In his most straightforward warning to date, Securities and Exchange Commission (SEC) chair Gary Gensler published a video explaining how crypto exchanges have miscategorized most crypto assets as non-securities.
In addition to failing to register with the SEC, exchanges have failed to disclose risks, segregate customer assets, surveil market misconduct, nor file information necessary for reasonable investment decisions.
Within the four-minute video posted last Thursday, Gensler explained how many crypto exchanges illegally combine the functions of a clearinghouse, broker-dealer, and securities exchange. Investor protection safeguards require these functions to be handled by independent entities in order to avoid conflicts of interest and misconduct incentives.
Despite years of warnings from the SEC, which is tasked with protecting everyday investors, many digital asset exchanges have skipped disclosing information to the public. Gensler noted that failure to register with the SEC accompanies a lack of consumer protections — an unregistered crypto platform such as Celsius, Voyager, or FTX may claim its customers’ deposits are somehow its property upon declaring bankruptcy, for instance.
- Unregistered crypto platforms also publish misleading statements to potential investors and customers.
- The FDIC issued a cease-and-desist letter ordering Voyager Digital to stop falsely claiming its cash deposits were 100% insured.
- Despite its claims to the contrary, the now-defunct crypto broker didn’t safeguard almost any customer cash in FDIC-insured bank accounts.
Decentralization doesn’t make laws disappear
Gensler’s comments also apply to decentralized finance (DeFi) and some non-fungible token (NFT) marketplaces. Many decentralized exchanges (DEXs) list tokens that pass the Howey Test, making them investment contracts. The SEC has already classified dozens of digital asset offerings as securities offerings and warned that thousands of additional, unregistered crypto securities are out there.
Managed NFT collections on some NFT marketplaces might also qualify as securities. In DeFi, many platforms offer classic features of securities exchanges: yields, profit-sharing agreements, broker-dealing, or attractive interest rates on idle deposits.
Gensler’s tweet and video naturally proved unpopular on Crypto Twitter, which supports non-Bitcoin digital assets and generally dislikes the SEC. Commenters accused the SEC of failing to provide a clear path to register or using lawsuits to bankrupt digital asset startups.
“Yet you provide no guidance on how to do that,” one user replied to Gensler’s video. “And everyone who did in good faith has been sued into business failure. You seem to spend more time on Twitter making videos these days instead of doing your job after getting demanded by congress to provide clarity and new rules that make sense for these assets, as demanded by the users of these assets,” they said (their emphasis).
Others alluded to Sam Bankman-Fried’s attempts to court regulators — including the SEC — behind the scenes before FTX’s meltdown. Others complained about the commission’s continued unwillingness to classify the industry’s second-largest coin, Ethereum, in terms of its status as a security.
SEC chair Gary Gensler ramping up crypto enforcement
Recently, the SEC has pursued major enforcement actions against digital asset firms. It filed a case alleging that Ripple and its co-founders raised $1.3 billion in an unregistered securities sale in December 2020. The case is ongoing but both Ripple and the SEC are confident that the presiding judge will make a decision soon — in their favor, of course.
Last November, the SEC extended its all-win track record against crypto in court by gaining a judgment against LBRY, a decentralized content-sharing app that conducted an unregistered securities sale.
The SEC is now threatening to sue Coinbase, the world’s second-largest crypto exchange. Coinbase issued a rebuttal to the SEC’s Wells Notice, which alleged that it operated an unregistered exchange, listed unregistered securities, and offered staking and wallet activity that may qualify as securities activities.
For its part, Coinbase accused Gensler of an “about-face” on the legality of its offerings and refusing to specify which assets are securities. It also says it had been working with the SEC to register.
Securities firms need to fulfil investor protection obligations
Gensler believes that almost every crypto asset is an unregistered security, except for bitcoin and a short list of tokens that have received a no-action letter from the SEC, like TKJ and QUARTERS. It’s worth noting that although he’s chair, SEC determinations are made collectively — he’s just one voter among five commissioners who get a say.
In any case, crypto exchanges and digital asset investment firms that list securities must fulfil their investor protection obligations like any other firm. Many crypto assets, decentralized apps, and NFT marketplaces list securities. Worse, many exchanges illegally commingle clearinghouses, broker-dealers, and securities exchanges within one entity.