The Breakdown - With Congress Impotent, Courts Are the Only Option for Fighting SEC Overreach

Episode Date: March 4, 2023

Today on “The Breakdown,” NLW discusses Silvergate, a scathing open letter from three U.S. senators to Binance and whether courts can stop an overreaching Securities and Exchange Commission. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   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 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: Malte Mueller/ 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.

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's Friday, March 3rd, and today we are talking about why courts and the legal system might be the best way to fight SEC overreach. 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 conference. 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, jam-packed end of the week. First of all, a quick follow-up on Silvergate. Obviously, they were the main character of yesterday's show, and what started as a trickle of

crypto companies leaving the bank has now turned into a flood. By Thursday, the list of companies that had cut ties with Silvergate included Coinbase, Circle, Paxos, Crypto.com, BitStamp, LedgerX, CBOE Digital Markets, Galaxy Digital and Gemini. Silvergate's share price dived about 58% dropping to an all-time low. For those who haven't listened to that show, Silvergate had announced on Wednesday that it would be delaying filing its 10K annual report, and the notice of delay stated that the bank was answering questions from its auditors and accountants, needed to assess the impact of ongoing regulatory and DOJ scrutiny and needed to reconsider its ability to, quote, continue as a going concern.

It's assumed that Cracken is the only major crypto exchange continuing to use Silvergate, having cut ties with crypto banking rival signature bank on Wednesday, although Cracken have not commented on whether they still have significant business with Silvergate or not. Now, one of the other subplots of the Silvergate revelations was speculation around the status of micro-strategy's $205 million-b Bitcoin-backed loan from the bank. Some breathless short-sellers have speculated that the loan might be called in if Silvergate declares bankruptcy, catalyzing a micro strategy margin called that some have been speculating about since the beginning of the spare market.

Micro Strategy calmed this speculation on Thursday afternoon, tweeting, We have a loan from Silvergate not due until Q1.25. There are market concerns regarding Silvergate's financial condition. For anyone wondering, the loan wouldn't accelerate because of Silvergate insolvency or bankruptcy. Our Bitcoin collateral isn't custodied with Silvergate, and we have no other financial relationship with Silvergate. It's worth noting that Silvergate's send leverage product which granted the loan to micro strategy uses Fidelity and Coinbase as their custodial partners. Now, there are just a ton of

rumors floating around about Silvergate right now. I've read rumors that the FDIC is seizing them. I've seen rumors of a bailout from Citadel or some other bank. And for now, I'd take any scoops or breaking news tweets with a huge grain of salt and skepticism. When it comes to the crypto community, the takes are firmly split into two camps. On the one end are those who are incredulous. Former BitMex CEO Arthur Hayes says Silvergate must be run by the biggest bunch of Muppets ever. Step 1, take U.S.D deposits from crypto firms and pay no interest. Step 2, by three-month U.S. Treasury bonds, yielding 4.78% percent. Step 3, assume 10 billion of deposits make $478 million in a year.

That's all you have to do. To this, Dylan LeClair responded, the peak of their deposits was during a zero-interest rate period, so they reached for yield in long-duration paper. As depositors fled, they were forced to realize losses in liquidate. Would have been a different story if rates were at 4 to 5% in 2021. How press writes, Silvergate is likely going bankrupt. However, this bankruptcy is not due to crypto. It's due to bad banking practices.

There are also multiple other options for crypto firms and most have already moved to signature. The media and regulators will try to pin this as another crypto issue. We have to push back when they do. Now, on the other end of the spectrum were those who were just bummed out about this. Crypto lawyer Haley Lennon writes, The Silvergate Bank News is a bummer. Silvergate Bank was a pioneer for this industry when banks wouldn't touch crypto companies. Mikey Polito from Blockworks writes lots of dunking on Silvergate from the cheap seats right now.

Maybe the criticisms are fair. Maybe the Twitter armchair experts don't have all the information. Either way, they were one of the first banks to take a big bet on crypto. They have my respect. Compounds Robert Leshner writes, rooting for Silvergate. You don't want to see the pro-crypto banks fail. Now, this will probably come as no shock to you guys, but I tend to think that both of these perspectives could be true simultaneously.

Whatever comes next, we'll be able to better understand how much of Silvergate's troubles were them being caught up in the challenges of the industry versus were self-inflicted wounds. At the same time, even if they were total Muppets, to use Arthur's words, it is undeniably problematic that the industry is being systematically cut off from banking access. Masari's Ryan Selkis wrote, there are tens of thousands of Americans working full-time in crypto who have willed a trillion-dollar industry into existence in the past decade with zero government or institutional support. Anyone celebrating choke point 2.0 does not believe in the Constitution. And yet it definitely feels like there's a bit of news tightening happening right now.

