The Breakdown - New Crypto Exchange Sues the SEC!

Episode Date: February 23, 2024

NLW covers an interesting case out of Texas that is meant to provoke a determination that the SEC is not allowed to regulate crypto. 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 Thursday, February 22nd, and today we are talking about the SEC getting sued. 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.L.Y. Breakdown Pod. Well, friends, a fun one to start today.

A new exchange is taking the fight to the SEC, suing the regulator in federal district court. Legilex, in collaboration with the Crypto Freedom Alliance of Texas, filed a lawsuit against the regulator on Wednesday. The lawsuit claims that the SEC does not have the proper authority to regulate crypto assets and is asking for a declaratory judgment from the court. The argument is the same we've heard before in numerous other crypto cases. Quote, that Congress has not provided the SEC with broad authority

to regulate digital assets. The filing also includes the familiar Howey test argument that digital assets are generally not investment contracts because, quote, they do not involve any kind of ongoing commitment on the part of the asset seller or developer to manage any common venture for the asset buyer's benefit. According to the complaint, Legilex wishes to launch a new crypto trading platform, but is concerned the SEC could pursue enforcement action at a later date. Therefore, the new exchange is asking the court to confirm that their platform is not an unregistered securities exchange, broker or clearing agency, and that the SEC has no jurisdiction over their activity. The complaint notes that the SEC has, quote, refused to propose for public comment any

regulations setting forth its view on what purportedly brings a digital asset within its regulatory domain and in fact explicitly denied a recent petition for rulemaking imploring the agency to do so. Crypto lawyers are excited about this new lawsuit as an opportunity to present the best possible case against the SEC. Jake Chivinsky, the chief legal officer at Variant Fund, wrote, crypto goes on offense in the courts. This lawsuit proactively challenges the SEC's unlawful attempt to seize power over digital asset markets

that it has no authority to regulate. If you think the SEC could use litigation to bully this industry out of the U.S., think again. Paul Grewell, the chief legal officer at Coinbase commented, how many suits will it take before the SEC gets that all this community asks is to understand the rules so that it can follow them faithfully? Apparently the answer is, at least one more. Amanda Tuminelli, the chief legal officer at the Defi Education Fund wrote, So this is huge. Today, Legilex and the Crypto Freedom Alliance of Texas, CFAT, sued the SEC, seeking a declaration that, quote, secondary market sales of digital assets like the one that Legilex intends to facilitate through the legit.exchange are not sales of securities. To be clear,

this is the first time that I am aware of that a crypto market participant has proactively sued the SEC, pre-launch of their project and pre-anything by the SEC, to ask a court to adjudicate digital asset-related securities questions. Plaintiffs are not looking for money or any reward other than legal clarity on these important questions. End quote. So who is this Legilex? And what is their proposed trading platform legit exchange? The project was put together in September founded by Mike Vavzach, who is also the general counsel at Alliance Dow. According to the complaint, the exchange is in a late stage of development and intends to host peer-to-peer trading without a custody component. It lists a range of tokens that it will host trading for, including many that have been named in other SEC lawsuits.

It seems the exchange will be the perfect vehicle for running this kind of test case against the SEC. Vavzac even hinted at a concept in a tweet from last week, referring to Legilex as, quote, a thought experiment became a side project, became something so much more. The other plaintiff in the case is the Crypto Freedom Alliance of Texas. CFAT was also formed in September and advocates for the responsible development of crypto policies in Texas. In this case, it argues that the SEC's current policy stance, quote, impedes the ability of other authorities whose jurisdiction may properly extend to digital assets to enter the field. The nonprofit has received the backing of A16Z crypto, Coinbase, Ledger, Bain Capital

Crypto, blockchain capital, and paradigm. Overall, the lawsuit seems tailor-made to be a clean test with a very limited set of facts. The case deals with a yet-to-be-launched exchange, so won't get bogged down with ancillary issues as we've seen in the Coinbase and Binance lawsuits. Ledgelex have loaded up with legal talent, employing former U.S. Solicitor General Paul Clement to head up the litigation. Clement has argued over 100 cases before the Supreme Court. By going on the offensive, Legilex has also been afforded their choice of venue, selecting to run the case in the Fifth Circuit of federal court in Fort Worth. Bill Hughes, a lawyer at Consensus, provided some color on the judge, writing,

