The crypto market seemingly had its comeuppance during 2022, as a prolonged crypto winter crushed asset values, and a number of large exchanges and crypto platforms went kaput, including the collapse of platforms like Celsius and FTX. But perhaps the most consequential change in the crypto industry somewhat flew under the radar: Regulators went on the offensive.
While the government has mostly taken a blithe approach to crypto since the advent of Bitcoin more than a decade ago, the U.S. Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) shifted their stance in a big way in 2022. That came to a head in June when the DOJ filed insider-trading charges against Nathaniel Chastain, a former executive at NFT marketplace OpenSea. The suit alleges that Chastain was caught “using confidential information about what NFTs were going to be featured on OpenSea’s homepage for his personal financial gain.”
A month later, in July, the SEC likewise filed a lawsuit against three people—Ishan Wahi, a former Coinbase employee, his brother Nikhil Wahi, and their friend Sameer Ramani—accusing them of insider trading. The lawsuit alleged that while working at Coinbase, Ishan Wahi tipped off his brother and Ramani with confidential listing announcements over 8 months, which the two used to realize roughly $1.5 million in profits. The DOJ filed parallel charges, and one of the men pled guilty to one count of conspiracy to commit wire fraud in September.
While the lawsuits may seem rather routine to an outside observer, the SEC’s case, specifically, could have a profound and even crippling effect on a $1 trillion global crypto market.
What makes the case remarkable is the fact that the crypto market is and remains outside of the SEC’s legal purview—the agency does not currently regulate it. Though the SEC has provided something of a “road map” for crypto issuers and others in the space in recent years (such as its 2017 DAO report and in its “Munchee” ruling, in which it found that certain digital assets can be or are securities), there are still no hard-and-fast regulatory guidelines to work with.
In short, the lawsuit could settle a key point of disagreement. The SEC is saying that at least some cryptos are securities, and by pursuing charges against individuals for insider trading, it’s making the case that it has the power to regulate them. If it is successful in its prosecutions, too, experts say that the past year’s crypto winter could look more like little more than a snow flurry compared to the potential ice age that could come next.
Far-reaching ramifications
The SEC’s insider-trading suit’s far-ranging potential ramifications boil down to the fact that the regulatory body, currently, does not have vast regulatory powers over the crypto markets. Yet, it is attempting to prosecute individuals for trading what it has determined to be “securities”—specifically, it names nine tokens that the SEC evidently thinks meet the definition of a security in accordance with federal law. Those tokens are Amp, RLY, DDX, XYO, RGT, LCX, POWR, DFX, and KROM, according to the SEC’s filing.
Fast Company reached out to the SEC, but a spokesperson said the agency couldn’t comment on ongoing matters outside of what has been provided in public documents.
But since the SEC does not regulate the crypto markets, and because there currently is no concrete guidance issued to help exchanges and token issuers determine whether certain cryptocurrencies are, in fact, securities, the insider-trading suit appears to be an attempt at a legal run-around to stake a regulatory claim. If, for example, the SEC is ultimately successful in prosecuting the insider-trading suit, such a victory could, by default, hand the agency the regulatory reins over the crypto market.
“That would immediately throw the crypto market into flux; exchanges would need to scramble to figure out what tokens are securities, legal and compliance teams would need to quickly get up to speed . . . and crypto investors might see some of their holdings disappear or collapse in value overnight,” says Benjamin Cole, the William J. Loschert endowed chair of entrepreneurship and professor at Fordham University, as well as a fellow at the British Blockchain Association.
“It could send the industry through the rendering plant,” Cole says, and “it could cripple centralized crypto exchanges.”
There would also be outstanding questions to answer, Cole adds, such as whether previous decisions—for example, when the SEC determined that the two largest cryptocurrencies on the market, Bitcoin and Ether, were not securities—are subject to review. All told, it could throw the entire crypto industry into flux. And while exchanges and adjacent firms attempt to find their footing under new rules and guidelines, the markets could collapse as scared investors head for the hills.
“It paralyzes everything”
Another particularly interesting element in the SEC’s case is the fact that the agency is targeting individuals—not organizations, companies, or exchanges—for transacting unregistered securities. The underlying logic is that if the individual people trading securities were, in fact, trading securities, then wouldn’t the exchanges and platforms they were using to trade them be in legal jeopardy, too?
After the SEC filed insider-trading charges against its former employee, Coinbase did respond immediately with a blog post, written by Paul Grewal, the company’s chief legal officer, called “Coinbase does not list securities. Period.” In that post, Grewal explained that “Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange—a process that the SEC itself has reviewed,” and that rather than hash things out with Coinbase, “the SEC jumped directly to litigation.”
As such, it seems that even Coinbase was surprised at the SEC’s aggressive stance, especially given that Coinbase and many other large U.S.-based exchanges have been effectively begging regulators for some sort of regulatory framework in which they can try to operate. A person familiar with the situation tells Fast Company that most of the large exchanges have worked with government regulatory bodies in the hope of nailing down some guidance, but have yet to receive it. The exchanges, this person says, will “do whatever the SEC says,” if and when guidance is announced or produced through litigation.
