The Breakdown - The SEC Finally Picks a Fight With Someone Who Can Fight Back

Episode Date: March 24, 2023

Gary Gensler just doesn't stop. This week we’ve seen actions against Justin Sun, SushiSwap and now Coinbase. NLW covers the latest Wells Notice from the SEC and why Coinbase might prove a tougher opponent than what Gensler is used to.  “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Kevin Dietsch/Staff/Getty Images, modified by CoinDesk.  Join the discussion at discord.gg/VrKRrfKCz8. Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com.  

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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 CoinDes. What's going on, guys? It is Thursday, March 23rd, and today we are discussing why the SEC has finally picked a fight with someone who can fight back. Before we dive 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.ly slash breakdown pod. All right, guys, well, what I've learned this week

is that I cannot leave my house. The last time I left, FTX collapsed, the entire industry hollowed out. So much of what we've been living through now happened when I was gone, and this time, gone for just a couple of days. The SEC's Gary Gensler has decided to absolutely carpet bomb the industry with enforcement actions.

That's, of course, on top of the White House releasing their most antagonistic crypto report ever, and Elizabeth Warren deciding that proof of reserve audits are the next target for her bottomless ire. I haven't even had a chance to catch up on the macro and Powell's rate hike and presentation, but for now we're talking crypto. I'm coming to you from a hotel room, and let's start with the great big deal. Yesterday on Wednesday, Coinbase disclosed that they had received a well-zeant. notice from the SEC, warning that they may be in violation of securities laws in the operation of their exchange and staking services. Now, you've probably heard me talk about Wells Notices

before. They are provided to alert affirm that the SEC has concluded an investigation and intends to proceed with an enforcement action. Wells Notices do not include the particulars of the alleged securities violation, but Coinbase stated in a disclosure filing that, per conversations with the SEC staff, quote, the company believes these potential enforcement actions would relate to aspects of the company's spot market, staking service, Coinbase Earn, Coinbase Prime, and Coinbase wallet. Now, Coinbase is no stranger to battles with the SEC. They have been publicly critical of the SEC for their lack of willingness to productively engage when they've tried to seek clarification. One individual familiar with the situation told CoinDesk that Coinbase

had engaged in over 60 different discussions with the SEC on topics ranging from registration and listing of digital assets to appropriate market structure, but claimed the SEC had basically declined to offer any advice or answers to questions. Coinbase's criticism of the SEC reached its previous peak in July of last year, when the firm petitioned the regulator asking for clear rulemaking around a securities definition for digital assets. SEC Chair Gary Gensler has said for his part on multiple occasions that he believes that crypto exchanges, including Coinbase, are operating as unregistered securities exchanges, and that he considers the vast majority of crypto assets to be securities. His commentary has been dismissive of the need for additional clarity, despite the fact

that numerous other jurisdictions have provided clear regulatory frameworks. Instead, Gensler has claimed that the rules are clear and that crypto firms simply need to, quote, come in and register. The Coinbase case basically shows just how BS that phrase is. Coinbase chief legal officer Paul Gruel released a blog post claiming that, quote, we asked the SEC for reasonable crypto rules for Americans, we got legal threats instead. Gruel pushed on several key points. First, before Coinbase went public in April 2021, they were required to present their business model to the SEC for approval to be listed. And guess what?

No objections were raised at the time. Coinbase had actively engaged with the SEC to work on a pathway for registration at the regulator's request because, quote, there is no existing way for a crypto exchange to register. The exchange presented two alternative proposals, spending millions on legal advice and getting zero, zero feedback from the SEC. Gruel also claims that none of the assets listed on Coinbase nor their staking product are securities offerings. Coinbase has an established internal process for evaluating crypto assets against the Howie Test and rejects 90% of the assets that they review. He noted that in communication

