The Breakdown - Could Prometheum's Custody Plans Force the SEC on Ethereum?

Episode Date: February 10, 2024

Ugh, yes we're talking about Prometheum and an argument that their Ethereum custody plans could lead the SEC to designate Ethereum a security. 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 Friday, February 9th, and today we are talking about, well, something I find enormously frustrating, so you're going to want to hear it. 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 in the show notes or go to bit.ly slash breakdown pod. Well, friends, happy Friday. Some days we talk about things of great import here at the breakdown, important policy discussions, the implications for executive and agency power.

Other days, we get to just have fun. For example, this week talking about the surge in excitement in Bitcoin. And then there are some days when we just have to talk about some utter joke of an organization that is only relevant because of how fully it has become a stooge for anti-crypto forces. Yes, today we are back talking about Prometheum. Prometheum have announced their roadmap for product launches this year. The firm claims they will offer institutional Ethereum custody in late March, followed by their trading platform in the second quarter.

There is some concern that this product could allow the SEC to declare Ethereum to be a security after years of regulatory ambiguity. Prometheum achieved notoriety last year by cozying up to the SEC. The firm, which was completely unknown at the time, was handpicked to represent the SEC's viewpoint in a congressional hearing. They were cast as the example to demonstrate that SEC registration is entirely possible. Other exchanges just weren't trying hard enough. Prometheum is the only firm to get approval for special purpose broker-dealer licensing from

the SEC, although many other crypto companies have tried. Following the hearing, however, it was revealed that Prometheum had no products, and it was an open question whether they could even. legally offer trading in any crypto assets under current laws. Since then, Prometheum has gained licensing to provide settlement and clearing of crypto assets through a subsidiary. This would technically satisfy the SEC's concern that there is a clear conflict of interest in offering trading and clearing under the same roof. In addition, the firm now claims to be an SEC qualified custodian. That term has been used in proposed

SEC rulemaking, but does not appear to have a clear meaning at this stage. For his part, Prometheum co-CEO Aaron Kaplan has rejected the suggestion that Prometheum is an SEC plant. In an interview this week, he said, I've never met or spoken to Gary Gensler. There is even more to this story than we're going to get into today. There's a potential connection to a large Chinese crypto firm, GOP lawmakers demanding answers from Gensler about how they got licensed and, of course, receiving no response, other GOP lawmakers questions about their connection to the CCP, and basically infinite speculation about how much of this is an SEC and Elizabeth Warren control.

effort. Well, the controversy surrounding Prometheum got kicked up a gear on Wednesday when Fortune published an article entitled, The SEC may be forced to declare Ethereum a security after controversial new launch. For years, of course, the SEC has avoided making their position on Ethereum known, refusing to publicly state whether it is a security or a commodity. Again, in the context of this, I'm not getting into the Hinman Doctrine and all that complication, but Prometheum is only regulated by the SEC, so technically cannot offer any services related to commodity tokens. By allowing Prometheum to launch Ethereum custody, the thought is that the SEC would be implicitly declaring that Ethereum is a security. Prometheum CEO Ben Kaplan explicitly

confirmed this is the intended approach, stating, the CFTC is not our regulator. When the SEC says to us it's not a security, then we'll be troubled. Kaplan appeared to be disclosing then that Prometheum hasn't received confirmation from the SEC that Ethereum is a security, but they're willing to take silence as a good enough answer. Fortune offered a handful of legal opinions to support the article's thesis. Boston University lecturer Mark Williams said the announcement was just marketing, but it could be impactful nonetheless. He said, it's a gamble. Maybe it's part of their business strategy to force the hand of the SEC. William Brannan, vice chair of the crypto practice at Lowenstein Sandler, said that Prometheum would be courting unnecessary controversy by announcing Ethereum custody as their

