The High-Stakes Clash Between Crypto and Regulators

By Mark Pearce

“Know thy self, know thy enemy” advised Sun Tzu and 2,500 years later many in crypto would do well to take heed of this advice.  At least in the court of social media, the SEC (U.S. Securities and Exchange Commission) is often portrayed as the enemy with ‘experts’ constantly posting warnings that the SEC will come and get you.  It is, of course, not just the SEC but traditional regulatory bodies in many jurisdictions across the world that are trying to impose their will on the crypto world.  However, the SEC has been especially vocal in its efforts to bring crypto within its regulatory remit.  This article will consider some of the powers and restrictions the SEC has and what actions they have taken to date.

The SEC is, in its own words, “to protect investors, maintain fair, orderly and efficient markets; and facilitate capital formation.”  With “broad authority over all aspects of the securities industry” the SEC wants to protect investors from unscrupulous investment offerings, which is a noble aim.  However, unlike Team America’s World Police, this American institution is limited both in terms of location and remit, oh and they are not puppets either.

Are crypto tokens securities? Often the first question asked for any project, there is a tension between the legal concept of a security and the SECs interpretation of security.  However, even looking at the broad test that the US applies to define “securities” following Howey, the SEC has conceded that Bitcoin is not a security.  The SEC also suffered a partial loss in its case against Ripple with the judge ruling that Ripple’s XRP token was not a security where it was sold on a digital asset exchange.  It is worth noting though that where the XRP token was offered directly to institutional investors and hedge funds then the XRP token could qualify as a security.  There was an even more embarrassing episode in the SEC’s case against Digital Licensing Inc (known as DEBT Box) where the federal judge ruled the SEC’s conduct, “constitutes a gross abuse of the power entrusted to it by Congress and substantially undermined the integrity of these proceedings and the judicial process.”

The recent confirmation that the SEC has issued a Wells Notice against Uniswap further underscores SECs relentless attack on the crypto world.  Uniswap has, it says, “processed $2 trillion in transactions without a hack.  It is integrated into thousands of applications built by teams around the world and is the most copied open-source smart contract protocol, replicated over 2,000 times.”  It is also the largest use case of Ethereal using 25% of Ethereum’s blockspace.   So, while the crypto world clearly knows that the SEC might well be its enemy, it is not as clear that the SEC knows crypto.

This uncertainty is not a surprise given that the US Securities Act is nearly a century old and Howey was decided in 1946.  This is representative of most of the rest of the world where either there is no legislation that can apply to crypto assets or, such as in the UK, the authorities put out hastily compiled guidance where even they conclude, “none of the statutory rules in the Capital Gains Act 1992 apply”.  While some jurisdictions are pushing themselves forward as crypto-centres, it is probably fair to say that no country has complete legislation on crypto, its regulation, tax status etc.

The SEC is a US entity and its remit is limited to US related activities.  This is one of the reasons why many crypto-related products specifically exclude US persons from participating.  Of course, in the digital world it is relatively straightforward to hide where you may be physically located, which is why there has been a rise in requirements for stricter enforcement of user identification checks on major exchanges.

Regulation and oversight is not only needed but welcomed by many in the crypto world but it cannot be done by existing entities that are not fit for the purpose.  Outside of the rugs and scams, there are major issues that need addressing with the processes adopted by exchanges.  In February the owners of BitForex were suspected of illegally withdrawing $56.5m.  More recently, Federal prosecutors have charged KuCoin and its founders of failure to adhere to anti-money laundering laws allowing “billions of dollars in illicit funds to be transferred since its founding in 2017.”  These are, of course, sensational headlines but are equally still a major concern for traditional banks.  In 2021 HSBC was fined £64m for anti-money laundering failings while Natwest was fined £265m for failing to prevent a firm laundering over £400m.,

The EU already passed the Markets in Crypto Assets (“MiCA”) regulations in 2023 and has now taken the step of requiring crypto asset service providers to collect certain information about transactions including the identity of the sender and receiver.  This flies in the face of one of the purposes of crypto, which is to allow pseudonymous transfers of assets without ‘big brother’ oversight.  It’s interesting to note that the new EU legislation is not due to come into force until 2027; three years is a lifetime in the crypto world and who knows what processes and protocols will be in place by then.  

Perhaps it is worth remembering the dystopian mantra from Orwell's 1984, “War is Peace, Freedom is Slavery, Ignorance is Strength”.  If the historic regulators of the TradFi world such as HMRC, the SEC, the EU etc continue to impose regulation, levy charges and give unsupported guidance in ignorance, or perhaps fear, of the crypto communities then their very efforts to bring peace and harmony to the crypto world will likely result in a protracted war with both sides arguing they are fighting for freedom.  As the CEO of Uniswap, Hayden Adams wrote, “Rather than working to create clear, informed rules, the SEC has decided to focus on attacking long-time good actors”. These do not sound like overtures of peace but rather trenches being dug for a long, protected struggle.