The Breakdown - Fighting the Regulatory Rugpull

Episode Date: April 29, 2023

On this edition of the Weekly Recap, NLW breaks down: Gary Gensler's latest cringey SEC video Coinbase's Wells Notice response  Dual legislative hearings from Thursday  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 “The Breakdown” is written, produced and hosted by Nathaniel Whittemore aka NLW. Research is by Scott Hill. Editing is by Rob Mitchell and Kyle Barbour-Hoffman. Our theme music is “Countdown” by Neon Beach.

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, April 29th, and that means it's time for the weekly recap. Now, before we get into today's show, a quick note. If you're enjoying the breakdown, why not come join the Breakers community on Discord? It's a place for discussing the show and the larger news happening in crypto Bitcoin and beyond. and has a really great community that you can join at bit.ly slash breakdown pod. Also, if you are looking for even more breakdown, come check out the YouTube channel.

I've been posting what I call Breakdown Bytes, which are shorter, breaking sort of news stories that happen when it's important. And again, you can check that out in the link in the show notes. Now, for today's weekly recap, I have to say, it's a little bit like Groundhog Day or maybe Groundhog week, I guess. This week we got another hearing or two. We got more intransigent crypto opponents, more tension with the SEC, more banking crisis, more macro insecurity, and of course, AI relentlessly marching on.

But where we're going to focus today is the regulatory battles that continue to define so much of this bear market. And let's start with another delightfully patronizing video from our Securities and Exchange Commission chair, Gary Gensler. On Thursday, Gensler tweeted, Intermediaries for Investment Contracts are required to comply with securities law and register with the SEC. Instead, many crypto platforms are contending that their investment contracts are something else. The law cares about what something actually is, not what you

call it. Now, the point of this video was that crypto platforms should register as securities exchanges. To make his point, he used a belittling analogy about evading leash laws by calling your dog a goldfish. Now, despite the absolutely cringe delivery, Gensler actually touches on the real fundamental issues that stem from the lack of regulatory clarity in the U.S. He says that without registration, crypto investors are denied the basic protections afforded in other U.S. markets, which is true. He points out that without regulation, crypto custodians are not providing appropriate segregation of customer funds and that bankruptcy courts are not able to separate out customer assets. He notes that many crypto exchanges have conflicts of interest with internal market makers.

And to be clear, there are very few crypto firms that have chosen to remain in the U.S. that would disagree with these points in their entirety. But the problem is the lack of ability to register under a clear set of rules. There is no disclosure regime that makes sense for crypto assets. And without clarity on the legal framework for crypto assets, there's no ability to register and continue to operate. The core of Gensler's argument, which has notably changed in recent months, is that Congress granted the SEC a broad scope to regulate all kinds of different investments, regardless of what they are called. If this argument falls flat when applied to novel forms of investments that do not neatly fit the existing regulatory frameworks. As SEC Commissioner Hester Perth,

pointed out in her most recent dissent, the regulator has not always been so reluctant to provide tailored legislation for novel asset classes. In 1998, for example, the SEC introduced rules around alternative asset systems to enable electronic trading. In 2011, the SEC provided tailored disclosure requirements for asset-backed securities, recognizing that existing disclosure regimes were not a good fit. There is no reason the SEC cannot take this approach with crypto exchanges and assets to enable financial innovation to continue in the U.S. Genzer closes his video with yet another call for crypto firms to come in and register. But Coinbase's chief legal officer Paul Gruel explained just how unproductive that suggestion is.

He said to be clear, we would like to be able to register, but it is not simply a matter of going to the website and downloading a form, as has been suggested. Because it can't be done, it is disingenuous to suggest otherwise. Understandably, crypto Twitter was just incensed again at this video. Nick Carter writes, stop commissioning, cringy video content on Fiverr. Richard Trixon says, Gary still insists on talking to everyone like they're in kindergarten. It's not productive, hypocritical, and highly condescending. But my favorite quote came from crypto lawyer Preston Byrne, who writes,

quoting and mocking the piece. In many places, we have leash laws. Let's say you're walking your dog without a leash. A cop sees you, ignores it for 10 years, then one day barges into your bedroom at 4 a.m. without a warrant, shoots the dog and gives you a ticket. This is just like our securities market. Now compare this video from Gensler with another video that came out from Coinbase. Columbia Business School Adjunct Professor Omin Malikhan said,

One of these is made by people who want America to lead and succeed. The other, not so much. Yes, Coinbase has responded to the SEC's Wells Notice informing them of incoming enforcement action in a dramatic public fashion. On Thursday, Coinbase released a video putting forward their position on SEC crypto enforcement alongside a 73-page written response. Coinbase CEO Brian Armstrong opened the video by explaining why Coinbase decided to headquarter in the U.S.