The lawsuit will be heard in Fort Worth before Judge Reed O'Connor. As the significant cases section of his Wikipedia page reveals, he does not take kindly to government overreach in any form. But temper yourself, friends, because a pre-enforcement action is a tricky thing to get past the pleadings and through to discovery and a trial. There is a reason you don't see more of these cases. They normally are dismissed for failing to be justiciable. We will need to see how peculiar this case is and how good the plaintiff's lawyers

are, and they are really good by any measure, before the judge would be able procedurally to address the merits of the case." End quote. Interestingly, we've seen the SEC take the same approach to jurisdiction shopping, splitting the Coinbase, Binance, and Cracken lawsuits across circuit courts in New York, D.C., and California, respectively. The speculation at the time was that the SEC hoped to come up with just one favorable verdict between multiple venues, which would be sufficient to chill the industry. By adding another more favorable venue to the mix, this lawsuit could help the crypto industry chalk up a win, or at least prepare a strong case for a Supreme Court appeal. Indeed, it seems likely that one of the thoughts behind the case is that it could be perfect

for putting the major questions doctrine issue before the Supreme Court, due to it being a fairly limited set of facts, which have broad application to the limits of SEC authority. As a refresher, the major questions doctrine suggests that government agencies require Congress to grant them power explicitly. It's a new and still unsettled legal concept, which only applies to regulatory subjects that are of significant economic or political importance. an administrative law assistant professor at Georgia State, and noted anti-crypto commentator, thinks that bringing the major questions doctrine to the Supreme Court is precisely the plan. He wrote,

I expect the Fifth Court to be more amenable to the MQD and other arguments than judges in DC and New York. We are almost guaranteed to get a circuit split over whether crypto assets can ever be securities, and whether the MQD prevents the SEC from regulating crypto. The Fifth Circuit cannot make law with this action for the entire country. With many regulations, once a court chucks a reg, it's remanded for the whole country. With enforcement actions or declaratory judgments like this, it's case by case. Anyway, this lawsuit practically guarantees that the Supreme Court is going to get to decide the issue of crypto, and the issue of crypto is going to help set the boundaries of the MQD, end quote.

Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7, 365, and moves at the speed of real life. Not everyone believes it.

We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and lows of the industry, facing forwards towards progress throughout. And now they're inviting us to see what crypto can be. Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice. Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, PVI, DBA, Crakken. What happens next? Well, as we know, litigation is a lengthy process. The next step, once the SEC

accepts service, is that they'll have 60 days to file a response and most likely a motion to dismiss. They could also ask for more time, which will almost certainly be granted. Either way, the case has now been added to the list of major court actions which could decide the future of crypto industry in the United States. For those of you who are really looking for an analogy to understand what's going on here, in the same way that Prometheum is basically a made-up concept that the SEC is using to try to argue that exchanges can reasonably come in and register, this is sort of the inverse Prometheum. In other words, the crypto industry putting together a hypothetical slash pre-launch exchange to advance its legal arguments. Now, this was not the only SEC news. Coinbase is also taking

on the SEC with a new public comment letter about the ETH-ETF applications. Coinbase has filed a comment urging the SEC to approve the conversion of the Grayscale Ethereum Trust into an ETF. Chief Legal Officer again, Paul Grewell said that across 27 pages with 96 legal citations, Coinbase has provided the quote legal, technical, and economic rationale for approval. He added on Twitter, our letter lays out what anyone knows who's paid even the slightest bit of attention to the subject. ETH is not a security. In fact, before and after the merge, the SEC, the CFTC, and the market have treated ETH not as a security, but as a commodity. Ether's proof of stake has demonstrably strong governance that exhibits robust characteristics

across ownership concentration, consensus, liquidity, and governance, mitigating risks of fraud and manipulation. End quote. Key to Coinbase's letter is a correlation study between the regulated Ethereum futures market on the CME and the underlying spot market. A similar study regarding Bitcoin performed by Bitwise was crucial to providing grayscale, with the legal argument to compel the conversion of GBT into an ETF. If these two Ethereum markets are tightly correlated, the logic is that the futures market would count as a market of sufficient size to prevent manipulation, satisfying the SEC's requirement of an ETF approval. The study found that spot and futures markets for ETH had a 99.3% correlation on an hourly interval and a 96.2% correlation on a five-minute

interval. This is a stronger correlation than the SEC found in their own study of spot and futures markets for Bitcoin. Coinbase wrote in their letter, ETH's market depth, tightness of spreads, and price correlation across spot markets are highly indicative of a market resilient to fraud and manipulation. ETH's notational dollar trading volume is significantly greater than the vast majority of the stocks that comprise the S&P 500. Since the applications for Spot Ethereum ETFs began pouring in late last year, analysts have been claiming that they should be approved using the same logic that was applied to the Bitcoin ETFs. This has, I think, to all of us, felt intuitively true. But with this comment letter,

