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What investors want to know about the SEC's crypto crackdown

The Securities and Exchange Commission cracked down on the biggest names in the cryptocurrency world last week.

First it accused the world’s largest crypto exchange, Binance (BUSD-USD), of violating securities laws, mishandling customer funds, inflating trading volumes and misleading investors.

One day later it sued the largest US crypto exchange, Coinbase (COIN), for allegedly ignoring requirements to register with the SEC.

What does all of this mean for the industry, crypto stocks and digital currencies?

Investors have a lot of questions. Yahoo Finance asked experts for some answers.

Is this an existential threat?

One legal expert said the two new lawsuits pose existential threats to Binance and Coinbase even though the cases are civil and not criminal.

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"These, obviously, are pretty much life-and-death stakes for these companies,” University of Kentucky securities law professor Alan Kluegel said.

That’s because the SEC holds wide authority within American financial markets to shut down trading firms and exchanges, reverse the unlawful sale of unregistered securities to the public and suspend or permanently bar actors from the industry, Kluegel said.

If the SEC is successful in its actions against either platform, it can also force them to either stop trading crypto on behalf of American consumers or to set up as registered exchanges and broker-dealers.

Brian Armstrong, CEO and Co-Founder, Coinbase, speaks during the Milken Institute Global Conference on May 2, 2022 in Beverly Hills, California. (Photo by Patrick T. FALLON / AFP) (Photo by PATRICK T. FALLON/AFP via Getty Images)
Brian Armstrong, CEO of Coinbase. (Photo by Patrick T. FALLON / AFP) (Photo by PATRICK T. FALLON/AFP via Getty Images) (PATRICK T. FALLON via Getty Images)

Ratings agency Moody’s Investors Service on Thursday changed its outlook on Coinbase from stable to negative, citing "the uncertain magnitude of impact the SEC’s charges will have on Coinbase’s business model and cash flows."

There will be an early test this week of how serious the SEC’s case is for Binance. The regulator has already asked a federal court to freeze the assets of Binance’s US entity Binance.US, and a hearing is scheduled for Monday on that request.

Binance.US said in a Thursday tweet that it was stopping US dollar deposits and that users would soon not be able to withdraw dollars from the exchange. It intends to change to a "crypto-only exchange."

Lisbon , Portugal - 2 November 2022; Changpeng Zhao, Co-Founder & CEO, Binance, at Media Village during day one of Web Summit 2022 at the Altice Arena in Lisbon, Portugal. (Photo By Ben McShane/Sportsfile for Web Summit via Getty Images)
Changpeng Zhao, CEO of Binance. (Photo By Ben McShane/Sportsfile for Web Summit via Getty Images) (Ben McShane via Getty Images)

It’s likely that these two lawsuits will take years to reach a resolution.

There is, however, an older case that could help set a precedent much sooner. The SEC filed a lawsuit in 2020 against a startup company called Ripple, alleging the sale of its XRP token represented an unregistered securities offering. XRP is now the world’s sixth-largest cryptocurrency.

"I don't think that this SEC under this leadership necessarily cares whether they win or lose in the courts," Ripple’s chief legal officer Stuart Alderoty said at the Piper Sandler Global Exchange & Fintech Conference on Wednesday. "I think what they are engaging in is a coordinated campaign to essentially destroy the crypto economy in the United States."

Cathie Wood, CEO of Ark Invest, speaks during a panel discussion at the Bitcoin Conference, Thursday, April 7, 2022, in Miami Beach, Fla. Thousands of cryptocurrency enthusiasts are gathering in Miami as the city builds its reputation as one of the key locations to develop the blockchain technology despite its underdog status. (AP Photo/Rebecca Blackwell)
Cathie Wood, CEO of Ark Invest. (AP Photo/Rebecca Blackwell) (ASSOCIATED PRESS)

One investor, Cathie Wood, doesn’t appear worried about the potential impact on Coinbase. Her flagship fund, the ARK Innovation ETF (ARKK), bought more than 400,000 shares of Coinbase on Tuesday after the exchange had been sued by the SEC. She has been a longtime proponent of crypto.

The scrutiny of Binance was "a good thing longer term for Coinbase," she told Bloomberg.

Will Congress write new rules?

The good news for investors, perhaps, is that these legal battles could help establish how, and whether, cryptocurrencies are regulated in the US.

"We've needed regulatory clarity in the United States for many years now," Moffett Nathanson Partner Lisa Ellis told Yahoo Finance Live.

One key area of debate in Washington is whether certain digital currencies are securities or commodities and therefore fall under the oversight of the SEC or the Commodities Futures Trading Commission.