first product, given the SEC's ambiguous stance. He noted that Prometheum is likely working closely with regulators to get clarification on their product offering. Rod Geffner, a partner at Satis and Goldberg, and a former SEC enforcement attorney, said it was unlikely that the SEC would block Prometheum at this stage. He said it was far more likely that they would be allowed to go ahead due to Gensler's stated desire to have an example of a compliant exchange. Then again, in reaction to the article, Mike Selig, a partner at Wokey Far, said it was unlikely that Promethe's product would change anything, tweeting, SEC has effectively conceded ETH isn't a security multiple times but left ambiguity. Prometheum need only reasonably believe ETH is a crypto asset security

to custody it. S.C. permitting Prometheum to custody Eith as a security because of this ambiguity won't make Eith a security. He noted that Prometheum has the broad latitude to self-certify digital assets as securities, making them eligible to be traded on their platform. This is the same authority that Coinbase and other crypto exchanges use when they determine that the digital assets they offer are not securities. Of course, aside from the confusion around what this means for Ethereum itself, the biggest question will be whether or not Prometheum can successfully launch a product. Other than working closely with the SEC, the firm has literally zero track record. The likelihood that such an inexperienced firm that has so many questions surrounding it

will actually attract institutions to try out an untested custody service seems dubious at best. Members of the organization are claiming that they're seeing, quote, immense interest in their services, but refuse to name any specific institutional customers. In my estimation, Prometheum has already backfired for the SEC. Parading them out in front of Congress made Gensler look much weaker, not stronger like he wanted to. It did not answer people's questions about the challenges of just coming in and registering, as they say all the time, and instead made everyone, and not just crypto people, but congressmen and women as well, say, really? That's the example you're going to hold up? An organization which can't even legally launch a product? This is not one where I have ambiguous feelings, as you can tell,

and I am certainly not alone in this. Bill Hughes, a lawyer at Consensus writes, Prometheum as a black flag op to corner the market on crypto regulation, would put Gensler on the Mount Rushmore of Machiavellian administrative state bureaucrats, no question, an all-time great D.C. Swamp maneuver. Technocrats would start naming their kids Gary and hanging his portrait above their mantles. 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.

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Speaking of the folks in Congress having it up to here with the SEC, a group of Republican senators, including Cynthia Lummiss and J.D. Vance, have written to the SEC complaining about their unethical handling of a different crypto case. The lawsuit in question is an enforcement action against a project called Debtbox. In this case, the SEC materially misrepresented the risk of the project draining bank accounts and shifting money offshore in order to obtain a temporary restraining order. Once the SEC received the TRO, they used it to freeze bank accounts owned by the project, its founders, and their other unrelated businesses. The court has called on the SEC to show cause why they should not be sanctioned for this

behavior. The SEC moved to dismiss the case last week and said that no further disciplinary action from the court was necessary. They wrote in a recent filing that, quote, agency officials have taken and are taking broader corrective action to ensure the concerns raised by the court do not arise again, including holding mandatory trainings for all enforcement division staff, involved in investigations and litigation, on the importance of candor and the duty to promptly correct any inaccuracies. The Senator's letter, however, suggests that this conduct raises further questions about the SEC's behavior in other crypto enforcement cases. They write, regardless of whether commission staff deliberately misrepresented evidence or unknowingly presented

false information, this case suggests other enforcement cases brought by the commission may be deserving of scrutiny. The letter continues, it is unconscionable that any federal agency, especially one regularly involved in highly consequential legal procedures, and one that under your leadership, has often pursued its regulatory mission through enforcement actions, rather than through rulemakings, could operate in such an unethical and unprofessional manner. Notably, the senators serve on the Senate Banking Committee, which has oversight powers over the SEC. They did note the agency's pledge to conduct additional training, writing that, perhaps such training in the most elementary aspects of legal conduct is necessary.

However, we are skeptical that this response and the commission's pledge to reshuffle personnel is proportionate to the very serious allegations outlined by the court. The senators noted that confidence in the SEC and trust in its pure motive, and conducting enforcement actions is paramount. They wrote, This trust is undermined and your mission compromised by episodes like the Debtbox case. Now, one surprising one from D.C., leading House Democrat Maxine Waters says she is close to a deal on stablecoin legislation. Waters and her Republican counterpart Patrick McHenry have, of course, been at the negotiating table for over a year regarding the stablecoin bill.