Coinbase have now provided the comprehensive study that gives the actual correlation data that could force the SEC into approving ETHETFs or form the basis to argue in court that a denial would be arbitrary and capricious. One last SEC story today, the head of the SEC's crypto litigation team has left the agency to join the private sector. Ledon Stewart headed up the specialist litigation division and was an attorney of record on major SEC cases against ripple, Coinbase, and Bitrex. Stewart has joined the law firm Whiteon case as a partner beginning this week. The firm has a high-profile crypto team which has worked on the Celsius and FTX bankruptcies, as well as advising multiple ETF issuers.

Joel Cohen, the head of the firm's white collar practice, said, Lodon is extraordinarily well positioned to counsel crypto industry players and defend them against regulatory or private actions. The crypto industry has come under fire recently for hiring former government employees straight out of their positions, which some lawmakers point to as an egregious example of the revolving door between Washington and the private sector. Stewart addressed these concerns stating, quote, I think it's really important for crypto companies and any companies that are interested

in getting involved in crypto and fintech, whether they be issuers or tech companies or financial institutions, to be able to be advised by people who know how regulators like the SEC think about issues. I actually think it's a really positive thing when people spend time in government and then go back to the private sector, because they can really share expertise and a skill set that the private sector otherwise wouldn't be privy to. For those not watching all that closely, earlier this month, Charles Gasparino of Fox Business had flagged a bunch of departures at the SEC, tweeting, SEC bracing for major exodus among senior enforcement lawyers in its crypto assets and cyber unit, according to officials at major law firms, who have seen several of the resumes.

suggests that the bleed of senior staff under Gary Gensler's controversial leadership of the agency isn't letting up. Stewart then is the first SEC departure to make headlines, but it sounds like she won't be the last. When this news first circulated, it drummed up a lot of controversy. Industry figures debated how former SEC lawyers who have done their best to destroy crypto in the U.S. over recent years should be engaged with. Gabriel Shapiro, the General Counsel at Delphi Labs, was not having it, tweeting, if you're in crypto, don't hire them because, let's face it,

the let me savagely raise the industry, then get a job in it on the pitch that I can prevent companies from the other guys like me routine should not be rewarded. Still many other crypto lawyers were more practical, suggesting that former SEC staff could provide key insight on how to deal with the regulator, and that crypto firms should simply hire the best people for the job. Staying in the swamp for our last story, sources say that the Senate Banking Committee isn't planning to push forward with crypto legislation in the short term. According to Coin desk sources, crypto bills are not gaining enough traction to move through the committee. The major proposals being proposed in the Senate are largely related to crypto anti-money laundering

measures. These are headlined by the Elizabeth Warren proposal to subject a huge portion of crypto infrastructure to the Bank Secrecy Act. Most commentators have called this bill either unworkable or ineffective in carrying out its stated purpose of addressing illicit financing on crypto networks. The anonymous sources said that the committee has no immediate plans to consider the Warren bill or any crypto legislation. Committee Chairman Sherrod Brown had recently stated that he is in talks with various senators to discuss their ideas around illicit finance and crypto, but this new report seems to indicate that those talks have produced relatively little. Brown's office responded to the story by stating that, quote,

he has made clear that cracking down on illicit finance is a priority for this Congress and that he's, quote, continuing to work with the members. The next stage for any of the proposed bills would be a markup session in the committee where the bill's final language and any amendments are finalized. The sources say a markup is not currently on the agenda. Even if Warren's bill was moved through the Senate, it seems unlikely the legislation would survive a House vote. The House Financial Services Committee has held a string of hearings over recent weeks

regarding illicit finance and crypto, one of which featured a senior treasury official confirming that reporting which claim that crypto was used to fund Hamas had vastly overstated the scope of the problem. He added in that hearing, terrorists still prefer to use traditional products and services. These hearings have undermined the credibility of Warren's claims among House Republicans, with Tom Emmer pointedly remarking that, quote, we have senators who are legislating on these false figures. So overall, guys, good news that it doesn't seem like that bill is proceeding, and that is going to do it for today's breakdown. One more big thank you, as always, to my sponsor for today's show Cracken.

Go to crackin.com and see what crypto can be. Until next time, be safe and take care of each other. Peace.