The Breakdown - Crypto Takes the Fight Back to the SEC

Episode Date: October 13, 2024

A reading and discussion inspired by https://blockworks.co/news/sec-wrong-about-crypto-asset-securities Unlocking Bitcoin DeFi with ExSat The exSat Network aims to unlock and scale the Bitcoin ecosystem without compromising Bitcoins Ideology. The network has partnered with the largest mining pools in the world, major custodians and exchanges, Cefu, Cubolt, Matrixport, Copper, OKX and aims to have over $200M TVL at mainnet launch on the 23rd of October.  Follow exSat’s Twitter to stay up to date @exsatnetwork or visit the testnet exsat.network 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 Sunday, October 13th, and that means it's time for Long Read Sunday. 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. Hello friends, happy weekend. One of the things that we discussed on the show with Scott Melkar on Friday was that it feels

like there's this burst of activity coming forth from the SEC at what is potentially the end of this phase of the agency's operations. Now, of course, Gensler still has years on his term, but it feels like something's going to give. Exemplary of that is the changing response that organizations in and around the crypto space are giving when they get served with Wells notices or actual legal action. We kick off today with the latest such response. This was a tweet from marketmaker Cumberland, and it doesn't mince words. Today we became the latest target of the SEC's enforcement first approach to stifling innovation and preventing legitimate companies from engaging in digital assets.

This comes, despite bipartisan pushback on this approach, in the most recent House Financial Services Committee hearing in which the SEC was called a rogue agency, cited for its failure to work with Congress, and taken to task for abusing its power. At issue in our case is the SEC's view that some of our transactions involving certain crypto assets were securities transactions. We have engaged in five years of good faith discussions with the SEIC on this point. On our end, we've shared dozens of written summaries and statements, produce thousands of pages of material, and made our senior management and compliance personnel available for many hours of interviews. Today's complaint is the first time the SEC has outlined

the specific transactions at issue. The SEC asserts these transactions required us to register as a broker-dealer. While we strongly disagree, we took that step and acquired a registered broker-dealer in 2019. Only then, despite Chairman Gensler's call to just come in and register, where we told we could only use our broker-dealer to trade BTC or ETH, both commodities and not under the jurisdiction of the SEC. This naturally calls into question whether the guidance to come in and register was provided in good faith. We are not making any changes to our business operations or the assets in which we provide liquidity as a result of this action by the SEC. We are confident in our strong compliance framework and disciplined adherence to all known

rules and regulations, even as they have been a moving target. It wasn't long ago, EDH was claimed to be a security. We have proven before our firm's willingness to defend ourselves against overzealous regulators wielding their power in ways that harm rather than benefit the market. We did it when Chairman Gensler was chair of the CFTC, with the court finding its case against DRW based on little more than an earth is flat-style conviction. This time, the SEC's approach seems to be a game of catch, 22, where the ability to come in and register is just a mirage. We're ready to defend ourselves again. Back to NLW here. This aggressive posture or stance is now starting to become much more common. And in that light, we now turn to our main essay on this LRS.

It's by Defi Education Fund's Chief Legal Officer Amanda Tuminelli and Variant Fund Chief Legal Officer Jake Chravinsky. The piece is titled, The SEC has been wrong about crypto asset securities all along. Cryptotokens were never securities and the SEC's backtrack proves it. I will turn this over to an AI version of myself to read. The Securities and Exchange Commission has finally admitted what we've known all along. Crypto asset security was a made-up term with no legal basis. After years of misleading the courts and the public, the agency's quiet abandonment of the term signals a major retreat in its regulation by enforcement campaign against the digital asset industry. Rather than putting out proactive or helpful guidance in recent years, the SEC has been suing industry participants

in a thinly veiled attempt to kill crypto. So far, it isn't going well. If there was any doubt that the SEC's approach is destined for failure, the recent shattering of the myth behind crypto asset security should put it to rest. Last year, the SEC filed enforcement actions against many of the major centralized exchanges and is currently fighting in different courts against Bina. Coinbase, and Cracken. Two weeks ago, the SEC moved to amend its complaint in the Binance case. Buried in a footnote on page 24 of the motion, the SEC gave a stunning apology. As this court noted and as the SEC reiterates, with its use of the term crypto-asset securities, the SEC is not referring to the crypto asset itself as the security. Rather, as

the SEC has consistently maintained since Telegram, the term is a shorthand. Nevertheless, to avoid any confusion, the amended complaint no longer uses the shorthand term, and the SEC regrets any confusion it may have invited in this regard. This episode of The Breakdown is brought to you by XAT Network. As regular listeners know, one of the things that I think is really exciting right now is all of the new builder energy around Bitcoin, and XAT Network is a great example of that. XAT Network utilizes a combined consensus mechanism of P.O. and POS, enabling miners to earn revenue and stakers to earn Bitcoin yield. Their state data index mirrors Bitcoin

UTXO data, creating a venue for BTCFI to flourish and a platform to trade Bitcoin assets. X-SAT Network partners with MatrixPort committing 5,000 to 10,000 NBTC to the network, assisting with DAPD development and enhancing security. Ultimately, the goal is for X-SAT network's decentralized asset custody to enable you to earn Bitcoin yield without sacrificing security or transparency. The X-Sat Network aims to unlock and scale the Bitcoin ecosystem without compromising Bitcoin ideology. Check out X-SAT.network or follow X-SAT on Twitter at X-SAT network, that's EX-S-A-T-N-E-T-W-O-RK, and unlock Bitcoin Defi with X-Sat. Rarely in history has a single footnote scrambled the minds of so many expert lawyers at once.