McHenry pushed the bill through the committee stage in July despite Waters' protests, but there remained key issues that needed to be settled. Democrats were concerned about a provision which would allow state regulators to oversee stable coin issuers rather than handing regulatory authority to the Fed. Whatever final bill comes, it likely requires Waters' endorsement to stand any chance in the Democrat-controlled Senate. According to reporting from Politico, Waters has said a deal is, quote, very, very close. The article adds, her comments are the first real sign that talks have progressed after imploding last year. Waters confirmed that federal oversight is still

her line in the sand, stating, that's what's important to me. Our central bank should have the power of oversight and should have the ability to be at the head of this. However, she said that Democrats had, quote, work something out with the feds, and I think it's okay. During a congressional hearing earlier this week, Treasury Secretary Janet Yellen was pretty clear on how she viewed the issue stating, it's critical for there to be a federal regulatory floor that would apply to all states and that a federal regulator should have the ability to decide if a stable coin issuer should be barred from issuing such an asset. Since this issue was first raised, staple coin experts have noted that a tiered approach should be appropriate. This would allow smaller stablecoin issuers

to work with state regulators while still allowing the Fed to intervene as necessary. A couple more stories before we're out of here. Over in Montenegro, Terraform Labs co-founder Doe Kwan has won his appeal against extradition. The decision has been set aside and will be returned to the original court for a new determination. Kwan has been battling against extradition request to both the U.S. and South Korea. He faces criminal charges for fraud in both jurisdictions in relation to the collapse of Luna and the rest of the Terraform ecosystem in 22. The Montenegro Court of Appeals essentially said that the proper legal process was not followed correctly and that the extradition order was therefore invalid. Nothing in the appeal indicated that

Kwan could not be extradited, just that the court needs to ensure its reasoning is sound and follows the law. Kwan was arrested in Montenegro late last year after being caught traveling on a fake passport. He has now served his time on that charge, but his extradition will now need to await a new hearing. Kwan's CFO, Han Chong-June, was extradited to South Korea Monday to face criminal charges. Han was arrested alongside Kwan when he entered Montenegro. One interesting speculative story, a curious Twitter post from Coinbase Chief Legal Officer has spurred speculation. Paul Grewell tweeted yesterday, a word of advice to outside counsel. Don't front-run your in-house counsel in sharing good news with their business partners. Let them have that moment.

We regularly have to deliver tough messages. Depriving us of the first shot to share news when it's good is discourteous at best. Now, there are only a handful of legal matters where Coinbase would have engaged outside counsel that could be the subject of this good news. The main active case is Coinbase's lawsuit against the SEC. The most recent event in that case was a hearing where Coinbase had asked the judge to decide in their favor without proceeding to a full trial. The key issue is whether numerous crypto tokens offered on Coinbase could be considered unregistered securities. Good news in that case would obviously be good news for the entire industry. The other possibility would be the lawsuit between Satoshi wannabe Craig Wright and the Crypto Open Patent Alliance, which is currently in its

first week of a full trial. Coinbase is a key member of Copa, and the lawsuit is seeking to end Wright's claims that he is Satoshi and holds intellectual property rights over the Bitcoin white paper. Wright has used these claims to pursue copyright infringement and defamation lawsuits against Bitcoin developers and personalities over the course of the last several years. We have chosen not to cover that trial in a detailed way this week, as by all accounts, it is a dumpster fire. Wright is currently in the middle of giving evidence and has been repeatedly caught in lies and revealed to have fabricated evidence. So whatever the good news is that Griewell has received, we hope the industry can learn of it soon. And friends, we will wrap there for

today. I hope you are getting ready for a wonderful weekend full of relaxation and fun. 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.