6/6/2023 4:25:00 PM
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A Crypto Exchange Crackdown
The Securities and Exchange Commission filed lawsuits against Binance and Coinbase— two of the biggest crypto exchanges. WSJ’s
Caitlin Ostroff discusses the allegations and the potential impact on the global crypto ecosystem.
Further Reading:
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SEC Says Binance Misused Customer Funds, Ran Illegal Crypto Exchange in U.S.
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SEC Sues Coinbase, Alleges It Is Unregistered Broker
Further Listening:
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The Rise of Binance - And The Effort to Reel It In
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The Charges Against FTX's Sam Bankman-Fried
00:00 / 16:17
FULL TRANSCRIPT
This transcript was prepared by a transcription service. This version may not be in its final form and may be updated.
Kate Linebaugh: Our colleague, Caitlin Ostroff, covers cryptocurrencies. And kind of top line, what happened this week?
Caitlin Ostroff: Oh God, so much. And somehow it's still only Tuesday. So Monday morning is when the Securities and Exchange Commission sued Binance, which is this crypto exchange giant. It's hard to quantify just how much bigger it is than everything else. And then if that weren't enough, we woke up this morning Tuesday and all of a sudden they had also sued Coinbase, which is the biggest US Exchange. So yeah, lots happening on the regulatory front this week. The line that crypto has had for ages is that cryptocurrencies by and large are not within the scope of regulators' purview, that these aren't the same as stocks or bonds and because of that are not within their vehement. Well, the SEC has come out and said, "Well, yes, actually it is."
Kate Linebaugh: Binance has said it will defend itself against litigation and Coinbase accused the SEC of taking an enforcement-only approach. How would you describe this moment for crypto?
Caitlin Ostroff: It feels like all of a sudden the tension has really ratcheted up. We've been kind of in this slow burning move toward regulators cracking down on crypto. And then all of a sudden you have this burst of activity and it feels like crypto is a little bit in a fight for its life, at least in the US.
Kate Linebaugh: Welcome to The Journal, our show about money, business and Power. I'm Kate Linebaugh. It's Tuesday, June 6th. Coming up on the show, the crypto crackdown is here. As its name suggests, the Securities and Exchange Commission regulates securities, things like stocks and bonds, and it's under that mandate that they've been cracking down on cryptocurrency exchanges. So tell us about these two companies, Binance and Coinbase, that the SEC sued this week.
Caitlin Ostroff: Yeah. And they're very, very different companies. So Binance is kind of this global crypto exchange, started in 2017. Part of the ethos of crypto was, We don't have to conform to the rules of traditional finance." And so you had this big falling global company for Binance that was offering trading of almost any cryptocurrency you could think of. They were offering derivatives and you have all of these different instruments they offered. Coinbase took a very different approach, so that was founded in the US. And Coinbase, like Binance, is actually a listed company, so it's listed on the NASDAQ. And so they went through that listing process. They've always said that they try to do things by the book. They've been much slower to list tokens than competitors have in the past, and so you have kind of a very US-focused company on that side that has says it's tried to really engage with regulators.
Kate Linebaugh: What is the SEC alleging about both these exchanges?
Caitlin Ostroff: So for Binance and for Coinbase, they're saying that, "You were a securities exchange and you didn't register." So if a company is a securities exchange, if they're selling securities, they have to go through a really hefty registration course, they have to hire all of these lawyers, they have to go through all of these tests and audits. And essentially, by being a securities exchange that isn't registered, you're kind of operating this illegal black market. You're not allowed to offer all of these things that you were offering for trading and you're basically operating an unregulated form.
Kate Linebaugh: Why wouldn't Binance and Coinbase have registered?
