The Breakdown - Binance SEC Hearing Goes Much Less Well Than Coinbase Hearing

Episode Date: January 23, 2024

Binance was in court arguing that the SEC lawsuit against them should be thrown out, in an echo of Coinbase's hearing with the SEC last week. This one seemed to go significantly worse for the crypto team. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Tuesday, January 23rd, and today we shift our focus back to Binance after a minute away. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link at the show notes or go to Bit.L.Y slash Breakd pod. Hello friends. Well, we are in the inevitable, I think, lull following the Bitcoin

ETF launches. We're seeing that sell the news price action that was anticipated by many. And in that process, we're kind of catching up on a bunch of the legal stuff that had been a little bit shunted to the side over the past few weeks. As I mentioned today, we are catching up with yet another legal case, but this time it is Binance. On Monday, Binance lined up against the SEC in court to argue that the case should be dismissed. This will sound familiar if you listened to yesterday's show about Coinbase making some similar arguments. Indeed, this hearing was functionally very similar to the Coinbase hearing from last Wednesday, covering many of the same legal issues and looking to get rid of the case early in the process. Now, for a more in-depth

discussion of that case and a little bit more of a legal underpinning, go listen to last Thursday's show. Clearly, I've lost all track of time, but it was, in fact, last Thursday. Now, for the purposes of today, the big points are that these cases are dealing with the SEC's jurisdiction over crypto tokens in general, and that Binance and Coinbase have a very difficult legal standard to reach in order to have their cases dismissed at this early stage. The Binance case is being heard in the D.C. Circuit, while Coinbase is being heard in New York. That means that the SEC has a second chance to reframe their legal argument in front of a separate judge in a separate jurisdiction. And indeed, unlike in the Coinbase hearing, Judge Amy Jackson was far less willing to give

Binance the benefit of the doubt. She began the hearing by interrogating Binance's position on whether crypto tokens could be subject to securities law. Almost a dozen unrelated tokens are named as securities in this case, including Solana, Cardano, and Maddo. Binance attempted to run the same argument as Coinbase, that crypto tokens do not represent an investment contract which gives rights to an underlying revenue stream. Jackson was unimpressed with this argument, cutting Binance lawyers off after several iterations to state, notwithstanding the fact that you guys keep telling me the same thing over and over again, tell me if any court ever expressly adopted your opinion. She noted that the case law is very clear that the securities laws are designed to be flexible and broad.

Finance argued that while the purpose of the law is to be broad, it also must have limiting factors. Unimpressed, Jackson pushed back, stating, you're being a little too cute. The SEC also appears to have refined their argument since last week. They claimed, quote, the token represents the embodiment of an investment contract. Many noted that the SEC had taken a very different position in the Coinbase hearing. Coinbase chief legal officer Paul Grewell posted last week's transcript in which the SEC stated, token itself is not the security. Binance raised the point that the SEC's current argument could be used to sweep collectibles into their jurisdiction, noting, just last fall, the chairman of the SEC was

unable to answer the question whether a digitized Pokemon card was a security. Unimpressed, Jackson retorted, well, the last time you were here, you couldn't tell me if BNB was a commodity, and now you were saying it is. Now, the B&B token is a major focus in this case, and one of the differentiating factors to the Coinbase lawsuit. Jackson appears satisfied that BNB was initially offered as a security, but less certain that secondary sales in the open market would qualify. The SEC attempted to differentiate the Ripple decision from current proceedings stating, the programmatic sales and Ripple were direct sales on the platform. They weren't secondary sales. And the court made very clear in its opinion that was specifically not addressing secondary sales. Their point was that the Ripple case was much

narrower than some have interpreted as being, not covering secondary sales in general. Once again, Jackson was skeptical of this interpretation, asking the SEC to make that argument formally in a filing if they wished to rely on it. Discussions around the BUSD stable coin were brief. Finance argued that a stable coin could not give rise to a reasonable expectation of profit, so should not be considered a security. The SEC pointed to the recent Terraform decision, arguing that BUSD was also offered as part of a yield-bearing investment. Jackson appeared unconvinced by this argument as well. On top of all this, the major questions doctrine was given a quick once over, with Jackson appearing skeptical that crypto was currently a large enough industry to qualify.