And it seems that producing a regulatory framework, or winning jurisdiction over the crypto space through the courts, is the SEC’s aim. “That’s why this is such an interesting case,” says Cole. He adds that regulators are trying to exert some control over the crypto markets, and though Congress and the White House are making some progress in that regard, it’s been slow-moving. As such, the SEC is making moves to try and stake regulatory claims.
That also hasn’t gone unnoticed by other regulatory bodies, such as the Commodity Futures Trading Commission (CFTC), which regulates commodities trading. There’s something of a simmering turf war between the CFTC and SEC over which could ultimately end up regulating cryptocurrencies, and after the SEC filed its insider-trading case against Wahi, Caroline D. Pham, commissioner of the CFTC, tweeted that “the SEC’s allegations could have broad implications beyond this single case,” and that the case itself was “a striking example of ‘regulation by enforcement.’”
But again, Cole notes that the SEC has, so far, only targeted individuals in this case—an unorthodox maneuver. “If you’re trying to get the herd of buffalo to behave in the way you want, a hunter might take aim at the bull or leader of the herd,” Cole says. “Instead, the SEC is going after the antelope that’s grazing alongside the buffalo,” he adds. “It’s fascinating.”
Fascinating, frustrating, and potentially catastrophic for the crypto industry.
“This backdoor approach by the SEC could have broad-ranging consequences for anyone who’s out there, relying to some extent on how the issuer classified their token, and did their own due diligence, but diligence done in a world where the guidance isn’t clear,” says Steven Gatti, a partner in Clifford Chance’s financial services group, who specializes in regulatory enforcement matters before the SEC and other regulators.
“From a token issuer’s perspective, the SEC has sued someone else alleging that ‘your token is a security’ without fully explaining how they arrived at that conclusion,” he says.
“If you’re operating in the space, what do you do? Shut down? File a statement? It paralyzes everything.”
The potential fallout
While it will take some time for the insider-trading cases to work their way through the courts, many in the crypto industry are keeping a close eye on them, while also contending with numerous other threats. That includes the overall downturn in the crypto markets coinciding with a larger pullback in the stock markets, and, of course, the failure and bankruptcies of numerous crypto exchanges and platforms.
Pundits and talking heads have also been urging crypto investors to head for the exits in recent months as well. In all, it’s created a very difficult environment for crypto companies, which face economic and regulatory pressure as well as the possibility that their customers could cash out what’s left of their holdings and move on.
“People will be spooked out, people might pull their money out of exchanges, investors in companies like Coinbase may want to bail, and users may go to decentralized exchanges,” says Cole. “It’s a very tough time to be a centralized exchange, and it’s going to get worse.”
All of that uncertainty is roiling the industry that’s already in legal and regulatory limbo, and it’s unclear when some concrete direction will land to smooth things out. And much of the uncertainty and corresponding damage being done to the crypto markets lands at the feet of SEC chair Gary Gensler, who’s taken a much more antagonistic approach to crypto than his predecessors.
“Gensler has probably been the most aggressive SEC commissioner I’ve ever seen,” says Joshua White, an assistant professor of finance at Vanderbilt University and a former financial economist for the SEC. “Most commissioners want to come in and say they’re the Wall Street cop—they want to crack down on bad actors,” White says. It’s possible that Gensler’s relative aggression has led him to try and “remake the markets” along the way.
White adds that it’s only a matter of time before Congress, the SEC, and other regulatory bodies collide. As mentioned, the Biden administration has already put the wheels in motion in terms of generating a crypto regulatory framework, and Republicans in the House of Representatives have also formed a new subcommittee focused on rule-making for digital assets. But it’s unclear what all of the action on Capitol Hill will ultimately produce.
One thing is clear, though, to White: “When Gensler gets called up to Capitol Hill, he’ll be the smartest person in the room,” he says. That may be why and how Gensler is attempting to outmaneuver other regulatory bodies to stake the SEC’s claim to the crypto space.
And, again, if the SEC does prevail in its insider-trading suit, it’s possible or even probable that the crypto market would find itself under the SEC’s purview almost immediately.
“If the exchanges all of a sudden have legal liability, they’ll need to work with the SEC to fix any problems, and they’ll halt trading on a lot of cryptos to determine if each coin or token are unregistered securities, and that’s going to agitate a lot of users,” Cole says. The issues could cascade from there, he says, with users potentially filing lawsuits, creating more risk and liability. It could, in effect, kneecap an industry that’s already trying to regain its footing after perhaps the roughest year in its short existence.
In the end, though, experts say that the insider-trading problems, the disintegration of large exchanges, and more, prove that the crypto market does need to be regulated, even though the lack of regulation was, and remains, for some part of its appeal. But an apparent power grab by the SEC may do a lot of collateral damage in the meantime.
“I think recent events have clearly demonstrated the need for regulation here, but that doesn’t mean that the SEC can unilaterally define its jurisdiction,” says Gatti. “If Congress wants to change the law to say that the SEC gets to regulate digital assets, they can do that. The SEC doesn’t get to make that decision.”
Update: A quote by Benjamin Cole in the tenth paragraph of this story has been updated with ellipsis for clarity.
Recognize your brand's excellence by applying to this year's Brands That Matters Awards before the early-rate deadline, May 3.
