The Breakdown - Is the SEC About to Go Scorched Earth?

Episode Date: September 20, 2023

The head of the SEC's cyber unit has basically issued a warning saying the SEC isn't done yet and will be pursuing more action against exchanges and DeFi protocols. The crypto industry is wondering how far the SEC's resources really extend to fight legal battles on so many fronts. 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 Wednesday, September 20th, and today we're asking whether the SEC is about to go scorched earth. Before we do 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 are go to bit.ly slash breakdown pod. Hello friends, lots to get through today, so let's dive right in. The SEC is not done going after crypto exchanges, according to David

Hirsch, the head of the agency's crypto assets and cyber unit. Speaking at the Securities Enforcement Forum Central and Chicago on Tuesday, Hurst said security's law violations within the industry extend far beyond existing litigation. Now, keep in mind, the crypto division of the SEC is currently bogged down with complex lawsuits against both Coinbase's, and and Binance, two of the largest crypto exchanges. Hearst said his unit is investigating similar activity across other firms and believes non-compliant business practices, quote, hold true well beyond any two entities. Hirsch warned, we're going to continue to be active as to intermediaries. That can be brokers, dealers, exchanges, clearing agencies, or any others who are active in this space

are within our jurisdiction and are not meeting their obligations, either through registration or failure to provide adequate or complete disclosures. Now, the SEC is apparently also turning its gaze towards defy platforms in this crusade against crypto intermediaries. Hearst said, quote, we're going to continue to conduct investigations, we're going to be active in the space, and adding the label of defyy is not going to be something that's going to deter us from continuing our work. Now, a common theme of recent comments from SEC chair Gary Gensler is to mock, quote, so-called decentralized finance. This perhaps indicates that the SEC believes underlying most defy protocols they will be able to find a company to sue. All that said, despite outlining an ambitious

enforcement agenda, Hirsch did concede that the agency's resources are constrained. Over recent decades, the SEC has largely dealt with regulated financial institutions, with sprawling legal and compliance departments eager to cut a deal, pay the fine, and move on. The SEC's campaign against crypto firms has largely presented existential threats rather than manageable fines, leading to a significant number of contested lawsuits. Hirsch admitted during the panel that, quote, do have a lot of litigation going on, to which the events moderator retorted, it feels like you're at capacity. Reflecting on that point, Hirsch recognized the scale of the task he was proposing, stating that, there are more tokens extant, I think maybe 20,000, 25,000 last I read,

than the SEC or any agency has the resources to pursue directly. And similarly, there are a number of centralized platforms out there, some that are acting as unregistered exchanges. So in some ways here, Hershey's begrudgingly admitting that the SEC is getting close to capacity, at least when it comes to ongoing litigation. They're dealing with Coinbase, Binance, and Ripple all as major cases. LBRY Library seems to be wanting to go to appeal. Then there's Grayscale, which continues to be a legal battle, as well as the two recent NFT cases which settled. So the question is, can the SEC handle five lawsuits at once? Can they handle 10?

Even if you think the answer is yes, at what point do you think the answer becomes no? Frankly, this is maybe why people like Coinbase CEO Brian Armstrong, are encouraging the industry to take up arms effectively and actually fight these legal battles out in court. Now, of course, this brings up the other question of whether the SEC can bank on funding for additional resources to expand this endeavor, or whether they need to have some alternative approach. This, of course, echoes the talking point from both the GOP as well as from Dems like Ritchie Torres, that basically the status quo was not an option, that the SEC's regulation by enforcement approach is reaching the end of its limits to the extent that it ever was successful

at all, and that a much smarter pathway at this point might actually. be rulemaking and guidance rather than just trying to sue the industry off the face of the planet. Look, crypto companies are fighting back. It's only a matter of time before we see some sort of coordinated defense fund, and it wouldn't be surprising to me if even this beleaguered industry can marshal a heck of a lot more resources than the SEC can on its own. Now, the other side of the coin is how much time the SEC actually has left to bring the industry to heal. Fox business reporter Eleanor Territ tweeted yesterday, only 13 days left for the SEC to bring enforcement actions that will count towards fiscal year 2023 enforcement numbers. The agency filed