It was a place, Brian said, where I felt entrepreneurs could work in good faith with regulators to help define new rules for new industries as they emerge. Brian asserted that Coinbase has continuously attempted to engage with regulators in situations where there was a lack of clarity around compliance. Summing up the exchange's position, Brian said, A Wells notice at this stage, when there is not a clear rulebook, is not constructive, and it's not good for America. We are prepared to defend that position in court, but it doesn't have to come to that.

We want a true dialogue about a workable path forward for our industry. Chief Legal Officer Paul Gruel explained his frustration at the lack of progress in engaging with regulators. Coinbase, he said, has been talking to the SEC about our business for many years now. We've repeatedly asked the SEC for its own views on how security's laws might apply to Coinbase and our industry. To be candid, we have mostly gotten silence in response. Regulation needs to be created in a fair way and shared with the public. Now, the tone throughout this video expressed that Coinbase is committed to continuing to engage with regulators to forge a path forwards, but that this path needs to be consistent and transparent

to allow onshore companies to grow with regulatory certainty. Gruel called the Wells notice broad yet fundamentally vague and added that, quote, we still do not know exactly what it is we do that is of concern to the SEC. Coinbase views litigation as a last resort, with Grewell suggesting, quote, we are on the brink of a fight that doesn't need to happen and frankly shouldn't happen at a time when we could be working together to provide clarity and stability to an important new industry for consumers and investors, not to mention the U.S. economy as a whole, we are instead gearing up for litigation. He described the lose-lose scenario of litigation for the SEC and the industry.

Coinbase does not want to litigate against the SEC, and the SEC should not want to litigate this case either. Litigation will put the SEC's own actions on trial, erode public trust in the SEC's mission, undermine any incentive for market participants to engage with the SEC, and put at risk broad aspects of the SEC's enforcement program. Grewill said that Coinbase is open to a wide range of solutions to the issue, including registering as a securities exchange and delisting assets that the SEC formally, formally identifies as unregistered securities. But he noted that currently, that pathway has been closed off, stating that progress in that direction, quote, must be rooted in a fair and proper application of securities laws, and there must be an actual

path to register which does not exist today. Grewell closed by confirming that, quote, Coinbase will defend itself vigorously in litigation if it comes to that, but it doesn't have to come to that. Now, Coinbase's written filing, drafted by law firm Sullivan and Cromwell, delivered a blunt assessment of the SEC's chances in litigation. The commission's case against Coinbase, they right will fail as a matter of fact and law. This filing spelled out in chapter and verse the deficiencies in the assumed case which would be made by the SEC and noted that crypto cases against major firms have so far been a resource-intensive quagmire. It cited the ripple case

which has been running for years in an attempt to define a single token as a security. Now obviously much of crypto agrees with Coinbase. Cyrus EVM writes, this presentation tells a compelling story with the right tone. Coinbase was founded in America to cement the United States as a finance and technology hub with strong rule of law and reasonable regulators. It's time for the SEC to work constructively with the crypto industry. Attorney Jeremy Hogan writes, there's just no way to reconcile, allowing Coinbase to sell shares of stock to the public, and then turn around two years later and say the sales are all unlawful.

That's not investor protection. It's a regulatory rugpole. Indeed, some legal minds are pointing out just how insane the SEC's entire approach here is. Banking and FinTech lawyer Bradford Harden says, This whole thing is such a wreck. The commission let this industry develop openly and with full transparency about the core functionalities. Let the biggest player go public while holding no relevant federal permissions but listing hundreds of assets.

And now has announced after 10 plus years that all of it has always been illegal, even though there's been no change in law or regulation? Is there any precedent for something like that? NFT collector JWPE writes, we will look back on this one day with a sense of shock and perhaps even, even indignation at how certain regulators thought that they could bend the law to their will. Mike Townsend writes, Coinbase is the David fighting Goliath, but it doesn't have to be a fight. SEC regulators are not serving the American people. They are blocking financial innovation.

Now, there's also a lot of chatter about whether Coinbase is going public with this sort of thing was or wasn't a smart strategy, but frankly, how much worse could it be for them? The SEC has issued them a Wells notice but said nothing about what they're actually doing wrong, And I don't think that Sullivan and Cromwell are just blowing smoke. I think that they believe that the SEC would have a very difficult time in litigation. Since the SEC is playing political games, why not engage on that political front? I support it. Maybe it gets them to the table. Probably not, but we've got enough court cases to deal with right now anyways.

