SEC v. Binance/Coinbase, and Its Aftermath (EN)

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Presto

9 min readJun 19, 2023

“All we have to show is that one of them is a security and that they should be properly registering and having rulebooks against fraud, manipulation as an exchange, broker, and alike… And we’re very confident in this.” — SEC Chair Gary Gensler

On consecutive days in June 2023, the Securities and Exchange Commission (SEC) initiated legal proceedings against two crypto exchanges, Binance and Coinbase, for alleged violations of securities laws. These lawsuits, filed just one day apart, drew attention to the absence of adequate regulatory oversight within established crypto firms and reiterated the SEC’s stance that the majority of crypto assets should be classified as securities. Given that the lawsuits targeted Binance, the world’s largest exchange, and Coinbase, a dominant player in the U.S. market, the impact of this development on the crypto industry is significant. With that in mind, this article aims to explain the specific charges brought forth by the SEC against Binance and Coinbase, examine the SEC’s reasoning behind classifying crypto assets and staking programs as securities, and discuss the potential implications arising from the SEC’s formal complaint.

Timeline

June 5, 2023: SEC files 13 charges against Binance entities and founder Changpeng Zhao
June 6, 2023: SEC sues Coinbase for operating as an unregistered securities exchange, broker, and clearing agency
June 9, 2023: Binance.US will halt dollar deposits as early as 6/13
June 9, 2023: Robinhood announces that crypto assets(ADA, SOL, MATIC) that the SEC identified as securities will be delisted from its platform

Summary of SEC v. Binance & SEC v. Coinbase

This case arises from Defendants’ blatant disregard of the federal securities laws and the investor and market protections these laws provide.

According to the complaint, the SEC alleges that Binance has illicitly encouraged U.S. investors to engage in trading crypto assets on unregistered trading platforms provided by the company. Specifically,

Despite the legal obligation for securities exchanges, broker-dealers, and clearing agencies to acquire licenses for service provision, Binance offered investors a range of services, including BNB/BUSD sales and trading, BNB Vault, Simple Earn, and staking, all in the absence of legitimate licensing credentials
Binance’s parent organizations, BAM Trading and BAM Management, intentionally presented themselves as if they had independent control to avoid regulation when Changpeng Zhao was the one exerting actual control over the operations
Binance bypassed U.S. investors (citing insider sources)
Merit Peak and Sigma Chain, the entities under the ownership of Changpeng Zhao, facilitated unauthorized mixing and misappropriation of customer funds, while also engaging in cross trading activities

Similar to Binance, the SEC states that Coinbase did as follows:

Coinbase disregarded securities regulatory requirements and provided services as an securities exchange, broker-dealer, and clearing agency
Coinbase operated as an unregistered broker through Coinbase Prime and Coinbase Wallet
Despite being well aware of the Howey Test and its regulations concerning securities trading, Coinbase permitted trading on its platform, prioritizing its profit over the interests and protection of investors
Without a doubt, Coinbase’s staking program should be classified as an investment contract/security.

In the complaints, the SEC underscores that Binance and Coinbase have been operating as unregistered securites exchanges, broker-dealers, and clearing agencies. However, what sets these two cases apart is that Binance’s complaint alleges multiple instances of fraud, encompassing issues related to Changpeng Zhao’s improper mingling and misappropriation of customer funds, manipulation of self-dealing transactions and liquidity. On the other hand, Coinbase’s complaint focuses exclusively on securities law violations without fraud allegations and only making a single reference about Coinbase CEO Brian Armstrong.

Why Security?

Crypto Assets (SOL, MATIC, ADA…)

Reasonably to view SOL as an investment in and expect to profit from Solana Labs’ efforts to grow the Solana protocol, which, in turn, would increase the demand for and value of SOL
Reasonably to view ADA as an investment in and expect to profit from the Cardano Foundation’s, IOHK’s, and Emurgo’s efforts to grow the Cardano platform, which, in turn, would increase demand for and value of ADA
Reasonably to expect to profits from Polygon’s efforts to grow the Polygon protocol, which, in turn, would increase the demand for and value of MATIC

The main rationale behind the SEC’s legal action against Binance and Coinbase lies in the SEC’s designation of crypto assets as securities.

In their respective complaints, the SEC extensively discusses a total of 12 crypto assets in Binance’s case and 15 crypto assets in Coinbase’s case, outlining why each of them is deemed a security. The primary focus revolves around determining whether these crypto assets fulfill the requirements laid out in numbers 2 and 4 of the four criteria of the Howey Test (“with an expectation of profits to be derived solely from the efforts of the promoter or a third party”) as discussed in “Is Crypto a Security”. The SEC argues that all the mentioned crypto assets meet these criteria.

According to the SEC, these crypto assets satisfy the Howey Test primarily because the majority of projects actively promoted their competence and technological advantages across various media platforms. Consequently, investors developed an expectation that the utility or value of the tokens would increase as a result. The SEC highlights that most projects conducted initial sales and used Twitter, Medium, and interviews to promote the utilization of funds for project development purposes, further emphasizing the alignment of objectives between the project and its investors. Additionally, the SEC asserts that the promotion of the deflationary token model, whereby tokens are burned to reduce their circulating supply, coupled with references to price and liquidity, fostered investors’ anticipation that the projects’ efforts would enhance the value of their tokens.

Staking Program

THROUGH ITS STAKING PROGRAM, COINBASE HAS ENGAGED IN THE UNREGISTERED OFFER AND SALE OF SECURITIES IN VIOLATION OF SECTION 5 OF THE SECURITIES ACT.

The SEC has accused both exchanges’ staking programs of violating securities laws and presented arguments detailing how these programs meet the four criteria of the Howey Test.