760 total enforcement actions in FY 2022. I wonder if we'll see a surge of cases in the next two weeks. Now, certainly when it comes to the crypto industry, there is a broad sense of bring it on. Cryptotrater Lacksman writes, SEC warns of upcoming charges against crypto and defy exchanges. Few might think this will kill crypto. I feel like this will kill SEC. Crypto McKenna retweeted the headline, SEC warns more charges against crypto and defy exchanges are coming, and added the Latin phrase, if you want peace, prepare for war. Simplest of all, the Gordon Law Group just said, Bring it on, Gary.

Now, moving to the global sphere, a German regulator has stressed the risks of crypto and called for global regulations to apply consistently without exception. On Monday, Rupert Schaefer, executive director of strategy, policy, and control, at the German Federal Financial Supervisory Authority, Baffin, published a blog post on the importance of united global regulation on crypto. He warned of the dangers of unregulated crypto firms using a fairly labor to analogy to airspace regulation. Schaefer likened the crypto regulation to air traffic control regulations, which are relatively uniform throughout the world. In this analogy, some crypto assets and DFI

projects were UFOs. He stated then that it would be negligent to simply ignore them. Schaefer warned that FTX was a major crash and there would be many more like it to come. Now, the regulator praised the recently passed MECO regulations in Europe, but argued that further steps need to be taken. He produced a long list of global proposals from the Financial Stability Board, the International Association of Securities Commissions, the financial Action Task Force and the Basel Committee, and this he claimed was enough to establish a global consensus stating that, quote, the international regulatory principles have been adopted and the framework has been set. Now, the common principles must be implemented consistently and consistently worldwide.

There should be no white spots in the flight radar. The global rule should also apply to niche financial centers. Now, this blog post comes a little over a week since the conclusion of the G20 summit, which was pitched as an opportunity to discuss global synchronization of crypto policy. G20 leaders did manage to produce an endorsement of the latest set of policy recommendations published by the Financial Stability Board, and in her article previewing the meeting, Noel Adjison highlighted that the adoption of FSB recommendations was, quote, very likely since the recommendations don't actually say anything interesting. Noel noted that the FSB recommendations are more around notational international cooperation

and vague platitudes about enforcing risk management rather than firm policy outlines. At the same time, none of the recommendations mentioned by Schaefer actually achieved consensus approval at the G20, calling into question how the regulator can claim that there are any common principles whatsoever. Moving over to the UK. The UK House of Lords have passed a bill which would grant authorities the power to freeze and seize crypto assets associated with crime. Currently, UK authorities cannot apply for crypto assets to be frozen unless there has been an arrest or conviction. This bill would allow them to more quickly apply for freeze orders. Hundreds of millions worth of crypto linked to crime have been seized by local authorities, but experts say this new bill

could help deal with situations that aren't easily dealt with under the current legal framework. Phil Aris, Director of UK Public Sector Relations at TRM Labs said, one area this will be used is on occasions where assets have been identified, significant links to criminality can be proven, but the subject of the investigation is unlikely to face justice in the UK. Think of those committing fraud outside of the UK and targeting UK residents. A government fact sheet suggested even more broad use, stating that, quote, the creation of a crypto asset-specific civil forfeiture power will mitigate the risk

posed by those that cannot be prosecuted, but use their funds to further criminality or for terrorist purposes. Isabella Chase, senior policy advisor at blockchain analytics firm, TRM Lab, suggested that the measure could assist with police funding, stating that, quote, it would go either to the law enforcement agency that seized the assets or to fund economic crime work, and then half of it goes to the home office again solely to fight economic crime work. Corker Bining was less enthusiastic about the fundraising prospects, noting that as the UK cracks down, quite, they might find that the pool of available targets quickly dwindles as

