The Breakdown - Crypto Wins A Key Battle in its War with the SEC

Episode Date: May 20, 2023

On this edition of the weekly recap, NLW covers: Ledger turmoil Stablecoin reserve shifts Binance out in Australia  Binance total market share dips below 50% SEC says Filecoin is a security Judge rules Hinman emails can't be locked Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto 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 Saturday, May 20th, and that means it's time for the weekly recap. A quick note before we dive in, you should, if you are not yet subscribed, subscribe to the breakdown newsletter. Yes, we have finally resuscitated this thing. It has had fits and starts in the past, but now we are doing something we call first five. every weekday morning it comes out with the five most interesting, confusing, enraging, or otherwise important stories in Bitcoin, Macro, and beyond. You can check it out at Breakdown.b-Behive-B-E-H-I-I-V-com, and I think you'll enjoy it.

Now, every Saturday, I ask what the week before will be remembered for when it comes to crypto and the larger economy. And to me, there are two big things that stand out this week. The first is, of course, Ledger. For those of you, you who haven't listened to the Ledger episode from earlier this week, the TLDR is that on Tuesday they announced a feature called Ledger Recovery. Now, Ledger Recovery was a way for people who were maybe new to the space or who were just generally insecure about keeping their own seed phrase on a piece of paper, which is how Ledger normally does things. This new feature, Ledger Recovery, would allow them to effectively have a backup. And the way that it would work is that the Ledger device would

send out a copy of the seed phrase split into three parts. It would go to Ledger and two other companies and the person would have to use ID verification services to request to have it come back. Now, you might already have spotted some of the issues here. All of a sudden, a hardware wallet, which is supposed to be a self-sovereign device and totally outside of the realm of tamperability, has introduced a whole slew of new weaknesses. There's a KYC and identity verification process. There's these three companies that are involved. But the biggest thing that had people upset was that in the past, Ledger had made it seem like there was no way for the device. to ever send out a seed phrase, however that seemed to be changing. Because of the device

could copy that seed phrase and then encrypt it to send it out in these three parts, didn't that break the relationship that people thought they had with their ledgers? Now, over the next couple days, Ledger really dug itself into a deeper and deeper hole. At one point, its team tweeted, technically speaking, it is and has always been possible to write firmware that facilitates key extraction. You've always trusted Ledger not to deploy such firmware, whether you knew it or not. It's important to understand that at the end of the day, any hardware wallet solution a user chooses to go with will always require that person to trust the developer to build and maintain a secure device to store your assets. This was exactly the wrong thing to say, and just further outrage the community. Now, what's more in a Twitter space is the next day on Wednesday, the CEO of Ledger kind of got into it with people.

He said, this is what future customers want. This is the way that the next hundreds of millions of people will actually on board to crypto. Now, as I said on my show earlier this week, that might be true. There will likely be a wide band of custody solutions for future crypto users, and it's totally possible that the majority will use something that is either custodial or has some sort of custodial backup like this. But what has happened this week is that Ledger has basically failed to remember the customers they already have and the values that they have, but I think it will be a lesson to just about

everyone else in the hardware wallet space. Now, the other big thing that happened this week was stable coins changing their reserve profile. This happened in two different ways. First, Tether announced that they would be buying Bitcoin with their excess reserves, which is basically the profit that they make from holding U.S. treasuries. Tether said going forward, they'd use up to 15% of net profits on the Bitcoin purchases, but that this was different, that they weren't having their actual USDT backed by Bitcoin. This was just an additional fund above the 100% reserve ratio, of which 85% is treasuries and cash. And then there was Circle's USDC. Worried about the potential impacts from a U.S. debt default, Circle moved out of

treasuries that were dated past the end of this month. Through their BlackRock managed funds, they now have $8.7 billion in short-term repo agreements. The great irony of these things is, of course, that people were so worried, and when I say people, I mean politicians specifically, so worried at the idea that stablecoins might destabilize the financial system, and yet here we are, and stablecoins are worried about the financial system destabilizing them. Now, there were also a number of other meaningful stories that I haven't had a chance to cover this week yet. Some of them fall in the category of the shifting sands of exchanges. This week kicked off or really last weekend ended with Binance leaving Canada.

While this week had more issue for them, as the firm's Australian division announced the suspension of bank transfer services. Overnight on Wednesday, Binance Australia announced that bank transfers using the National Instant Settlement Pay ID service were suspended effective immediately, and that bank transfers using traditional rails would be impacted shortly. They said, we regret to inform you that with immediate effect, we are unable to facilitate pay ID AUD deposits for Binance users due to a decision made by our third-party payment service provider. We are working hard to find an alternative provider to continue offering AUD deposits and withdrawals to our users.