with the SEC surrounding the issue of the Wells notice, quote, we asked the SEC specifically to identify which assets on our platform they believe may be securities, and they declined to do so. Indeed, there are a number of pretty astounding points from Grewell's thread and blog post. Tell us the rules and we will follow them, he writes. The SEC will not let crypto companies come in and register. We tried. We are confident in the legality of our assets and services and if needed. We welcome a legal process to provide the clarity we have been advocating for and to demonstrate that the SEC simply has not been fair or reasonable when it comes to its engagement on digital assets. Now, as a recent breakdown guest, Austin Campbell said, people who are trying to do the right

things simply do not say this publicly about a regulator unless privately they have already decided to declare war in response to an action. Coinbase CEO, Brian Armstrong, also wrote a thread outlining many of the same points. He hammered the inconsistency of the SEC given that Coinbase had gone public. Two years ago, Brian writes, the SEC reviewed our business in detail and approved Coinbase to go public. Our S1 clearly explained our asset listing process and included 57 references to staking. Coinbase runs a rigorous asset review process and has rejected more than 90% of assets that have applied to be listed on the platform. Now, when someone asked Brian to explain all of this in football terms, he dropped a pretty singularly perfect tweet.

Brian writes, imagine you've got both football and soccer refs on the field. But we're actually playing pickleball, the fastest growing new sport in America. The refs can't really agree on the rules of this new game, and one of them decides to change a call they made back in April 2021. Now, ultimately, Brian explained why these sort of legal issues around crypto just have to end up in front of a court. While we understand that this is all part of the journey to reforming our financial system, we are right on the law, confident in the facts, and welcome the opportunity for Coinbase and, by extension the broader crypto community to get before a court. We are proud to stand up for our customers and the industry in these moments. Going forward, the legal process will provide an open and

public forum before an unbiased body, where we will be able to make clear for all to see that the SEC simply has not been fair, reasonable, or even demonstrated a seriousness of purpose when it comes to its engagement on digital assets. Now, the crypto industry's reaction was about what you would expect. Some were surprised and some were angry but not surprised. The blockchain Association's Jake Trevinsky says Coinbase has spent an extraordinary amount of time and resources working in good faith to seek regulatory clarity from the SEC. The idea that they'd be rewarded with nothing but a well's notice is sad, but not surprising, from an agency best known for regulating by enforcement. Thankfully, Coinbase is ready to fight and in a strong position to do so successfully

as a matter of law. Remember, the SEC doesn't make the law, it only makes allegations, which ultimately must be tested in the courts. Often, as here, the SEC is wrong. David Marcus, formerly of Meta, now the CEO of Light Spark, writes, from the very beginning, Brian Armstrong made the decision that Coinbase should play by the rules, engage with regulators and lawmakers, and behave like a responsible actor in what used to be a nascent industry. We should be proud of this exact kind of U.S.-born responsible innovation and leadership, but instead, such companies that play by the rules are treated far worse than ones that operate full-on fraudulent operations. What kind of an incentive system is this?

A16 Z's Chris Dixon says since day one, Coinbase has heavily invested in being fully compliant with U.S. law, even when it forced them to move slower or lose a competitive edge versus other exchanges that chose to take shortcuts. The U.S. has a strong history of fostering innovation, and regulators have played a key role in establishing clear rules and pursuing bad actors. We hope the U.S. will take a more constructive approach to collaborating with innovators while protecting consumers. That, my friend, is about the end of the diplomatic commentary. Others are, I think, quite reasonably, a bit more fed up. James Murphy at Met a Lawman says, I just read the full statement from Coinbase's top lawyer about the Wells notice from the SEC. The things

that immediately jumps out is this. Coinbase, very reasonably, asked the SEC staff to tell them which specific tokens the SEC contends our securities. The SEC refused to tell them. This, my friends, is absolutely nuts. The entire point of the Wells notice process is to allow the defendant a chance to prepare a written rebuttal to the charges against them and hopefully head off a meritless lawsuit. But the SEC has refused to tell Coinbase what tokens they claim are securities. How do you rebut that? This is literally the plot of Franz Kafka's book, The Trial. This is why this just come in and register phrase is bull-h-it. An American company tries to get clarity on the rules, do everything by the book,