Speaking of legislation and rules and lawyers, are we seeing any progress on the actual legislative front? As you know, we had two hearings last week that related to crypto, and this week, actually, we had two hearings as well, though with much less fanfare. Congress held two simultaneous hearings, in fact, to discuss the gaps in the digital asset market infrastructure. The House Financial Services Committee, which oversees the SECC, and the Senate Agricultural Committee, which oversees the CFTC, her testimony discussing the issues that would need to be addressed in any comprehensive crypto legislation. The witnesses covered a wide range of views with several industry figures, as well as staple anti-crypto witness Professor Hillary Allen. You will remember that Hillary Allen is the one who wrote

the case for banning crypto in foreign affairs recently. And again, if you needed more proof that her opinion is taken seriously on Washington, here she is yet again as a congressional witness. Zachary's Wayhorn, partner at law firm Davis Polk, explained that the current market structure laws and regulations do not align well with digital assets. He says, we've all heard the sirens call to come in and register. Sounds enticingly attractive. But this is an oversimplification that conflates registration, which may be theoretically possible, with compliance, which is not. Allen retorted that, quote, this is a misdirection. It is entirely possible for a blockchain-based technology business to comply with existing investor protection and financial stability regulation.

While much of each of the hearings was a rehashing of old arguments, one point that rang clear was just how firm the Democrats' position on not allowing any regulation to move forward has become. In her opening statement, House Financial Services ranking member Maxine Waters said, quote, we do not need an entirely new and special framework for crypto. We already have one. Rather, crypto firms like other tech companies before them must recognize that they are not exceptional. They need to comply with the laws of the land. Following the hearings, House Financial Services Democrats tweeted out the statement that, quote, we are open to legislating to close specific gaps in the securities market infrastructure, but neither the Biden administration, investors,

the SEC, nor other financial regulators have called on Congress to pursue new legal frameworks for the crypto industry. This is genuinely teeth nationally disingenuous. Preston Burnaghan writes, investors are literally screaming for Congress to create a legal pathway for tokens and have been for years. Austin Campbell writes, if I were a foreign jurisdiction, I would read this as an open invitation to take jobs, economic activity, and future control of the financial system away from the United States. Also, the president's working group itself did, in fact, call for legislation on stable coins. One bright spot, I guess, came from New York Democrat Richard Torres, who continued his streak of

rational commentary, saying, quote, there's nothing unprecedented about the notion of tailoring rules. The SEC is statutorily designed to be a merit-neutral regulator, but it hardly requires a suspension of disbelief to imagine a regulator who has a personal or ideological antipathy for crypto, and therefore seeks to regulate the industry out of existence. Regulatory sabotage is the antithesis of merit-neutral regulation, which is the kind of regulation that Congress contemplated for the SEC. Now, I have to say it is a hard time right now for the progressive bitcoins out there, and especially for those who really associate themselves with the Democratic Party, which is not all progressives, obviously. This hardening of positions and partisan calcification has been one of the most

disappointing parts of this year. And perhaps it was inevitable. There are certainly many who have said to me it was inevitable forever, that at some point, the lack of partisanship around Bitcoin and crypto was going to give way to the gaping maw of partisanship which eats everything in America. And so maybe this was inevitable. Maybe it was also driven by the fact that, was such a mainstay in Democratic circles and that they felt personally betrayed as the great big Democratic donor was ripped away from them. This is of course all speculation, but whatever the case, the positions have hardened. And I think it's only going to get worse as we get into re-election season. Especially coming up to a presidential election, this is not the time that a lot

of productive work gets done. The Democrats clearly think it's good politics to lump crypto in with all of tech that they believe that people dislike, and even if they're not going to make it a of their platform, they believe that their antipathy would be better than actual cooperation and a good faith attempt to get something done. One person who has made hating crypto a central part of her platform is of course Elizabeth Warren, who used it in her formal re-election announcement. However, the good news for the crypto faithful is that Warren's streak of being loud but not actually being able to get anything done seems to be continuing. Her recently reintroduced new crypto legislation is apparently having a very hard time finding any sponsors, and so has been delayed.

Anyways, guys, given this environment, I will give a big shout out here to Jason Mayer, who just put out his book, The Progressive Bitcoiner. We're going to need a lot of those alternative takes to keep this partisanship from getting so brutal that it consumes the industry. Jason will be on Bitcoin Builders next week, so if you want to hear that show, go subscribe to Bitcoin Builders. Anyways, guys, that's it for this week. I hope you are having a great weekend wherever you are.

Until tomorrow, be safe and take care of each other. Peace.