The Breakdown - Is the SEC’s Terra Lawsuit Trying to Set Precedent That Stablecoins are Securities?

Starting point is 00:00:00 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. The Breakdown is produced and distributed by CoinDess. What's going on, guys? It is Friday, February 17th, and today we are talking about the SEC's lawsuit against Doe Kwan and Terra. Not to mention some very weird transfers from Binance, but before we get into all that, 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 pot. Good Lord, another Friday and another flurry of activity to end the week.

Starting point is 00:00:52 We have so much to get into, so let's dive right in. On Thursday, the SEC sued Terraform Labs and its founder, Doe Kwan, for fraud and violations of securities law. The SEC alleges that Terraform and Kwan misled investors in a range of ways, including representing that Terra's UST stable coin was being widely used for payments on a Korean platform called Chai and descriptions of the stability of the UST peg mechanism. The SEC wrote in their complaint, Terraform and Kwan also misled investors about one of the most important aspects of Terraform's offering, the stability of UST, the algorithmic quote-unquote stable coin purportedly pegged to

Starting point is 00:01:26 the US dollar. UST's price falling below its $1 peg and not quickly being restored by the algorithm would spell doom for the entire Terraform ecosystem, given that UST has a lot of the and Luna had no reserves of assets or any other backing. End quote. Both the yield-bearing anchor protocol and the Luna token, which underpin the ecosystem, were also alleged to be crypto-asset securities in the SEC's complaint, which also deals with a range of older Terraform lab products, including synthetic assets,

Starting point is 00:01:52 offered via Terra's Mirror Protocol. On top of all of that, one of the bombshell allegations relates to the first major depigging event of UST in May 2021. The SEC alleges that Kwan and Terraform worked with an unknown, named U.S.-based trading form to restore the peg after the stable coin dipped down to trade at around 93 cents. It claims that Kwan used this event to promote the robustness of the algorithmic pegging mechanism, when in reality the stable coin had been saved by massive open market operations. From the complaint, quote, almost immediately upon U.S.T.'s recovery in May 2021,

Starting point is 00:02:25 Terraform and Kwan began to make materially misleading statements about how U.S.T.'s peg to the dollar was restored. Specifically, Terraform and Kwan emphasized the purported effectiveness of the algorithm underlying UST and maintaining UST peg to the dollar, misleadingly omitting the true cause of UST's re-peg, the deliberate intervention by the U.S. trading firm to restore the peg. End quote. Until this document, rumors of marketmaker intervention in that 2021 depegging event had just been rumors.

Starting point is 00:02:55 David Z. Morris from CoinDesk said, The SEC documents against Juan confirm what had been widely rumored that there was a secret bailout in May 2021. This means every subsequent representation of TerraUSD's stability was an act of fraud. By the way, for what it's worth, most of the chatter on crypto Twitter right now is assuming that the market maker in question here is jump. The SEC didn't name them, however, and there's so much more to go through that I'm just going to leave that as assumed by many but unconfirmed. So let's take a step back now and try to sum up some of the key points. This lawsuit is one of the most broad and detailed legal arguments we've seen from the SEC about how it claims to have jurisdiction over a wide range of crypto.

Starting point is 00:03:32 so it's worth spending some time digging into their arguments. First up is the fraud. As Haseeb Qureshi of Dragonfly Capital put it, the fraud case is rock solid. Chai using Terra was a complete fabrication, with fake on-chain transactions and everything. I was surprised by how egregious this was. People at Terraform Labs knew it was bullshit.

Starting point is 00:03:52 Now, the strength of the fraud case is important because it puts the SEC on very firm ground to run this lawsuit. It's the most serious allegation and is so egregious that it could drown out in depth technical arguments about the securities law violations that are being alleged. Still, overall, this lawsuit looks like the encapsulation of the SEC's argument that everything in the crypto ecosystem is a security and should fall under their jurisdiction. The SEC is claiming that five different tokens in the Terra Luna ecosystem were securities.

Starting point is 00:04:19 Luna in mirror tokens, wrapped Luna tokens, synthetic assets minted on the mirror protocol, and finally, the U.S.T. staple coin itself. This is the first time the SEC has attempted to define the law around wrapped tokens. and it makes two arguments. Firstly, that the wrapped Luna tokens were receipts for securities, being the underlying Luda tokens and therefore securities themselves. The second argument argues that the smart contract which converted Luna into RaptLuna was a common enterprise for the purpose of the Howie test.