Or perhaps a better way to put it is that you can almost feel the excitement of crypto's opponents in Washington. Take this, for example. Three U.S. senators have written a scathing letter to Binance, demanding details about its money laundering controls, and accusing the exchange of being a, quote, hotbed of illegal financial activity. The letter penned by Senators Elizabeth Warren, Chris Van Hollen, and Roger Marshall, claimed that the exchange had, quote, facilitated over 10 billion in payments to criminals and sanctions evaders. The letter addresses both Binance U.S. and Binance International as well as other affiliated companies. There is a lot in this letter. I mean, the thing is eight pages long. They accuse Binance of trying

to evade U.S. regulators. They discuss a lack of transparency, basically saying that Binance's opaque corporate structure was meant to, quote, purposefully evade regulators. They also accused Binance of facilitating money laundering and sanctions evasion. And just to give a taste of the way that this letter is phrased, they're not accusing CZ of being lax or loose with his practices. they literally write, quote, it appears that money laundering is central to Binance's business strategy. Riddled throughout the letter are tons of accusations that Binance is basically just another FTX. They say that CZ's, quote, assertion that Binance U.S. is fully independent is eerily similar to claim Sam Bankman-Fried made regarding the distinction between FTCS and FTCS.

Claims that appear to be false, given that FTXUS is filed for bankruptcy, its users have lost access to their funds, and its new CEO has declared that it is, in fact, insolvent. The senators conclude by requesting details of the company's balance sheets, internal procedures, and any communication about alleged efforts by CZ to limit compliance. Dirty Bubble Media writes, this letter sent by Senators Elizabeth Warren, Van Hollen, and Marshall to Binance and Binance U.S. is absolutely devastating. They're flat out accusing Binance of fraud and money laundering.

This is not good for CZ. Bitfinex agreed saying this is nuclear. Cryptodamus says, seems like the suckers at Binance U.S. are getting set up to be the fall guys. Now, CZ, for his part, said it was just more fud. And some others pointed out questions of the authority of these folks to even request this info. Patrick Tan, whose general counsel at Chain Argos, writes, Did Senator Warren and friends finally discover the legal domicile of Binance? Or is this like one of those letters to Santa where every kid just writes North Pole?

You can't really think of Binance as a legal entity with a domicile and a regulatory jurisdiction. It's just a state of mind. It's a feeling we all have inside of us. It's a higher level of consciousness. close your eyes and you will become one with Binance. Base Carbon writes, I miss the vibe from last bear market, Nero's zero regulatory fud. CZ would log on and make announcements like, happy to announce finance has incorporated with a new HQ in Malta,

well technically in a new micronation that we founded inside Malta, and we'd all act like that was normal. So what do I make of all of this? I think people are correct to say that this is some of the most visceral language we've yet seen from this sort of letter. But I think people are also right to question the authority of these senators. As for me, I basically think it's all political bullshit. Ratcheted up political bullshit for sure, but political bullshit nonetheless.

Why? Well, ultimately what this letter is is a grandstanding reprinting of a bunch of Reuters pieces from the last six months with some colorful language in between. What it is not is an indictment from the Department of Justice. And until we see that, this is just posturing. It is posturing for these politicians, and obviously, and especially Elizabeth Warren, to position themselves to be the main characters in which, whatever actual legal process there might or might not be. That doesn't mean that everything contained here in is dismissible fud. It could be that DOJ charges are coming. I'm just saying that as of right now,

Elizabeth Warren saying the same things that Reuters said just more loudly and angrily doesn't make them actually any closer to a DOJ action. Zooming out, I don't know how it all plays out for Binance. I think my base case right now is that Binance U.S.'s days are probably numbered. It feels fairly likely to me from where we are now that at some point in, call it the next six months, We get a tweet from CZ that basically says, you know what, screw the U.S. We're out. I mean, NXO effectively said this when they announced their settlement with the SEC, that all of this just isn't worth it and the rest of the world is big. Not to mention, other jurisdictions are courting.

Europe is actually getting its crap together and some common sense and clear regulations. And I think it's extremely notable that China seems to be giving its tacit approval to a slight loosening of crypto restrictions in Hong Kong. It wouldn't at all surprise me if that's something of a nod to geostrategic realignment. Join CoinDesk's Consensus 20203, 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,

founders, and more. Use code breakdown to get 15% off your paths. Visit Consensus.com. or check the link in the show notes. Anyways, bringing it back to Binance and then being likely to leave U.S. shores. This morning, CZ retweeted a piece about Binance U.S.'s attempt to buy bankrupt Voyager's assets and said, maybe we should pull out? We're still in support of the deal in helping return funds to users as quickly as possible, if allowed to do so.