Now, as you can see, Binance blamed this as a decision made by our third-party payment service provider, and that seems to have some validity. Simultaneously, Westpac, which is one of Australia's big four banks, banned customers from transacting with Binance entirely, calling the move a scam protection measure. Scott Colliery, Westpac's executive of customer service, said, quote, digital exchanges have a legitimate role to play in the financial ecosystem, but since the rise of digital currency, we've noticed that scammers are increasingly using overseas exchanges. Often our customers only discover they've been scammed after the money has left the country,

making recovery extremely difficult. The trial of our new security measures will better protect customers from scams. These problems, of course, add to a lot of list of issues with access to banking services for Binance this year. In February, Binance suspended deposits and withdrawals using bank transfers in the U.S. The prior month, now defunct signature bank, announced that they were limiting Binance's dollar payments via the International Swift Network to high-value payments over $100,000. Problems in Australia have also been mounting. In April, the Australian financial regulator canceled the local financial services license for Binance Australia's derivatives partner amid claims that the exchange had allowed

retail customers to access leverage and derivatives products in violation of local regulations. The exchange remains operational in Australia for spot trading only. On top of that, last Friday, Binance again, as we just said, announced that it would no longer be operating in Canada, citing unsuitable regulatory conditions. Recently implemented regulatory changes in Canada had limited retail crypto purchases to $30,000 annually, with exceptions for major commodity tokens like Bitcoin and Ethereum. Fourthcoming changes would prohibit the offering of leverage and derivatives trading, alongside requiring approval to sell particular stable coins, and some commentators believe that this confluence of tight regulations made Binance's business model unviable in Canada. As always, when it

comes to these things, the question is, is this an Australia thing, or is this a Binance thing? Now, some people weren't concerned. Daniel Pickering wrote, Finance Australia loses AUD. In one stroke of a banker's pen, the largest exchange in the country can no longer operate as normal. Long term, this makes no difference to Bitcoin and ensures that the Australian dollar is slightly less useful than it was last week. Cryptodomis writes Binance lost some banking services in Australia, apparently. The fact that it happened with immediate effect is actually far more telling than the fact that they lost the services. Cryptot trader, Mr. Sol agreed, saying Binance Australia has cut off fiat deposit and withdrawal with immediate effect. This is scary. Now, there is a lot of speculation

and less information about what is actually going on behind the scenes, how much this crackdown again, to do with crypto more generally versus Binance specifically. Still in aggregate, Binance's market share has fallen below 50% for the first time since August of last year. According to the Block's incomplete monthly data for May, Binance's market share is currently at a little over 47% after logging similar numbers in April. Back in February, Binance was riding high with a 62% share of market volume. That was the most concentrated market share of any exchange going back to the start of 2018. Now, that said, Binance remains the most used exchange in the world by a massive margin, with no other exchange registering more than an 8% share so far this month. Unconcerned with the

decline in market share, Binance chief strategy officer Patrick Hillman said, We've got a lot of market share right now. We don't feel the need to capture more. In fact, we want more competition. Competition is good for the marketplace. It's good for the industry. A finance spokesperson also said that they had expected to see market share fall after the end of the exchange's zero-fee Bitcoin trading promotion on major stablecoin pairs. This is not a concern for us, they said. We continue to maintain our strong financial performance. April saw a 50% reduction in spot volumes on Binance after the promotion was concluded towards the end of March. Then again, volumes are down across the board. Aggregated trading volumes have been below the trillion dollar mark

per month since October, according to data again compiled by the block. Recent U.S. regulatory action against finance has ensured that they bore the brunt of that loss in volume, with rivals KX and Coinbase picking up a little additional market share in recent months. Still, Hillman reiterated that they are pleased with the additional competition. We're rooting Coinbase on. We want them to grow. Seeing them leave the U.S. as a U.S. citizen is really tough for me to see. But if they're going to be able to now grow at the global level because they're able to offshore, fine. We need them to be a big player in the space. They're a good company to have. We need more of those. Now shifting to exchanges that aren't so good, liquidation of Voyager's assets could begin as soon as Friday after a

bankruptcy judge signed off on revised plans. After a deal, again with Binance U.S., to acquire Voyager's assets and repay customers fell apart in April, Voyager creditors approved a self-liquidation plan. The Voyager official committee of unsecured creditors tweeted on Wednesday, We're working with Voyager to go effective under the plan as soon as possible as early as this Friday. We're still working towards making initial distributions available no later than June. Voyager estimates that creditors could see a recovery of around 36 cents on the dollar, which is, of course, a far cry from the more than 70% recovery once anticipated under the Binance U.S. deal. Now, this recovery amount could increase depending on the outcome of a $446 million