"The digital asset regulatory environment in the United States is opaque," said Daniel Stabile, co-chair of Winston & Strawn’s digital asset practice group. "At this point, the best solution is for Congress to sort out the regulatory morass."

Earlier this month House Financial Services Committee Chair Patrick McHenry (R-NC) and House Agriculture Committee Chair Glenn Thompson (R-PA) unveiled a draft discussion bill as a possible framework to regulate cryptocurrency.

Rep. Patrick McHenry, R-N.C., chairman of the House Financial Services Committee speaks during a news conference on Capitol Hill in Washington, Tuesday, May 30, 2023. (AP Photo/Jose Luis Magana)
Rep. Patrick McHenry, R-NC, chairman of the House Financial Services Committee. (AP Photo/Jose Luis Magana) (ASSOCIATED PRESS)

The draft bill aims to create clarity around gaps between the rules of the CFTC and the SEC. It also tries to direct what firms need to do to register with the SEC and requires the SEC to write new rules that are customized to govern crypto.

The House Financial Services Committee is also working on a new bill pertaining to stablecoins, which are cryptocurrencies linked to a currency like the US dollar. A new discussion bill quietly put out Thursday night incorporates some concerns from Democrats.

In the Senate, Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) are planning this month to reintroduce sprawling crypto legislation after making some changes to it following the 2022 meltdown of crypto exchange FTX.

"There is some semblance of a bipartisan consensus in favor of regulating crypto, and most people feel the collapse of FTX was a wake up call about the urgent need to regulate a status quo that is dangerously deregulated," said House Rep. Ritchie Torres, a Democrat who serves on the House Financial Services Committee.

Who is safe from the SEC's dragnet?

There are thousands of cryptocurrencies. The SEC considers some of these assets to be securities, and therefore under its oversight. That belief is central to its cases against Coinbase and Binance.

The SEC alleged last week that 13 crypto assets available to Coinbase customers were “crypto asset securities” that should have been registered, including Solana’s SOL token, Cardano’s ADA token and Polygon’s MATIC token. It said Binance had been offering 12 coins without registering them as securities.

If the courts uphold the SEC’s arguments, a number of digital currencies may not be able to trade on exchanges.

One prominent online brokerage is already responding to the SEC’s actions. Robinhood Markets (HOOD) on Friday announced it would no longer allow trading of SOL, ADA or MATIC as of June 27. Robinhood currently allows trading in 15 crypto currencies, including bitcoin (BTC), ether (ETH) and dogecoin (DOGE).

The values of SOL, ADA and MATIC slid by double-digit percentages Saturday, a sign of nervousness among investors. Bitcoin was also down Saturday, as was ether.

The SEC could also still go after other crypto exchanges that allowed investors to trade the tokens at issue.

Some exchanges have already been a target of the SEC. US crypto currency exchange Kraken paid $30 million in fines to settle SEC charges in February, for allegedly violating securities rules by failing to register its crypto asset staking program.

One exchange based in Singapore, Crytpo.com, said Friday that it would shut down its institutional exchange service for US customers due to "limited demand" in "the current market landscape." It was unclear if the move was at all related to the SEC's campaign.

There is one big exception to the SEC’s securities dragnet: bitcoin, the world's largest cryptocurrency.

"The SEC has been extremely clear. Bitcoin is not a security," Steven Lubka, managing director of Swan Bitcoin, told Yahoo Finance. "We’re very, very confident that never changes."

Securities and Exchange Commission (SEC) Chair Gary Gensler testifies during a House Financial Services Committee hearing on oversight of the SEC, Tuesday, April 18, 2023, on Capitol Hill in Washington. (AP Photo/Jacquelyn Martin)
Securities and Exchange Commission Chair Gary Gensler. (AP Photo/Jacquelyn Martin) (ASSOCIATED PRESS)

The Howey Test

The SEC's framework for evaluating digital assets as securities relies on the so-called Howey Test. This test has its origins in a 1946 Supreme Court case dealing with tracts of Florida orange groves sold by W.J. Howey Co. and leased back to the company.

The Supreme Court labeled these leaseback deals as investment contracts, meaning they needed to be registered with the SEC. It also defined what constituted a security: "an investment of money in a common enterprise with profits to come solely from the efforts of others."

The SEC still uses that measure today. Bitcoin, its defenders say, doesn't meet that test because it was created by anonymous software developer Satoshi Nakamoto in January 2009 as an open-source concept.

SEC Chair Gary Gensler as well as former Chair Jay Clayton have indicated in numerous public comments they do not believe bitcoin is a security.

"It's not," Gensler reiterated on Wednesday.

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