US government’s crackdown on cryptocurrency akin to a witch-hunt
The collapse of major projects such as LUNA, Three Arrows Capital, and FTX, along with the banking crisis, has made US policies even more stringent. On March 8th, Silvergate Bank unexpectedly announced its cessation of operations and voluntary liquidation of assets. The bank was heavily impacted after FTX, its largest client, filed for bankruptcy in November 2022. According to Silvergate’s Q4 report, the bank suffered a net loss of $1 billion and saw investors withdraw more than $8 billion.
It is possible that the company’s high level of exposure to FTX has somewhat affected user trust and caused the bank run. However, many people point out that Silvergate’s biggest issue was its lack of investment portfolio diversification and insufficient cash reserves. While holding $13.3 billion, the cash in Silvergate’s reserve was only $1.4 billion.
Lawmakers who are “hostile” to crypto, such as Senator Elizabeth Warren, do not seem to think so. “As the bank of choice for crypto, Silvergate Bank’s failure is disappointing but predictable,” she wrote on her personal Twitter page, calling for regulators to enhance measures to prevent crypto risks. A few days later, the US government continued to close down Signature Bank. This made regulators more suspicious of exploiting the banking crisis to tighten the industry. Signature has a diverse deposit portfolio, no collateral loans in crypto, and is rated well-capitalized by the Federal Deposit Insurance Corporation (FDIC).
As the bank of choice for crypto, Silvergate Bank’s failure is disappointing, but predictable. I warned of Silvergate’s risky, if not illegal, activity—and identified severe due diligence failures. Now, customers must be made whole & regulators should step up against crypto risk.
— Elizabeth Warren (@SenWarren) March 8, 2023
The New York State Department of Financial Services (NYDFS) confirmed that the closure of Signature was not related to crypto. They affirmed that the “trust crisis” in the leadership had led NYDFS to make the decision to protect investors’ money. Former Congressman Barney Frank, now a member of Signature’s board of directors, criticized managers for sending an “anti-crypto” message through the bank.
Reuters later reported that the FDIC required any company that acquired Signature to abandon crypto-related business activities. However, the agency denied the report. When Flagstar Bank acquired Signature, they only took over deposits unrelated to crypto (about $38.4 billion) and some loans worth $12.9 billion. Only customers who had opened digital bank accounts were allowed by the FDIC to transfer these assets.
Is the SEC the biggest obstacle for crypto?
While the controversy between FDIC and Signature continues, the cryptocurrency community is no stranger to the US government’s crackdown on crypto. The most prominent case is perhaps the lawsuit between Ripple, the issuer of XRP, and the US Securities and Exchange Commission (SEC) in late 2020. Since then, the SEC has continuously accused a series of crypto tokens of being unregistered securities.
Furthermore, SEC Chairman Gary Gensler has stated that all cryptocurrencies except for Bitcoin are securities. His remarks not only faced opposition from the crypto community but also from another regulatory agency, the Commodity Futures Trading Commission (CFTC). For many years, both agencies have believed that they have the right to become the primary regulatory body for the crypto market and have been fighting in front of the US Congress.
In the meantime, the SEC has been suing almost every crypto project within reach. In just the first three months of 2023, the agency targeted Kraken’s staking service, BUSD stablecoin, Coinbase’s trading platform, and the decentralized autonomous organization Sushi DAO. Despite providing different types of services, these organizations were all cited by the SEC for offering unregistered securities.
So are the SEC’s arguments really accurate? According to Gensler, cryptocurrencies and staking activities meet the conditions of the Howey test. The Securities Act of 1933 defines assets as securities if they meet the following four criteria:
- An investment of money
- In a common enterprise
- With the expectation of profit
- To be derived from the efforts of others
When the SEC accused Ripple, they claimed that the company raised funds through the sale of XRP. In response, Ripple’s lawyers asserted that XRP was not an investment contract because the majority of token transactions occur on a secondary market that is independent of Ripple.
Moreover, XRP holders do not invest in a common enterprise (Ripple) as the profits are generated by many different traders. Regarding the last condition, XRP holders do not profit from Ripple, and “the company has never promised to bring profits to users,” according to Ripple’s response to the SEC.
As for ETH, in the Proof-of-Stake (PoS) model, validators lock a certain amount of coins to strengthen network security. In return, they can receive staking rewards. Some regulators believe that this model meets the Howey test because users invest money in a common enterprise with the goal of making a profit.
In an interview with CNBC on March 23, Ethereum co-founder Joseph Lubin argued that it is not enough to conclude that ETH is a security. Lubin suggested that cryptocurrency should be viewed as a commodity, as many people hold oil with the hope of making a profit, and oil is not considered a security. Additionally, the crypto community argues that staking serves not only to earn rewards but also to contribute to the network’s security.
They also pointed out that there is no centralized organization on Ethereum that controls all of the staked funds. For example, validators can collectively stake 40 ETH in a smart contract, but each person’s funds are stored separately and not affected by whether other validators validate transactions incorrectly or correctly. The rewards they receive, therefore, do not come from the efforts of any issuing organization.
In general, Ethereum and many types of cryptocurrencies are not securities based on the Howey test, a verification method proposed by the SEC. In the hearing on March 20, Ripple was also confident that the victory would tilt in its favor. If that does happen, it would be a victory for Ripple and the entire crypto market in the long-running legal battle. However, difficulties are still likely as the US government has many “strict” regulators for cryptocurrencies other than the SEC.
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