clawback claim by the FTX estate, which is still pending. Now, shifting over to our other constant main character, the SEC, there are a few relevant pieces of news this week. Grayscale has disclosed that it received a comment letter from the SEC to inform the crypto asset manager that Filecoin meets their definition of a security. Grayscale had been attempting to register shares in the Grayscale Filecoin Trust and had voluntarily filed a Form 10 to make the trust a reporting company. This classification would require the Filecoin Trust to file quarterly and annual reports. The SEC has asked Grayscale to withdraw that application, stating that because, in their view, Filecoin is a security, the trust would instead qualify

as an investment company. Grayscale does not believe that Filecoin is a security and, quote, intends to respond promptly to the SEC staff with an explanation of the legal basis for Grayscale's position. If Grayscale is unsuccessful in convincing SEC staff of their position, Grayscale says they may be required to register the trust as an investment company or alternatively dissolve the trust. Now, for those unfamiliar, Filecoin is intended to function as a decentralized file storage system, which utilizes the unused hard drive space of participants in the network. The token launched in 2017, and Filecoin tokens function as a payment mechanism for use of this storage. While the network never really reached significant adoption, the token is often used as a clear example of a

utility token that serves a functional purpose in operating a network rather than a security offering. Fox business reporter Eleanor Territ writes, interesting that the SEC investigated file coin five years ago and did not say anything about the product potentially being an unregistered security. Lawyer Bill Morgan writes, Grayscale no doubt previously obtained advice from high-paid securities lawyers that FIL was not a security before filing the registration statement, but just because there is so much clarity, they formed a different view than the SEC. Former CFTC staffer and crypto lawyer Mike Seelig writes,

Now we have regulation by comment with the SEC deeming Filecoin to be a security through a comment to Grayscale's trust product application without providing any supporting legal analysis. Building on that sad state of affairs, Scott Lewis writes, the Gary Gensler SEC has introduced a new and chilling form of regulatory overreach. The SEC investigated Filecoin five years ago and did not pursue any charges related to selling an unregistered security. Today, it issued a dictum via correspondence. There is no legal analysis. The primary impacted party is not the correspondent.

No due process, legal or bureaucratic accompanied the announcement. It is a breach of the values and norms of a democratic society and yet another failure in Gary Gensler's terrible tenure at the commission. Now, still for the SEC, it wasn't all roses on the legal front. The federal judge presiding over the SEC lawsuit against Ripple has ruled that documents related to a speech given by former SEC official Bill Hinman cannot be sealed. In 2018, Bill Hinman gave a speech outlining that the SEC, quote, doesn't see a lot of value in treating Ether today as a security, given that there is no central group or person responsible for the protocol. Hinman at the time was the director of the division of corporate finance.

Ripple has been seeking discovery of documents surrounding the preparation of this speech, including legal advice given to Hinman regarding that statement to support their argument that Ripple is not a security for similar reasons. In January, the judge ordered that these documents must be turned over to Ripple, rejecting the SEC's argument that they were subject to attorney-client privilege. This week, the judge ruled that the documents cannot remain under court seal, ensuring that they would be made available to the public. In her order, she wrote that the documents were not related to a protected SEC decision-making

process. Quote, therefore sealing these documents would not be related to preserving openness and candor within the agency, nor would such an interest be substantial enough to outweigh the strong presumption of public access. Eleanor Territ again writes, So what's next? According to my legal sources, immediate next steps will be both parties sitting down and sorting out the logistics of how and when the court documents will be released. Will the SEC try and file an interlocutory appeal to the decision?

Possibly, but it would be a long shot for Torres to grant such a motion as this is a discovery issue. It's also extremely unlikely that she would ever grant a stay of her order, saying the documents must become public even if the SEC did try to appeal. So now, some more waiting. Met a lawman James Murphy writes, One practical effect of the ruling permitting release of the Hinman documents is, Gary Gensler now has to worry that if the SEC sues Coinbase, all emails, notes, and memos about his conflicting statements on the SEC's authority to regulate crypto exchanges will be made public.

So, my friends, even if it takes a little while, it seems like we will soon get a glimpse of the thought process behind the SEC's apparent 2018 stance that Ethereum is not a security. That's a stance that's obviously been in question lately, and has pretty big implications for the industry. For now, we will continue on our merry way, having fights in every corner and at every turn, but I appreciate fighting alongside you. Until next time, be safe and take care of each other.

Peace.