It is an investment of money

Investors transfer stakable assets to Coinbase to participate in the platform’s staking program. During the staking period, Coinbase maintains full control over the staked assets, and investors acknowledge the possibility of losing the assets.

The investment of money is in a common enterprise

Initially, the Coinbase Staking Program combines the assets of both investors and Coinbase for staking purposes. Coinbase oversees the management of all staking programs, including associated wallets, without the obligation to maintain separate individual wallets for each user. Instead, Coinbase and investors’ staked assets are collectively managed within omnibus wallets. Moreover, the success of the platform is closely tied to the investors. Coinbase receives a portion of the staking rewards generated by investors as compensation, which can be adjusted based on company policies.

There is an expectation of profits from the investment and any profit comes from the efforts of a promoter of third party

Coinbase has marketed its staking program as an enticing “investment opportunity” and promoted it across various media platforms, highlighting the potential for investors to earn substantial fixed returns. Coinbase explained its approach, stating, “We use a delegated proof-of-stake model where we stake on behalf of our users directly at the protocol. We handle the complex technical aspects and receive the rewards, paying out a portion to our users while keeping a commission for our services.” The underlying premise is that Coinbase undertakes the complex and technically demanding task of staking on behalf of investors, fostering the expectation that they can benefit from Coinbase’s efforts.

Response from Binance, Coinbase, and Projects

Binance

Binance strongly disagrees with the SEC’s accusations of violating securities laws. Despite making cooperative efforts to address the concerns, Binance claims that the SEC has opted for lawsuits instead of having productive conversations. Mentioning the lack of clear guidance and regulation in the crypto industry, Binance argues that SEC’s actions prioritize control rather than a focus on creating effective policies. Binance points out that BNB is not a security but a token utilized in various projects like gaming and social networks, and also mentions CFTC’s classification of BUSD as a commodity.

Coinbase

Following the SEC’s filing, Coinbase CEO Brian Armstrong took to Twitter, stating that “we are confident in our facts and the law” and noting that the SEC prioritize control over clear regulation. Armstrong underscored that Coinbase’s case is unique, as it focuses on defining securities rather than any illicit conduct on the part of Coinbase. He also discussed the contrasting perspectives of the SEC and CFTC, Coinbase’s commitment to its listing process, and SEC’s approval of Coinbase’s IPO in 2021 following the assessment of its business model.

Solana ($SOL)

The Solana Foundation expressed its disagreement with the categorization of Solana as a security via their statement on Twitter.

Polygon ($MATIC)

Polygon Labs used Twitter to indicate that the development and deployment of the Polygon Network occurred outside of the U.S. They emphasized that $MATIC, an essential component of Polygon’s technology, was not offered within the U.S. and made accessible to users outside the states to ensure network stability.

Cardaono ($ADA)

Cardano founder Charles Hoskinson clarified on Twitter that the Cardano ICO occurred exclusively in Japan and did not involve any American participants. Additionally IOG stated that $ADA “has never been a security under US securities law” and asserted that the lawsuit will not affect the company’s operations.

Implication

$BTC/$ETH vs SEC Tokens

Following the filing of complaints against Binance and Coinbase, the crypto assets identified by the SEC as securities witnessed substantial price declines in comparison to Bitcoin and Ethereum. In response to Robinhood’s trading suspension announcement, $SOL, $ADA, and $MATIC experienced significant drops of over 20% in a single day. Moreover, a majority of the crypto assets mentioned in the SEC’s complaints also faced notable decreases in value.

It is noteworthy that historically, the SEC has maintained a relatively clear position on Bitcoin, considering it as a non-security, while its stance on Ethereum has been less definitive. However, the SEC’s decision to exclude Ethereum from the list of complaints, along with the absence of Proof of Work crypto assets such as $DOGE, $LTC, and $BCH, provides offers some insight into the SEC’s position on crypto assets.

TradFi vs Crypto

Control of the crypto industry could shift to traditional financial institutions. One of the keys to the case is the question of crypto exchanges fulfilling multiple functions, which Gary Gensler pointed out, saying, “In traditional finance, you don’t see the New York Stock Exchange running a hedge fund-raising market.” In response, industry leaders such as Soros Fund CEO Dawn Fitzpatrick have argued that traditional financial firms are expected to take on more responsibilities in the industry, potentially replacing certain functions of crypto exchanges as retail investors trust traditional financial institutions more due to their diligent management of client assets.

US vs non-US

In contrast to the crypto-friendly jurisdictions such as Hong Kong and the UAE, the SEC has adopted a more adversarial stance towards the crypto industry. Notably, Dubai has established itself as a thriving crypto hub, actively seeking to attract global companies like Binance, and Hong Kong has recently expanded its market access to encompass all investors, a departure from its previous restriction to investors holding at least $1 million in assets. Furthermore, in light of the lawsuits filed against Binance and Coinbase by the SEC, Hong Kong has demonstrated its commitment to embracing crypto companies and providing support to all exchanges, thereby expressing its intent to facilitate Coinbase’s operations within its jurisdiction.

Several companies, including a16z, have established offices outside the U.S., while crypto firms with significant US market presence, such as Crypto.com, have ceased business with US institutions. Consequently, trading volume on Binance US has experienced a considerable decline of around 78% following the SEC’s filing, and on-chain data further reveals a decrease in crypto trading volume during US trading hours and a decline in Bitcoin reserves held by US exchanges. Anticipations arise that more crypto companies may depart from the US due to this lawsuit, making it imperative to assess the forthcoming impact on the United States’ position within the crypto industry.

Disclaimer

All content in this article is intended to communicate and provide information and is not intended as the basis for investment decisions or for recommendations or advice for investment. The contents of the text are not responsible in any shape or form including matters that pertain to investment, law, or tax matters