So what's going on there? Well, the judge hearing the Voyager bankruptcy case yesterday said he was, quote, absolutely shocked by the SEC's objection to Voyagers' deal with Binance U.S. to conclude the bankruptcy. The Voyager deal has battled through rounds of objections over recent months. Initially, the Justice Department's representative, the U.S. trustee, objected on grounds that Binance U.S. may not have sufficient funds to close the deal, while the Office of Foreign Assets Control scrutinized the deal due to Binance's offshore ties. The latest objections, though, came last week from the SEC and the New York Department of Financial Services and New York Attorney General,

and came after 97% of creditors approved the deal. The SEC objected on the grounds that the billion-dollar deal should be blocked because Voyager could not guarantee that the associated sale of assets would not violate securities laws. In particular, the SEC suggested that Voyager's native token was a security, albeit without providing any analysis or precedent. At a hearing on Thursday, the judge addressed counsel for the SEC saying, You come here and tell me that I should stop everybody in their tracks because you might have an issue? It's kind of a weird objection. The judge's main complaint was that the SEC had asked Voyager to prove a negative with little guidance from the regulator. That is, the SEC declined to provide

rulemaking or a lawsuit proving that Voyager's token was a security, instead asking Voyager to prove that it was not. The judge continued, quote, I get the feeling that this objection has been made as a kind of cover, so you can say later that C, we raise these issues. You haven't really, you have done nothing. I need to know specifics. Council for the SEC suggested that creditors had not been sufficiently warned of regulatory risks, but declined to take a definitive position on whether the Voyager token was a security. Counsel for Voyager, meanwhile, reported to the court that the finance U.S. deal could see creditors recover 73% of their claims, an upward revision due to recent improvements in crypto markets. Jack Schickler, a regulatory reporter for CoinDesk said,

The SECs kindly stop all crypto until we figure out what our job is, Spiel. Spiel got extremely short shrift from a judge today. At Jammers 2012 says there comes a day when because I said so just doesn't cut it anymore. Today is that day for the SEC. Judge Wiles is pushing back hard on the SEC who are attempting to further punish Voyager creditors just because they weren't warned of risks. James Murphy at Met a lawman writes, regardless of the merits of the proposed plan to sell Voyager assets to finance US,

it is refreshing to see a judge who gets it. Now, of course, the question becomes, is there anyone in Congress who will actually step in and stop a rogue SEC? Two Republican lawmakers have recently written to assorted government agencies question the accounting treatment of custody crypto assets specifically when it comes to bankruptcy.

The two Republicans are Representative Patrick McHenry, the Chairman of the House Financial Services Committee, and Senator Cynthia Lummis, who co-authored the Responsible Financial Innovation Act last year with Senator Kirsten Gillibrand. These Republicans have asked several banking agencies how they're dealing with a controversial bulletin from the SEC last year, which directed firms to hold customer assets on their own balance sheets. The bulletin in question is Staff Accounting Bulletin 121. It was published by the SEC in April last year, and according to the letter from McHenry and Lummis, the bulletin, quote, upends decades of precedent regarding the accounting treatment of

custodial assets for banks, credit unions, and other regulated financial institutions. End quote. This has a particularly concerning effect for banks, which are required to hold adequate reserve capital to offset their liabilities, effectively requiring them to hold their customers' crypto assets and then double up with additional bank capital and reserve. The letter claims this bulletin would effectively, quote, deny millions of Americans access to safe and secure custodial arrangement for digital assets. when instead the lawmakers say, quote, we should be encouraging prudentially regulated financial institutions like banks and credit unions to provide digital asset services precisely because they are subject to the highest standards of capital, liquidity, recovery, and resolution, custody, cybersecurity, and risk management.

This issue came to a head recently during the Celsius bankruptcy, where deposited customer assets were ruled to be the property of the Celsius bankruptcy estate, rather than allowing customers to retain ownership. This ruling, quote, classified all Celsius customers as unsecured creditors and therefore at the back of the line to recover their assets, highlighting the legal risk of effectively forcing customer custodial assets to be placed on balance sheets. The letter also attempted to discover whether the bank regulators had interactions with the SEC informing this policy and if they view the SEC's position as in conflict with their own policies. Head Chair Jerome Powell said last year that the central bank was evaluating the SEC's directive, which he noted changes longstanding practice that customer assets would be kept off of a

financial firm's balance sheet. And as an indication of how these lawmakers view the action of Gary Gensler's SEC, the letter said this bulletin, quote, places customer assets at greater risk of loss if a custodian becomes insolvent or enters receivership, violating the SEC's fundamental mission to protect customers. Now, overall, I think it's pretty noteworthy that we've reached the point where McHenry and Lemus are just directly saying that the SEC is ignoring its mandate to protect customers. But candidly, I'd like to see, to quote Toby Keith, a little less talk, and a little less talk, and a lot more action here. So will Congress step up? I do not know. But at least some of these battles are coming to the courts. I guess that's the best we can hope for right now.

Anyways, guys, I hope you're heading off into a wonderful weekend. As always, I appreciate you listening. Until tomorrow, be safe and take care of each other. Peace.