Coinbase chief legal officer Paul Gruel described it as shameless. Uniswop Labs' CLO Catherine Menorick said, no government agency should work this way. Ripple Labs' CLO, Stuart Alderati, suggested the SEC, admitted has become a twisted pretzel of contradictions. Why react so strongly? There are at least three reasons. First, the footnote is demonstrably false.

Far from having consistently maintained that it is not referring to the crypto asset itself as the security, the SEC has relentlessly propagated the myth that tokens themselves are securities. The SEC declared that view as early as 2017 in its settlement with Munchy, where it said that digital assets may be securities and that Myun tokens were securities because they were investment contracts. The SEC has consistently reiterated that view in the years since. For example, in its 2018 ICO framework, the SEC analyzed whether a digital asset is offered or sold as an investment contract and therefore is a security.

In its 2020 complaint against Ripple Labs, the SEC alleged that XRP was an investment contract and therefore a security. And in its 2023 complaint against Coinbase, the SEC accused Coinbase of making available for trading crypto assets that are investment contracts under the Howie test. Even the SEC's reference to Telegram in its footnote seems insincere. The SEC cites the Telegram case as if to show through its own statements that it has a history of consistently maintaining that tokens themselves are not securities. But the citation itself doesn't reference a statement by the SEC. It quotes the court holding that tokens are little more than alpha-numeric cryptographic sequence. In reality, the SEC alleged in its 2019 complaint against Telegram that grams are securities

because grams are investment contracts. This isn't even the first time the SEC has made misrepresentations to the court this year. In an enforcement action against Debtbox, where the SEC lied to the court in order to get the relief it was seeking against defendants, the court took the rare step of imposing sanctions against the SEC because its pervasive misconduct demonstrate a pattern of organizational bad faith and broadly implicate the commission itself, not just isolated individuals. In an 80-page opinion using the term bad faith 46 times, the court stated that the SEC's conduct constitute a gross abuse of the power entrusted to it by Congress and substantially

undermine the integrity of the proceedings and the judicial process. Second, the footnote signals an SEC in disarray. As a federal agency with extraordinary power to regulate the U.S. economy, we expect, and administrative law requires that the SEC will maintain consistent positions within and across its divisions. In other words, the left hand ought to know what the right hand is doing. Yet, on the exact same day that the enforcement division half-heartedly apologized in the finance case for the confusion it caused by using the term crypto asset securities, the same division

used that term eight times in its settlement with E Toro, and the SEC's X account posted an investor alert from the Office of Investor Education and Advocacy using the term five times. These blatant inconsistencies call into question how entrepreneurs and investors are supposed to understand the law, or the SEC's interpretation of the law, when the agency itself can't even decide what language to use in describing it. Third, the footnote betrays the SEC knowing its view of the law is wrong and how it's taking different advocacy positions simply to win its enforcement cases. The argument that tokens themselves are securities is central to the SEC's enforcement actions against centralized exchanges. The SEC hung its hat on that argument in the

Binance case, claiming that tokens are the embodiment of the investment contract and therefore subject to the securities laws as they trade in secondary markets. The court explicitly called out the SEC's inconsistency in its use of the term crypto asset securities and rejected that argument. holding that it is not enough, standing alone, to bring secondary sales of specific tokens under the SEC's jurisdiction. As a neutral regulator meant to serve the interests of justice, the SEC isn't supposed to take different positions in different cases just because it wants to win them. Instead, the SEC should be presenting a consistent view of the law, assuming it has one. This footnote proves it does not. And that means defendants will have a renewed opportunity

to assert a fair notice defense against SEC enforcement, arguing that the law is so vague a person of common intelligence can't determine its meaning. The SEC's sudden abandonment of the term crypto asset securities isn't just semantics, much as they would like to handwave and say so. If the SEC can't characterize tokens as securities, it will have a hard time convincing courts that it has authority over secondary markets for digital assets. The crux of the securities laws is a registration regime for securities. But if the tokens themselves aren't securities, then it's unclear what exactly should be registered in the first place. Crypto lawyers aren't the only ones to notice the SEC's retreat from the term crypto asset securities.

In recent Congress hearings, members on both sides of the aisle, from Richie Torres to Tom Emmer, remarked on how the SEC made up the term despite having no basis in federal law, only to later retract it and apologize for its use. Now that the myth of crypto asset security has been exposed, the SEC will have to confront the reality of its weakness in both the courts in Congress. Back to Real NLW here. by way of wrapping up, one of the things that became clear earlier in the week is that Gensler views himself not just as fulfilling the mandate of the SEC as it's actually defined. In other words, not just the

promotion of fair and orderly markets, the promotion of investment, the protection of investors, but also it appears that he views himself as a defender of the dollar. Now, viewed through that light, his antipathy towards cryptocurrency starts to make a lot more sense. And yet the barrage of pressure from all sides, from Democrats and Republicans, suggest that this sort of self-appointment is not likely to carry the day. There is still a lot of damage that could be done, a lot of harm that could be caused, and ultimately we don't know exactly how much or what exactly is going to change. The big hope, of course, is that when the change comes, it's not just change in personnel, but a fundamental shift in attitude. The good news is it's highly likely that when the history

books are written, it will be these last years that were seen as the aberration in the SEC's approach to markets and innovation, rather than just as a new normal. At least that's my hope. That's going to do for today's Long Read Sunday. Appreciate you listening as always, and until next time, be safe and take care of each other. Peace.