Things are getting real, but not good for crypto

Instead of enjoying a spring thaw, crypto’s winter 2022 is turning into an ice age.

This, as New York Attorney General (NYAG) Letitia James on Thursday (March 9) alleged that the popular cryptocurrency ether is collateral in a recently filed lawsuit against KuCoin, one of the largest crypto exchanges by transaction volume behind similarly embattled peer Binance, Coinbase and Kraken.

The suit filed by James joins a number of other recent actions, including the collapse of crypto catering Silvergate Bank, which has sent the digital asset market tumbling. Bitcoin, widely seen as a sector barometer, fell 8% to trade below $20,000, while the broader market has lost around $70 billion in the past 24 hours alone.

The filing by James represents the first time a regulator has argued in court that ether, one of the most valuable digital assets behind the crypto’s nominal bitcoin and which has long been treated as a commodity by state and federal regulators, including the Commodity Futures Trading Commission. (CFTC), is a security.

According to the lawsuit, NYAG also believes that the luna (LUNA) token and terraUSD (UST) stablecoin, both traded on the KuCoin exchange, are also securities.

The core of the case rests on the claim that if the digital assets are proven in court to be securities, KuCoin will have been operating illegally in the state of New York.

It could have far-reaching implications on crypto markets and dramatically change how cryptocurrencies are traded in the US

An elaborate simulation of finance that provides gains and losses

“[This] action is the latest in our efforts to rein in shady cryptocurrency companies and bring order to the industry. All New Yorkers and all companies operating in New York must comply with state laws and regulations. KuCoin operated in New York without registration, which is why we are taking strong action to hold them accountable and protect investors,” Attorney General James said in a release announcing her office’s action.

The lawsuit alleges that “KuCoin, a cryptocurrency trading platform, violated the Martin Act in at least three ways,” and seeks to direct “KuCoin to implement geoblocking based on IP addresses and GPS location to prevent access to KuCoin’s mobile app, website, and services from New York, an accounting, restitution, escrow and costs against KuCoin.”

The petition underscores the NYAG office’s belief that ether, along with the LUNA and UST tokens, are speculative assets that rely on the efforts of third-party developers, including Ethereum founder Vitalik Buterin, to provide profits to the token holders.

Ever since the Ethereum network last year switched from a “proof-of-work” architecture to a “proof-of-stake” blockchain network where investors can “stake” their coins in exchange for rewards, speculation has simmered about what this shift was. may mean for its regulatory status.

Industry observers have noticed that the new “staking” protocol in practice is not that far removed from the interest paid on bonds.

The recent NYAG action is far from the first time KuCoin has faced regulatory pressure around its operations.

The exchange was accused by South Korean regulators last August of conducting “illegal business activities” without proper registration, and last December faced similar allegations from the Dutch central bank, which alleged the crypto platform was operating without a license.

KuCoin was last valued at $10 billion during a funding round last May, where the exchange landed $150 million in a Series B led by Jump Crypto.

Do the benefits of crypto outweigh the costs of regulating them?

Observers critical of crypto are wary of giving the industry the validating halo that proper regulation can provide, preferring to take legal action against it and let the sector dissolve into far-flung jurisdictions.

The idea is that regulating crypto could encourage deeper and harder-to-distinguish relationships between the digital asset ecosystem and the traditional financial sector, generating greater systemic risk.

Federal Reserve Chairman Jerome Powell earlier this week (March 7) called crypto “a mess,” adding that “what we’re seeing is quite a lot of turmoil, we’re seeing fraud, we’re seeing a lack of transparency, we’re seeing that we’re in danger.”

The specter of a security designation has long hung over the crypto sector’s various digital assets, and US Securities and Exchange Commission (SEC) Chairman Gary Gensler has indicated that he considers all tokens to be securities.

Despite that, and as reported by PYMNTS, only nine crypto firms have successfully registered with the SEC – and more than half of them are no longer in business. None of the nine registered during Gensler’s own tenure as SEC chief.

PYMNTS has also covered how crypto crime hit an all-time high of $20.6 billion last year – a figure that represents a “lower bound” estimate.

As the industry struggles to right itself and mature, it becomes increasingly difficult for even the keenest of observers to find a bright spot to light the way.