhao, the head of the exchange, tweeted that the stablecoin is “wholly owned and managed by Paxos”. Paxos said it “categorically disagrees” with the grounds for Secits investigation.
Thus, the authorities have reacted to potential wrongdoing by shutting down interactions with American firms. Since Tornado Cash is a piece of software that runs on the Ethereum blockchain, there is no way to stop it from working. So the Treasury Department has identified wallet addresses linked to the software, which it has prevented US institutions, such as stock exchanges, from operating. Similarly, it is more difficult to restrict the activities of Binance, which is not a US company, than it is to restrict the activities of Paxos, which is registered with the authorities in New York.
Regulators’ second priority is consumer protection. This is evident in the actions against the Kraken. “Whether through staking-as-a-service, lending or other means, crypto-intermediaries, when offering investment contracts in exchange for investors’ tokens, must provide the proper disclosures and safeguards required by our securities laws,” said Gary Gensler, head of Sec. He has begun labeling previously unregulated offerings as securities, which are regulated by default.
Mark Lurie of Shipyard Software, which works with decentralized exchanges, claims that the limits drawn by the authorities are “somewhat predictable”. Regulators use existing rules and their targets are US institutions. This lack of imagination can hinder innovation, worries Tuongvy Le, former one Sec enforcement attorney, now in the crypto arm of Bain Capital, an investment firm. “There are really new structures in crypto,” she says. Unlike Europe and Singapore, which have come up with new rules, America has so far relied on existing approaches. Nevertheless, the introduction of regulation is sometimes welcome. On 15 February Sec decided to tighten the standards for institutions holding cryptoassets. The price of bitcoin rose on the news. ■
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