Caitlin Ostroff: I mean, they would argue that they did not think they needed to. Again, the idea within crypto, especially at the time and still now, is that these are not securities. Because they are not offering securities, they are not securities exchanges. All crypto exchanges really say that when they list an asset, they do their own looks and checks to see is this going to be considered by regulators as something that people expected profit out of that it could be a security. But they often complain that there's no explicit guidance from regulators on what crypto coins could be securities versus ones that aren't. And so their argument is that they didn't need to register because they weren't one. The SEC is now kind of going back, looking at things they have listed and saying, "Actually, we do think this was a security and therefore you guys are operating an illegal securities exchange. You should have registered."
Kate Linebaugh: It seems like the SEC's case kind of hinges on the question of what is a security? Is that right?
Caitlin Ostroff: Yeah, I mean, and that's kind of like the series of logic that the SEC has to prove. Their burden of proof for all of these companies is essentially to prove that at least one of the assets it trades constitutes a security.
Kate Linebaugh: There are also additional allegations against Binance and its founder, a man named Changpeng Zhao, who's known widely as CZ. But before we get into those allegations, can you tell us about CZ?
Caitlin Ostroff: Yeah, so CZ presents as this very laid back kind of casual, meek and mild nerd is kind of his public persona. He's kind of adopted this almost cult following on Twitter of people who just absolutely adore him and the exchange that he's built. CZ is finance. There's obviously other key people within the organization, but he's the majority shareholder of almost all of the companies which are web of entities, and he's the one that Malay calls the shots on a lot of the day-to-day operations.
Kate Linebaugh: The SEC's additional allegations against Binance and CZ center on its US business. It alleges that Binance continued to allow US customers to trade on its global exchange even after it set up a US entity four years ago. It also alleges that Binance wasn't transparent about how that exchange was being run. Binance said its US exchange was independent. The SEC alleges it wasn't.
Caitlin Ostroff: In reality, not only was CZ the main shareholder, the 100% shareholder at the beginning, he was also calling the shots on a lot of the setup. He was ordering, set up these companies and he was basically controlling a lot of the operations without users being told that.
Kate Linebaugh: In the words of the SEC Chairman, Gary Gensler, CZ and Binance entities quote, engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law. The SEC also is alleging that Binance may have misused customer money. The regulator says some customer funds may have been used to buy an $11 million yacht. The regulator says US funds were transferred to another bank account owned by an entity controlled by CZ. Money from that account was then used to buy the yacht.
Caitlin Ostroff: And so the SEC is flagging that and they're saying that, "You shouldn't be buying a yacht from a bank account that has touched US customer funds." And so that's one of the concerns.
Kate Linebaugh: And how have Binance and CZ responded to all these allegations?
Caitlin Ostroff: They've said that no funds were ever co-mingled, user funds were never at risk, and they have denied that vehemently. They've also said that they were disappointed because they were expecting to settle with the SEC rather than have this come out as a lawsuit. And so clearly, that settlement didn't wind up happening. But certainly, Binance has said that they intend to fight this and that much of the allegations are not true.
Kate Linebaugh: As for Coinbase, the company said that quote, it has a demonstrated commitment to compliance and that the absence of clear rules for clear crypto has hurt the company. Both Binance and Coinbase said that they will continue to operate. These companies have both been around for years. Why is the SEC going after them now?
Caitlin Ostroff: It's kind of a million dollar question, and this is why a lot of people think it is a response to the collapse of FTX.
Kate Linebaugh: FTX, the crypto exchange that imploded last fall.
Caitlin Ostroff: They think regulators are over-correcting basically for having let FTX get big enough to cause some amount of damage to retail investors and institutional investors and that they're trying to make up for that lost time.
Kate Linebaugh: Others have pointed out that the SEC's investigation into Binance predates FTX's collapse. The SEC started looking into Binance in 2020.
Caitlin Ostroff: But a lot of people are kind of sitting there and going, "Well, why now? Why all of a sudden are these enforcements coming out and coming out back-to-back?"
Kate Linebaugh: Coming up, what these back-to-back lawsuits could mean for crypto. If the SEC were to win these cases, how big of a deal would it be for Binance and Coinbase?
