Brian Armstrong is wrong: Staking is a security and the U.S. Securities and Exchange Commission (SEC) just proved it. He just misunderstood their position. This is where the lack of understanding of regulations on the crypto side is starting to get concerning. If we saw the same level of ignorance of the law in banking board rooms as we’ve seen with crypto executives, we would be excused for withdrawing most of our money and putting it in a safe.
The Coinbase CEO’s preemptive reaction to the SEC action against rival exchange Kraken's crypto staking shows both a lack of knowledge about what a security is as well as a lack of basic knowledge about when securities laws apply and when they do not. It’s time for crypto executives to stop grandstanding and start getting better, unbiased legal advice.
Timothy Cradle is the director of regulatory affairs at Blockchain Intelligence Group.
Based on the responses from Armstrong and other crypto executives and decision-makers regarding regulations, it is clear many of them do not seem to understand that they are providing regulated services in a non-compliant manner. In the specific case to which Armstrong reacted before the facts were in, the SEC charged Kraken because it was paying interest on deposit accounts. That is a regulated activity that the SEC provides certain exemptions for, e.g., banks don’t have to register with the commission to pay interest on a savings account; it is certainly not the case that crypto companies are exempted from registering for paying interest to depositors just because the deposits are in crypto, as Brian Armstrong seems to assume.
Not only is that not the case, but this is also not the first time the SEC has successfully made this case in the form of an enforcement action. In 2022 BlockFI was fined for providing a similar service – paying interest on deposits – without registering with the commission. Coinbase, itself, received a letter from the SEC warning them away from providing a similar service to BlockFI. So why is it the case that Coinbase’s CEO does not seem to remember this and does not think the rules that apply to other financial services apply to his financial service?
It is either intentional ignorance or literal ignorance. Both are a concern when the future of a multi-billion-dollar financial services company is at stake.
Crypto 'regulation by enforcement' is simply not a thing
The problem is the pernicious concept in crypto that goes under the name “regulation by enforcement.” We need to excise this phrase from crypto, not just because it is imprecise but because it simply is not a thing. Regulators in the U.S. are not creating new rules; they are enforcing existing rules. Perhaps crypto executives need a quick refresher on the law and rule-making process:
1. A bill is proposed
2. The bill goes to committee
3. A bill is voted on
4. The bill is signed into law
5. Regulators write rules to match the intent of the law
6. A comment period is open to the public (no tweets accepted)
7. A final rule is written and published in the Federal Register
There is more nuance to the process, but that is it in a nutshell – it is a multi-year process on average, and that is how regulations are made. Precedent can be set with litigation by the regulators, but again, this action is not rule-making; this is enforcing existing rules.
If regulators have thus far been successful in obtaining enforcements then this should be a huge wake-up call to the crypto industry that financial transactions in crypto conform to regulated financial transactions and, as such, the existing rules apply. If their legal counsel is telling them otherwise, then it is time to get new legal counsel because this is a multi-million dollar lesson that the industry keeps learning and will keep learning until they make a change in strategy. A new lawyer won’t cost as much.
We’re starting to get a growing list of crypto services where one might ask: Is it regulated? And based on the enforcement actions we can say: Yes, unequivocally. Here are some examples:
Staking: Kraken enforcement action 2023
Rewards: BlockFI enforcement action 2021
Lending: Coinbase legal warning from the SEC 2021
Token issuance: Telegram (TON) settlement with the SEC in 2020
Crypto-based derivatives trading: Ooki DAO lawsuit from Commodity Futures Trading Commission 2022
All of these enforcement actions involve regulated activities; and there will be more settlements and enforcement actions to come.
Regulatory clarity is a simple hurdle to clear
Soon we’ll see definitive proof that tokens themselves are unregistered securities when the SEC wins the Ripple case. As if we didn’t already know that via multiple comments from SEC officials.
In the year to come we’ll have more concrete proof that certain crypto services are unregistered futures and derivatives exchanges – based on comments made by CFTC Chair Benham as he ramps up the enforcement division of the commission to set precedents by targeting non-compliant crypto exchanges.
Will it take multiple business failures to convince the crypto industry to mature and take their regulatory reality more seriously in the U.S.? Possibly. What we’ve seen in the past few months from regulators are existential challenges to the crypto industry: The Office of the Comptroller of the Currency and Federal Reserve Board are warning banks away; and Kraken and BlockFI have each received cease-and-desist orders for product lines in the past year. In the past month, we’ve also seen the TZero crypto app (an Overstock product) deciding to discontinue services due to regulatory challenges related to failures in their customer disclosures.
There is one argument in crypto regulation that makes sense: the need for regulatory clarity – though, even this is diminishing with ever more enforcement actions. We may need to trade the bad phrase “regulation by enforcement” for “regulatory clarity by enforcement.” At least the latter is something less difficult to argue against. In other words, why not just continue to ask regulators to state clearly what the rules are instead of begging them to stop suing you?
Regulatory clarity is a simple hurdle to clear. We’ve seen this with money-laundering regulation. In 2019 FinCEN issued FIN-2019-G001, FinCEN’s guidance on the “Application of FinCEN’s Regulations to Certain Business Models Involving Convertible Virtual Currencies.” Since 2019 there has been nothing in the U.S. with the same level of explicit detail stating how rules apply to crypto and under what circumstances. As a result, we see every crypto company, with few exceptions, registered as a money services business and adhering to the five pillars of Bank Secrecy Act (BSA) compliance.
With the SEC and CFTC, where there is no such explicit guidance, we see continued non-registration and consequent enforcement actions, settlements and cease-and-desist orders. There’s a clear causal relationship here between guidance and compliance.
Therefore, it is time for crypto executives and decision makers to think critically about regulations, stop complaining, hire better legal and compliance personnel who will tell them the hard truths (you are regulated, time to register), and have a more productive dialogue with regulators than they’ve had to date.