Starting point is 00:04:47 If this argument is successful, it could have some important ramifications for other wrapped tokens in crypto. Meet DC pointed this out, tweeting, I think this aspect, which isn't getting as much play, is more concerning than the receipt theory for wrapped assets. That is, wrapped assets could be deemed securities even if the unwrapped asset is not. The SEC also argues that the UST stable coin itself was a security. Again, there are two sets of legal analyses offered.

Starting point is 00:05:12 The first is that U.S.T was so tangled up in the Anchor Protocol, which offered up to 20% returns on U.S.T. deposits that the entire mechanism operated like a securities offering. Crypto attorney Collins Belton tweeted that, quote, The second theory is very broad and based on U.S.T. giving investors the, quote, right to purchase another security, Luna. Again, I think the SEC is trying to get some useful precedent on the books with an unsympathetic actor. This could be a big deal if the precedent stuck, since obviously any crypto asset that's permissionless could be said to give someone

Starting point is 00:05:41 the, quote, right to purchase a security so long as it can be used on any decks or venue, where only one security may also be traded. Obviously, huge of true. Meet TC writes, it's clear from the summary that the SEC is going to make a specific angle on stable coins here and, in fact, apply Howie. Howie. How do we know? the expectation of profit from UST is the publicized use of the asset in anchor to generate yield. Right off the bat, this implicates all stable coins in existence currently. Stables are the bedrock of Defi at the moment and tips us off as how Gary is probably going to attack other stables. Gabriel Shapiro, the General Counsel at Delphi Digital, also has concerns about broader ramifications of this case.

Starting point is 00:06:19 He writes, you can expect the argument for UST being a security to be a roadmap for how the SEC goes after other stable coins. They will allege that integration, promotion, marketing, commercial deals, etc., building the stablecoin ecosystems are, quote, efforts of others that are, quote, reasonably expected, and can lead to profits in connection with the stables. This is why I've been saying that stables might even pass the Howie test, never mind other types of securities tests like Reeves, despite them being, quote unquote, stable. So obviously here the big picture concern is that the SEC is using a lawsuit against one of crypto's biggest villains to make broad and sweeping precedent that can be used against the rest of the industry. Haseeb captured the sentiment well, tweeting, Many are complaining that this is too little too late, obviously, but I suspect this is more legal strategy than investor protection.

Starting point is 00:07:06 Terra is indefensible at this point. Who's going to fight for them? So if the SEC wins, they can claim precedent. Bad facts make for bad laws. In a press release, SEC Director of Enforcement, Gerbier-Grawal, spoke to the issue of centralized entities promoting themselves as defy-darlings during the last bull cycle. He said that the Luna ecosystem was neither decentralized nor finance. But that, quote, it was simply a fraud propped up by a so-called algorithmic stable coin,

Starting point is 00:07:32 the price of which was controlled by the defendants, not any code. Join CoinDesk's Consensus 2023, the most important conversation in crypto and Web3, happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths. Visit consensus.com or check the link in the show notes. So on any other day, we could go even deeper here, but there is just so much more to cover,

Starting point is 00:08:17 so let's move on to something of a big report from Reuters about Binance last night. The report was titled Exclusive. Crypto Giant Binance moved $400 million from U.S. partner to firm managed by CEO Zhao. So what's the story? Well, new allegations of troubling conduct at Binance in 2021 have emerged with Reuters reporting that the offshore exchange had secret access to a bank account belonging to its purportedly independent U.S. partner. The report cites banking records and company messages, which show that large sums of money were transferred from Binance U.S. to a trading firm managed by Binance CEO, CZ. It claims that over the first three months of 2021, more than $400 million flowed through

Starting point is 00:08:55 Silvergap Bank to the affiliated trading firm Merritt Peak. Company messages reportedly indicate that transfers began in late 2020. Reuters has no information on the purpose of the transfers or whether any of the money belonged to customers. At the time, Binance U.S. terms of services said that customer dollar deposits were held with Silvergate and a Nevada-based custodian called Prime Trust. During that final quarter of 2021, Prime Trust made $650 million in wire transfer deposits into the Binance U.S. account.