and the SEC provides no clarity and just legal threats. Brian Quintends, a former CFTC commissioner now at A16Z, says, Wells notices are intended to afford targets an opportunity to defend themselves in writing to the full commission before charges are filed. The vagueness of this notice deprives Coinbase of that opportunity and lacks due process. Custodia Banks, Caitlin Long, says it should be crystal clear by now that the Biden administration wants all crypto, even the legal parts of it, run out of the U.S. See also yesterday's White House Economic Report, which dunked on all financial

innovation while espousing the quote-unquote stability of traditional banks. So, my friends, the question is this, is there anything, anything at all that is redemptive about this? The good news is that I think there is. Let's actually look at the second part of that same tweet from Caitlin Long. She writes, got to be honest, as someone who hasn't been afraid to call balls and strikes, If any of this SEC action predates Coinbase's IPO, then the SEC stepped in it. The SEC's remit is investor protection. How did it protect investors to let a company IPO if it was violating securities laws? Now, as for me, I am completely and utterly convinced that the courts are our last best hope.

The U.S. government has three branches. The executive has clearly turned against us, or at least, the voices within the administration that are antagonistic are currently carrying the day. When it comes to the legislative branch, it is currently structurally, incapable of getting anything done because of partisan divides. That leaves us with the judicial system. And indeed, the judicial system is the only place where we've seen any sort of pushback against the overreach of the SEC. The judge in the Voyager case, for example, overruled the SEC in their objections to Binance U.S. acquiring Voyager's assets. And remember, it was because the SEC was

trying to say that there were unregistered securities involved, but wouldn't tell the judge which assets were unregistered securities, or more importantly, why. That case is ongoing, but the judge's frustration with it was encouraging. Join CoinDesk's Consensus 2023, the most important conversation in crypto and Web3, happening April 26th 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, founders, and more. Use code Breakdown to get 15% off your paths. visit consensus.com or check the link in the show notes. Over in SEC lawsuit land, meanwhile, Grayscale's first hearing in their suit against the SEC around the agency denying a proposal to convert the Grayscale Bitcoin Trust into a Bitcoin spot ETF was definitely points in favor of the good guys. The panel of judges, which included one Republican and two Democrats, seemed inclined to agree with the plaintiff that there was a pretty gaping logical inconsistency

in approving Bitcoin futures ETFs that use the same price indices as proposed spot ETFs, while saying that spot ETFs weren't approved for concerns over price manipulation. The lead counsel for the SEC was apparently at times visibly flustered during that hearing. All of this is to say that Coinbase is very unlikely to go down without putting up a hell of a fight. Scott Melker writes Coinbase is going to bury the SEC in court. They have the war chest and facts on their side. A judicial system has been dunking on the SEC in every available situation. And yet, I do think there is still reason to be concerned. Bill Hughes, a lawyer at Consensus writes, this Coinbase lawsuit will take forever, especially if there are facts to fight over,

and oh boy, believe me, CB will find some. 90% chance it goes up on appeal, however, it plays out at the trial court level. Gary is gone in two years max. He doesn't care. The lawsuit is the goal. Now, Laura Shin asked for clarification. Wait, the goal for who, she says, for Gary or for Coinbase? Bill Hughes says, Gary. This would likely last years. It's existential for Coinbase and I expect them to fight to the bone as they should for everyone's good. Now, ultimately, I agree with Apiacus. He wrote, reminder, a couple weeks ago, the SEC got picked apart by Grayscale's attorneys and an appellate panel in the D.C. Circuit. You can bet that Coinbase is set to do the

same in the coming months and years. Those two firms, whatever you think of them, are now the torchbearers of stopping the death of crypto in the U.S. You can also take heart from Attorney Collins Belton, who writes, the more I think about this, the more hyped I'm getting. Kind of like my Super Bowl. So many legal theories I wanted to see put to a judicial test finally about to have their day. I don't think there's a better centralized entity to have to take up this fight, to be honest, and this comes at a good time for the industry, the more I think about it. I get that some people will be skittish, but now there's a real chance of having concreteness in the U.S. in two to three years. So there you have it, guys. One of the big points of discussion after the New York