Now, not everything went against finance. On the subject of procedural fairness, the SEC claimed that they do not have to warn individual companies that they are in violation of securities law, but this argument fell flat. Jackson said, you could certainly have legitimate discussion about fairness using litigation to regulate the cryptocurrency industry after years of inaction, or whether it makes sense as a policymaker to go token by token, court by court. Overall, her concerns seem to be more about the practicality of the SEC's approach rather than its legal standing. In this case, like the Coinbase lawsuit, the SEC is alleging that almost a dozen crypto tokens were transacted as securities on the exchanges.

None of the protocol teams are a party to these lawsuits, so do not have the opportunity to argue that their tokens are not securities. Jackson said, I'm a little concerned about the discovery in many trials that each of these are going to generate, especially when the issuers aren't even parties in this lawsuit. The big point, and the one that the SEC cannot escape in these cases, is whether they have a limiting principle to their legal theories. Jackson echoed the Coinbase hearing and asked the SEC where the boundary is between tokens which are investment contracts and those which are not. She noted that this question is critical

for crypto market participants, quote, because there are people buying and selling these assets and they need to know. Judge Jackson ended the hearing without issuing a decision, with the expectation that a ruling will come over the following weeks or months. Now, the biggest loss for finance was that Judge Jackson appeared satisfied that BNB was in fact a security when it was issued, which should give the SEC's sufficient grounds to keep the lawsuit going. The big win for the industry was that the SEC's tactic of bundling up multiple token lawsuits into broader cases against exchanges was called out. The judge rejected the idea that these issues could be dealt with without running mini-trials for each asset. Indeed, she found that prospect

entirely unacceptable. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7, 365, and moves at the speed of real life. Not everyone believes it. We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and lows of the industry, facing forwards towards progress throughout. And now they're inviting us to see what crypto can be. Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice.

Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, BVI, DBA, Crakken. Now, there are a couple things and interpretations that I've seen from the crypto community. A lot of people were emphasizing the sort of gotcha and contrast and the SEC contradictions between their finance argument that the token itself represents the investment contract, their Coinbase argument that the token itself is not a security. I think that there may be more legal nuances than the Twitterati are giving it credit for, but I think a bigger and very clear takeaway is that Gensler and the SEC's continued comments that the law is clear has just

absolutely been blown out of the water. Now that said, when we were leaving the Coinbase hearing talking about how some people had them handicapped at 70% to win, in this case, it's hard to have observed this and not think that Binance got smoked. They're trying to run the Coinbase argument, but at the end of the day, the case is about the sale and promotion of B&B more than anything else. Now, if you are looking for a big win for the crypto industry about this, one possibility is that these cases could kill the SEC's plan of getting a generalized token precedent out of this. So far, the legal strategy of using ambiguity and then broad precedent to regulate the industry indirectly doesn't seem to be standing up to legal scrutiny.

Both judges are laser-focused on this limiting principle issue, and without a regulatory schema or some well-articulated boundaries, the SEC is going to be hounded by this issue the entire way. Now, one other story related to the SEC and update, really. The SEC have provided an update on their investigation into the hack of their Twitter account surrounding the ETF launch. You will undoubtedly remember on January 9th when a hacker sent a fake tweet from the SEC account

claiming that the ETFs had been approved one day ahead of the official announcement. The fake announcement sent Bitcoin's price action into overdrive, leading to almost $100 million in liquidations and allegations of price manipulation. The agency confirmed that the attacker used a sim swap to gain control over a cell phone associated with the SEC Twitter account. A statement from the regulator said, access to the phone number occurred via the telecom carrier, not via SEC systems. SEC staff have not identified any evidence that the unauthorized party gain access to the SEC systems, data devices, or other social media accounts. Now, here's where it gets very

notable. The SEC said that they previously had two-factor authentication enabled on the account, but had requested that Twitter customer support disable it due to issues accessing the account. Overall, the SEC said the investigation is still ongoing and that the attacker has not yet been identified. James Safart and analyst at Bloomberg wrote, The SEC deliberately turned off to FAA this summer, which is arguably worse than having never turned it on to begin with. If you've been active on crypto Twitter over recent years, you'll know that sim swaps have become an out-of-control problem. In September of last year, Vitalik's Twitter account was hacked and tweeted out a poisoned link to a