Starting point is 00:09:22 A Binance U.S. spokesperson told Reuters that the report used, quote, outdated information without elaborating further. They added that, quote, merit peak is neither trading nor providing any kinds of services on the Binance U.S. platform, and that, quote, only Binance U.S. employees have access to Binance U.S. bank accounts. However, according to the internal messages viewed by Reuters, then CEO of Binance U.S., Catherine Coley, questioned the transfers, asking a Binance international finance executive to explain the transactions, which she called unexpected, saying that no one mentioned them. In one message, Coley asked, where are those funds coming from? In response to to Coley, another Binance executive, Susan Lee, simply said that Merit Peak was, quote,

Starting point is 00:10:00 a vendor that facilitated trading on Binance U.S. and also provided loans and capital injections to the U.S. exchange. In April 2021, Binance U.S. announced that Coley would be replaced as CEO, and she has not made any public statements since. Neither Lee nor Coley responded to Reuters' article via their legal representatives. Roiders was unable to trace where the 400 million ultimately ended up. An unspecified portion of the money was sent to the Silvergate account for Resachills Incorporated firm called Key Vision Development Limited. According to a 2021 corporate filing for another Binance unit, CZ was identified as a director of Key Vision. Roiders were very pointed in drawing a conclusion from this evidence. Quotes, the money transfers suggest that the

Starting point is 00:10:41 global Binance Exchange, which is not licensed to operate in the United States, control the finances of Binance U.S. despite maintaining that the American entity is entirely independent and operates as its U.S. partner. For their part, Binance obviously denies this. Binance U.S. U.S.'s chief Financial Officer Jasmine Lee told the Wall Street Journal on February 8th that, quote, the extent of our relationship with Binance International is a shared name and a licensing agreement for technology. She also added that, quote, we do not transfer our funds back and forth. The company reinforced this message in a Twitter thread following the Reuters report. The Binance U.S. account writes last night, there have been many attempts to draw parallels between

Starting point is 00:11:17 Binance U.S. and fraudulent exchanges that have gone bankrupt. The real facts speak for themselves. There is no comparison. Our leadership team is staffed with former DOJ, SEC, FBI, and NYFED employees who are committed to operating a platform that is safe and abides by U.S. laws and regulations. While we try to ignore the noise of rumors, speculation, and inaccurate reporting, we want to get a few facts straight. Only Binance U.S. employees have access to Binance U.S. bank accounts, period. While there was a market-making firm named Merit Peak that operated on the Binance U.S. platform, it stopped all activity on the platform in 2021. We list our competitive and transparent marketmaker program on our website, which shows that

Starting point is 00:11:54 firms fairly compete for rebates. Binance US has never and will never trade nor lend out customer funds. Binance US always maintains one-to-one reserves and are subject to regular audits and regulatory reporting by government entities. Now, of course, the reason that people are paying attention to this is that after the collapse of FTX and Alameda research, there has been just more scrutiny of exchanges that maintain associated trading firms. And while Binance is saying that there is nothing like that in this relationship, not everyone is totally convinced. Investor Adam Cochran writes, yeah, Coley noped out of Binance U.S. for good reason, it seems. Hundreds of millions of unexplained dollars getting commingled and moved around cross-border. I'd have bailed in a

Starting point is 00:12:32 heartbeat, too. Larpologist writes, now we know why Brian Brooks resigned after just three months into the CEO job, LMAO. Now, one other note on finance. There was also a piece in the Wall Street Journal called Crypto Giant Finance expects to pay penalties to resolve U.S. investigations. This was pretty weird to me. People were reading that headline and tweeting about it as though there had been some settlement announcement between the U.S. government and finance, which was not the case. The WS.J piece was basically an interview with Binance Chief Strategy Officer Patrick Hillman, where he said that the exchange expects to face monetary penalties and that they were, quote, working with regulators to figure out what are the remediation we have to go through to make

Starting point is 00:13:11 amends for past violations. He basically claimed that the exchange had grown too quickly and was not initially aware of the vast scope of laws intended to prevent money laundering, sanctions evasions, and corruption, i.e., we were moving too fast, we might have missed some things, but it wasn't intentional. Hidman didn't estimate the size or fines or a timeline for settlement, but said he was, quote, highly confident and feeling really good about where those discussions are going. Now, again, there's nothing inaccurate here. It was just weird in the sense of it being reported as news in the first place. Substantively, the only real news in this situation will be when the U.S. government chooses what it's going to do.

