After the heavy regulation, how can cryptocurrency exchanges move towards compliance?

How can crypto exchanges comply with regulations after heavy regulation?

Author: Preston Byrne, partner of Brown Rudnick and lawyer of the Digital Commerce Department

Translation: BlockingBitpushNews Mary Liu


I was collectively criticized by the crypto community for questioning the legality of selling cryptocurrencies in the United States, especially during the period when I was pursuing a law degree in 2017. I wrote many articles at that time, and I had a lot of free time and freedom to write.

Unlike the latest group of critics of cryptocurrency, such as former government lawyer John Reed Stark (he seems to enjoy criticizing this industry when the market is low), when cryptocurrencies were not yet familiar to the public and were very niche, I played the role of a “critic”. For example, in an article on CoinTelegraph on July 9, 2014, “Reducing Legal Risks of Issuing Securities on Cryptographic Ledger”, I said, “[Almost] no one is doing things right. So far, I have not seen a structured cryptocurrency security.”

Joel Dietz and SwarmFund

At that time, people thought I was crazy, and others may have thought I was just a pure sprayer. The truth may be somewhere in between. Of course, please remember that in 2014, the idea of ​​”initial coin offering” (ICO) did not exist; entrepreneurs such as Joel Dietz marketed his “Swarm” crowdfunding token as “cryptographic equity”, which was coldly received by more complex projects such as Ethereum. One month after I was quoted in the CoinTelegraph article, Ethereum conducted an ICO. But even so, it was not called an ICO. According to any advice his lawyer gave to Joe Lubin, it was “cryptographic fuel sold for the Ethereum network”, or as described by the New York Attorney General’s Office in the lawsuit against KuCoin, it was a security.

Ethereum subsequently exploded in 2017, followed by a thousand imitators and other similar simulated projects, and US regulatory agencies responded slowly.

Bill Hinman

SEC Director Bill Hinman at the time gave his famous “Hinman Speech”, which added fuel to the ICO craze, proposing that (now disgraced) “full decentralization” be excluded from the Howey Test. This made venture capitalists generally assume: they have successfully convinced the SEC office that Ethereum is the next Internet, and the best way for the government is to let go and let Ethereum prove it.

It can be said with certainty that Ethereum has not solved many of the scaling problems necessary to become the next internet in five years. Given these broken promises, it is not surprising that the New York Attorney General’s Office has brought a lawsuit against KuCoin.

Chaotic and Strange Enforcement Cases

The events that followed Bill Hinman’s speech can only be described as chaotic. Prior to Hinman’s speech, the SEC had only cracked down on cryptocurrency businesses in obvious and notorious fraud cases.

The first case I remember was SEC vs. Trendon Shavers and Bitcoin Savings and Trust (a Ponzi scheme), and SEC vs. GAW Miners, Joshua Homero Garza, and others (another Ponzi scheme involving the sale of “mining contracts” and a $20 stablecoin called “Blockingycoin”).

In terms of non-fraud enforcement, just a few months after Hinman’s speech was published, the SEC began announcing its first batch of enforcement actions involving multiple token-related projects in settlement form. On November 8, 2018, the SEC announced the first such settlement with EtherDelta, the founder of an early decentralized exchange or “DEX.” The SEC claimed that EtherDelta was operating an unregistered exchange, implying that the SEC believed that some assets on EtherDelta – namely ether and ERC20s – were securities. Ten days later, the SEC announced its first settlements with two ICO projects, Airfox and Blockingragon; both defendants agreed to register their tokens as securities (which as far as I know did not happen).

A series of strange settlements followed over the next year, which failed to stop further ICOs and a series of strange transactions as project teams attempted to comply with Bill Hinman’s release of non-binding guidance in their own way.

For example, EOS advertised its product on a giant billboard in Times Square during the 2017 Consensus conference and raised over $4 billion in cryptocurrency (at the time’s valuation), but was somehow allowed to settle with the SEC for $24 million – without even registering!

Other projects were not so lucky. Kik Interactive, Telegram, and Ripple Labs launched massive ICOs; Kik and Telegram did very poorly in federal court, and I don’t think Ripple has a chance. Similarly, as far as I know, LBRY, a much smaller project that predates EOS by a few years in New Hampshire, did not settle with the SEC or allow its business to continue; the only logical reason I can find for this is that the SEC’s Boston office was short on cash, and in New England, New Hampshire is the only place you can find a cryptocurrency startup.

Not Surprising

This reminds us of Coinbase’s lawsuit which no lawyer practicing in the United States after 2018 would find surprising. The lawsuit lists many regulations, with the SEC alleging that Coinbase violated the registration requirements of the Securities Act of 1933 with respect to its custody of equity issuances.

It also accuses Coinbase of violating the registration requirements of the Exchange Act, which requires anyone engaging in securities transactions to register and be subject to commission oversight. In addition, Coinbase is charged with operating as an unregistered broker-dealer and unregistered clearing agency, acting as an “intermediary in payments or deliveries, or both, in connection with securities or transactions related thereto, or providing facilities for comparing data with respect to securities settlement terms.”

This article will not detail the sections on broker-dealer registration requirements or provide detailed Howey analysis of the many tokens mentioned in the complaint, including Solana, ADA, Matic, Filecoin, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, DASH and NEXO. The focus here is that as a remedy, the SEC is seeking a permanent injunction to prevent Coinbase from operating an unlicensed exchange. If they can catch any one token and win in litigation, Coinbase’s core business may be completely shut down.

What Now?

Then the question turns to what happens next, cryptocurrency is not going away, and I believe the answer is “new exchanges that do not bear all these regulatory burdens.” Here are some of my current thoughts:

  • There may be no better time than today (except for 2012) to launch a cryptocurrency exchange. Perhaps for the first time since the birth of Bitcoin, the compliance cost is lower than the non-compliance cost. Existing industry giants have a lot of legal and technical debt to deal with, which will distract their attention and cost a lot of money.

  • Cryptocurrency is not going away. In its fastest-growing markets, especially in Latin America and Africa, there is neither political will nor unified enforcement capacity to shut it down.

  • Let companies like Coinbase treat crypto tokens as old-fashioned securities, just as we regulate space Starlink like we regulate road traffic. Similarly, it is unrealistic to expect the US government to let crypto develop freely, and American crypto giants lobbying and compromising will push the US down a middle path, which will make crypto business more standardized in the next five years (perhaps sooner).

  • Successful companies will have growth strategies that do not include the United States and then need to be prepared to move to the United States when the regulations are favorable. Or, in other words, they need to develop a subsidiary that operates like INX and obtain the appropriate regulatory approval. I doubt that regulations will ultimately be relaxed so that companies like INX can operate like today’s Coinbase and Gemini. To achieve scale, startups need to establish a foothold in countries with large numbers of English-speaking crypto users that do not prohibit ICOs and allow exchanges to conduct spot-crypto trading without being regulated as broker-dealers or clearing agencies.

  • The only G20 country I can think of that meets these criteria is the United Kingdom. The UK should be used as a starting point for entering the African and Indian markets with English language while American lobbyists work together to (possibly) change the US government’s attitude towards crypto.

So. Cryptocurrencies have not disappeared, they just need some legitimate adjustments, and may the best and most compliant startups win.


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