wallet-drainer, and a similar attack compromised the account of smart contract auditing firm Sirtik earlier this month. Some SimSwap attacks have even led to hackers gaining direct access to crypto holdings, with October's attack on friend tech accounts as a prime example. Sim Swabs have become a routine and basic attack vector largely due to a lack of controls around the process at cell phone carriers. Hackers can easily obtain cell phone numbers associated with target accounts using a combination of leaked data and the standard social media account recovery process. From there, it appears that some cell phone carriers will happily provide a new SIM with a bare minimum of identity verification. The question is whether now that this attack has meaningfully affected the government agency,

will we finally see some action at cell phone carriers to address this fairly glaring security issue? Now, moving on to a totally separate topic, a bug in the code of a minority Ethereum validator client knocked out part of the network on Sunday. Nethermind, which runs around 8% of Ethereum validators, stopped producing valid blocks for a few hours. The issue with Nethermind has now been patched, but the event raised issues about client diversity. Ethereum decentralization advocate Superfiz tweeted, I just heard about a potential client bug at Nethermind.

This is no big deal as long as it only affects minority clients. As a matter of fact, it's a very deliberate design decision not to rely on any single point of failure. Now, this is certainly the design principle of the Ethereum proof-of-stake mechanism. The system has redundant infrastructure choices to ensure that the blockchain can keep working even with major outages. The issue is that one client, Geth, has taken over as the mandatory. majority choice for validators. Coinbase and Lido exclusively used Geth, and the client now represents

around 85% of Ethereum validators. This means that a bug in Geth could take down the vast majority of the network, leading to immense slashing losses for Stakers. Nixo, the executive director of Eath Staker wrote in a tweet, look y'all, Bessu had an issue earlier this month, wasn't a big deal because they're around 4% of the network. Nethermind has an issue today. It's not a big deal because they're around 8% of the network. Client bugs can happen in any client. Geth could be next, and it would be a big deal. Now, there are initiatives underway at Coinbase and other major staking platforms to improve validator diversity in order to mitigate this issue.

One of the barriers to this effort is that Geth has become the majority validator client because it was viewed as being technically superior. In other words, there is a cost to switching to a minority client with a weaker track record. Opinions vary about whether this is still the case, and larger stakers should be more able to deal with the burden of supporting multiple clients. More importantly, the problems that could be caused by a bug in Geth are large theoretical. We haven't seen a bug show up yet, and previous issues with Ethereum validators have been quickly resolved without protocol downtime. Of course, the nightmare scenario would be that a bug in

geth causes an unreparable fork due to a divergence in the consensus. If anything, this nethermind bug is sort of serving as a wake-up call to Ethereum infrastructure specialists, that client diversity could be a critical weakness in the network, and as such must be addressed. Now, one of the reasons that Ethereum resilience is front of mind is the upcoming Denkoon upgrade. This upgrade will add blob space to blocks allowing layer 2 networks to use cheaper data storage to maintain their state. While cheaper fees for layer 2 transactions will help with scaling in the future, some are concerned this will undermine Ethereum's profitability in the present.

Coin shares Ethereum researcher Luke Nolan said, transactional call data makes up 90% of the cost layer 2's pay in terms of gas fees. But after the Denkun upgrade, instead of posting their data through call data, layer 2s can use the new blob space mechanism which has significantly lower gas costs. So if we expect layer 2s to gradually shift to using this new blob space mechanism, we could see gas prices settle at lower levels, which means less ether is burned. Now, Nolan is concerned that Ethereum will flip into a significant inflationary issuance regime, but simply that it will be less deflationary.

However, this could be offset by additional activity, with Nolan adding, quote, the point of the Denkun upgrade is to decrease gas fees for user transactions using roll-ups and bring users back to the network because of lower transaction fees. So more activity means more gas usage overall. Overall, Nolan said that the point of Denkoon was to solidify Ethereum's market share and ensure that layer two networks are viable in the longer term. Quote, so secondary effects are in net positive over the long run, regardless of short-term gas fluctuation.

The upgrade is currently live on the goarly test net, with additional test net activations over the next few weeks. The main net upgrade is expected sometime after March, depending on whether bugs show up in test net deployments. All right, friends, that is the story for today. Like I said, kind of this quiet lull period, but crypto never stays quiet for long, and so I'm sure we will be back tomorrow with some more interesting news.

Until then, however, one more big thank you to my sponsor for today's show, Cracken, go to crackin.com and see what crypto can be. Until next time, be safe and take care of each other. Peace.