Attorney General's lawsuit against Ku-coin that alleged that ETH was a security was why not just go after Coinbase? Well, it seems like the SEC is willing to take up that fight. The difference, as Colin points out, and as many have pointed out, is that Coinbase can actually fight back. Now, this is obviously the biggest deal, but it's far from the only thing that has happened over the last couple days. Also on Wednesday, the SEC sued Tron founder Justin's son, and I have to say this was met with less consternation than the Coinbase complaint. The allegations are lengthy and include fraud, market manipulation, as well as selling unregistered securities. Also listed as defendants in the lawsuit are eight celebrities who are alleged to have

promoted Tron and BitTorrent tokens without disclosing compensation. This includes the Z. Lohan, Jake Paul, Soldier Boy, and Little Yadi, among others. The allegations around the tokens being unregistered securities use the typical arguments we've seen in previous ICO cases, that the tokens were promoted as investments and that Sun's team would be relied on to produce investment returns. Indeed, perhaps the only notable thing about this section is how much focus is placed on Sun's posting style, which was, they say, blatantly designed to pump the tokens. The SEC even repeated their recent argument that the use of the rocket ship emoji can be used to imply investment returns. Taking a similar approach to recent cases we've seen, the SEC

seems to be taking this opportunity to introduce novel allegations in a case that appears unlikely to see the inside of a courtroom anytime soon. On the fraud and market manipulation side of the lawsuit, the SEC claims that Sun systematically washed traded Tron by having his employees, quote, engage in more than 600,000 wash trades of TRX between two crypto-asset trading platform accounts he controlled. The activity is alleged to have required between 4.5 and 7.4 million Tron tokens to be washed traded daily during 2018 and early 2019. Son is also alleged to have cashed out more than 31 million in Tron tokens in undisclosed secondary market sales during this period.

Like I said, I have a lot less commentary from the crypto industry on this one than I did on the Coinbase charges, largely because this has been anticipated for quite some time. Now, there is still a ton to get through. We haven't had a chance to talk about that White House report yet, which I'm sure we're going to. However, just before recording, there was some late breaking news. We got a tweet from Philippe Adzich, the Minister of Interior of Montenegro. Now, if you've been paying close attention, Doe Kwan from UST and Luna,

has been widely rumored to be floating around somewhere in the Balkans, Serbia, Montenegro, Kosovo, etc. Philippe Adzich, again, the Minister of the Interior of Montenegro tweets, and this is a translation, one of the world's most wanted fugitives arrested in Podgrizia. The Montenegrin police have detained an individual suspected of being one of the world's most wanted fugitives, a South Korean citizen named Doe Kwan, co-founder and CEO of Terraform Labs based in Singapore.

The former king of cryptocurrencies, responsible for losses exceeding $40 billion, was apprehended at the Podgrutia Airport with forged documents. South Korea, the United States, and Singapore are all seeking his extradition. We are waiting for official confirmation of his identity. Well, just eight minutes ago, DB or Tier 10K on Twitter, shared a Korean news article where Korean officials have confirmed that it was in fact Do Kwan who was arrested in Montenegro.

Obviously, this is going to just be the beginning of the legal process around Doquan. As you can see from that first tweet, there is serious jurisdictional competition around who gets to deal with him. But for now, another huge moment in crypto history, one which we will, I'm sure, come back to soon. Anyways, for now, I've learned my lesson. I promise I will not leave my house anymore. And we will all have a much simpler life for it.

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