Caitlin Ostroff: It would be massive. I mean, if they end it with Binance having to admit wrongdoing or agree to stop operations in the US as the SE saw it in its complaint and other kind of monitoring that it called for, I mean, that would be a huge blow for Binance. I highly doubt it would be enough to really cause serious damage to the company long-term. But certainly in the US, I think people are expecting it could mean the end of their US operations and kind of a retrenchment from the American market.
Kate Linebaugh: What has the impact been of these cases so far on Binance and Coinbase?
Caitlin Ostroff: So to some degree, we've seen outflows from both exchanges. Traders have taken some funds off of it and you've seen fewer people wanting to trade, and so there's been kind of bigger price fluctuations in different coins over the last 24 hours. And so it's one of those things where you're kind of seeing a little bit of a pullback by some people. But again, no one's kind of fleeing completely from these exchanges. I think a lot of people expect them to fight this, and they don't expect there to be kind of any immediate determination on the health of either Binance or Coinbase in the near future.
Kate Linebaugh: Part of that calculation is based on how long these cases can take to resolve, especially if the companies don't settle.
Caitlin Ostroff: It seems likely that both these cases are going to wind up in court, and that means years worth of litigation. There's another big cryptocurrency lawsuit that the SEC had a few years ago, and that's still playing out.
Kate Linebaugh: What are you looking for next?
Caitlin Ostroff: I'm hoping I get a morning where there isn't a massive handout from the SEC and really trying to figure out who benefits from all of this. Because all of that money, any money getting pulled, is going to go somewhere. And so we're trying to figure out how crypto is reorganizing after this. Will companies actually be leaving the US? Will traders just be going to different US exchanges and what happens from here?
Kate Linebaugh: Could there be more SEC cases coming?
Caitlin Ostroff: I mean, certainly. The SEC up until now, weirdly enough, has primarily gone against really small no name companies in crypto. This is interesting in part because this is one of the rare circumstances where the SEC is coming out against really big companies in crypto. I think a lot of crypto companies are also trying to push for actual legislation in Congress out of this and saying, "The SEC is on a rampage. We only need to have actual legislation," and so maybe we see more efforts in Washington on that side. And then on top of that, you also have the US presidential elections starting to kick into gear, and it's been interesting that we've seen statements from Robert Kennedy Jr., and even DeSantis, on crypto and Bitcoin, and I think that's something that we're watching is to see where crypto puts its money behind some of those potential candidates. I mean, when the administration changes, the entire approach to crypto could also change.
Kate Linebaugh: Could these cases challenge that ethos that you mentioned, where crypto believes it doesn't have to conform to the rules?
Caitlin Ostroff: Yes, especially in the US, I think that will happen. One way or another, it's going to create a blueprint for how crypto companies have to function. Or it could be that the crypto companies are successful and they say, "Well, actually, no, crypto doesn't fall into any of these regulations." And so I think one way or another, this will wind up shaping how crypto companies operate. And so it will be potentially much more of ad hoc approach where it depends on where they're offering services.
Kate Linebaugh: What could this mean kind of more broadly for the overall crypto ecosystem?
Caitlin Ostroff: I think it will probably be a setback, especially if any of these cases are successful. And certainly, we saw crypto prices fall Monday as a result of all of this. I think people have bins skittish on crypto for a bit. They'll continue to be, especially with the regulatory uncertainty. But at the end of the day, one of the things that surprised me in covering this for the last couple of years is honestly just how resilient crypto has been and how resilient Binance has been. And it's one of those things where no amount of bad news seems to actually bother a lot of the diehard supporters of these coins. And so you might see more institutions leave potentially, but I think at the end of the day, you're still going to get some amount of people who want to trade crypto and accept whatever risks come with that.
Kate Linebaugh: That's all for today, Tuesday, June 6th. The journal is a co-production of Gimlet and the Wall Street Journal, additional reporting in today's episode by Dave Michaels and Patricia Kowsmann Thanks for listening. See you tomorrow.
If you have access to WSJ there is an audio version of this. The link was fussy about copying