Starting point is 00:13:46 And the way that it got manifest on Twitter was, I think, a little bit confusing. But either way, it was written in the Wall Street Journal, so a lot of other people read it too. Now, let's move on to one more topic, a quick update on a truly known fraud. SBF is in the hot seat after using a VPN in seeming violation

Starting point is 00:14:04 of his bail conditions. FTX Sam has been warned that he could face a revocation of his bail if he continues to defy bail conditions set by the court. Earlier this week, prosecutors sent a letter to the court claiming that Sam had violated a previous court order against using encrypted technology when he used a VPN to access the internet last week.

Starting point is 00:14:22 Sam claims that he was innocently using VPN to watch the Super Bowl and other NFL games. Prosecutors urged the court to again tighten the bail conditions, restricting Sam from using cell phones, computers, or any internet-connected devices except in limited case-related circumstances. Because of all of this, Sam was forced back to New York for a hearing and in that hearing on Thursday, Sam's legal representative called the proposed measures, quote, draconian,

Starting point is 00:14:45 claiming that Sam required the use of the internet to adequately prepare for his trial. Judge Lewis Kaplan was not having it, suggesting that the measures proposed by prosecutors might not be strong enough to prevent Sam from meddling in the case. Judge Kaplan said that he had, quote, probable cause to believe that Sam may have committed witness tampering, which is a felony, and expressed doubt that the VPN was used to watch football. Quote, what was he doing watching a football game on a VPN if that was, in fact, what he was doing, that someone can just turn on a television and watch for nothing. When Sam's lawyer claimed that the use of VPN was an oversight, Judge Kaplan responded,

Starting point is 00:15:17 quote, the condition was no encryption. If there is one person in this courtroom who knew that VPN's use encryption, I'm guessing it would be your client. Judge Kaplan's concern that the bail conditions may not be strict enough related to the numerous unmonitored phones and computers presumably owned by Sam's parents. Kaplan said, why am I being asked to turn him loose in a garden of electronic devices. When told that there was not really a solution to prevent Sam from accessing his parents' devices, Judge Kaplan quipped, Oh, I think there is a solution.

Starting point is 00:15:45 It's just not one anyone has suggested yet. That was the point at which Kaplan warned Sam that he could be facing a revocation of bail, forcing him to await his trial from behind bars if he continues to defy the court. Kaplan rejected the prosecution's proposed bail conditions, asking them to come back with something that could more effectively prevent future issues. I want this to be tight, he said. Now, a couple things about this. First of all, how is it that the judge in this case has to be harsher than the prosecution?

Starting point is 00:16:12 Isn't that the prosecution's job? Second, Sam just forgetting that he was using a VPN for the NFL is the biggest eye roll ever. I'm completely with Maya Zahavi when she tweeted, How f-foyled do you have to be? To be accused of the biggest fraud in decades have daddy's friends sign your bail and still think you can argue with the judge about your VPN access. Anyway, speaking of Daddy's friends, we found out this week who the two additional co-signers of SBF's bond actually were.

Starting point is 00:16:42 And as much as Twitter wished it was going to be someone like Bill Ackman or Kevin O'Leary, it was instead two Stanford professors. Andreas Popke and Larry Kramer, who put up $200,000 and $500,000 respectively. Now, wait a second, wasn't the bail $250 million? How does Sam's parents' house plus $200,000 plus $500,000, add up a to anything that's a reasonable approximation of $250 million. The answer is, of course, that it doesn't. And indeed, I don't give a crap about the individuals here.

Starting point is 00:17:15 They have their reasons why they supported Sam and his family, and that's all fine, well, and good. Big laughable cynical joke is the disparity between these screaming $250 million headlines for the prosecution to look like they're being tough and the reality of the situation. Jameson Lopp from Kasa really nailed this one here when he wrote, Wait, so SBF's $250 million bond is only secured by a couple million dollars in assets?

Starting point is 00:17:38 Motherfucker got 100x leverage on his stay out of jail trade. Yeesh! Anyways, guys, hope you're having a great Friday and looking forward to the weekend. I appreciate you listening, as always. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Is the SEC’s Terra Lawsuit Trying to Set Precedent That Stablecoins are Securities?

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