suspected criminals move their assets offshore to less enthusiastically police jurisdictions. The bill has already been passed in the House of Commons once, so we'll now return for a second vote before it can be given royal assent to become law. Now, I don't know what sort of free society we're dealing with here. With the big caveat that I am not a lawyer, the discourse around this is pretty wild to me. It seems like they're talking effectively about on-chain asset forfeiture without the requirement to charge anyone with a crime. This is the digital equivalent of police being able to take what they find in your trunk if they search your car and not have to give it back to you. That's an insane policy and so is this. And I hope

not just for the sake of the crypto industry, but for the sake of the UK itself, some real, real limits are put around this. Staying in the UK, however, for just a moment, on Tuesday, UK lawmakers passed the controversial online safety bill. The bill requires companies to assess the likelihood of customers encountering illegal content, and of children encountering harmful content. Proponents of the bill say it will be used to protect younger internet users and make the web a safer place. The government has claimed the bill would make the UK, quote, the safest place in the world to be online. Critics, however, have warned that, depending on how the bill is enforced, it could require companies to do away with encrypted messaging and essentially any notion of online privacy. WhatsApp, Signal, and

telegram have all threatened to exit the UK if the bill was passed. Earlier this month, regulators attempted to appease encrypted messaging apps by promising to only implement text scanning if it was technically feasible, but WhatsApp head Will Cathcart appeared unconvinced, tweeting last week that, quote, the fact remains that scanning everyone's messages would destroy privacy as we know it. That was as true last year as it is today. WhatsApp will never break our encryption and remains vigilant against threats to do so. Signal President Meredith Whitaker was a little bit more hopeful that the implementation would be thoughtful. She said, quote, while it's not everything we wanted, we are more optimistic than we were when we began engaging with the UK government. It matters that the government came out publicly,

clearly acknowledging that there is no technology that can safely and privately scan everyone's communications. At this point, it is imperative that we press regulators to incorporate the government's strong guidance acknowledging that no technology exists that can safely and privately scan end-to-end encryption communications, and push them to clearly and publicly commit to not using the unchecked and unprecedented power vested in them to undermine private communications infrastructure. Whitaker confirmed that Signal would remain available in the UK for the time being. But for content and messaging platforms, the enforcement of the bill is a high-stakes issue, with the maximum penalty being up to 10% of global revenue.

Lastly, today, an update from a story earlier in the week. We have recently talked about JPEX, a crypto exchange that has come under fire from Hong Kong authorities. At the time, withdrawals were effectively halted and one influencer had been arrested for promoting the platform. Reporting on Monday morning, stated that authorities had received 83 complaints related to assets, worth $4.3 million. Since then, the case has dramatically escalated. Authorities have now received over 1,600 complaints involving over $150 million worth of assets. Eight people have now been arrested with the expectation that more arrests are coming.

Police have now stated that the arrests are in relation to conspiracy to commit fraud rather than merely promotion of an unlicensed exchange. 20 locations have been raided across Hong Kong with police seizing cash, jewelry, computers, and phones worth around $1 million. dollars. Police have frozen around $2 million held in bank accounts owned by arrested suspects, alongside about $5.5 million in property. Authorities are currently considering the confiscation of around $8 million in criminal proceeds. On Monday, JPEX blamed the Securities and Futures Commission and their counterparties within the industry for causing an illiquidity crisis.

They said in a statement, when other cryptocurrency exchanges announced their entry into the Hong Kong market and began extensive promotion, JPX was subjected to continuous unfair treatment. The SFC sent letters to all of our partners requesting the cessation of cooperation with the platform. On Tuesday, however, Elizabeth Wong, director of licensing at the SFC, confirmed that the regulator had asked counterparties to step away from the unlicensed exchange. The regulator had been monitoring the platform for months and issued numerous warnings to users. She said that since those warnings were issued, JPEX went from bad to worse. Now, the events surrounding JPEX could be seen either as a sign that Hong Kong authorities are serious about enforcement of new crypto regulations, or an indication

that the city still is a long way to go in cleaning up the industry. As we discussed before, given Hong Kong's role as a bellwether for Chinese authorities' attitudes towards crypto, this is a story that we will continue to watch. However, for now, that is going to do it for today's breakdown. I appreciate you listening as always. Until next time, be safe and take care of each other. Peace.