Legal System and Cryptocurrency: The Increasingly Compliant U.S. Market
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Legal System and Cryptocurrency: The Increasingly Compliant U.S. Market
The path to compliance for cryptocurrencies faces challenges, as U.S. lawmakers and judicial authorities intensified industry regulation in March and April this year.
Navigating Web3 tides with focused insightsBy Michael Hiltzik
Source: Yahoo Finance
The path toward cryptocurrency regulation is facing challenges, as U.S. lawmakers and judicial authorities intensified oversight of the industry in March and April this year.
This is good news for ordinary investors and the broader economy. As previously written, the value of crypto tokens—from Bitcoin to the most farcical versions like Dogecoin—is so nebulous that they’re easily exploited to separate unwary or vulnerable investors from their money.
The term "cryptocurrency" may be relatively new, but the questionable transactions associated with it fit squarely within the framework courts have used for nearly eight decades to identify securities.
Cryptocurrencies can fluctuate wildly in value. They don’t generate income like bonds, nor can their prices be tied to liquid markets like those of publicly traded securities. To date, no one has convincingly explained what cryptocurrencies are actually useful for—except paying ransoms to fraudsters who hijack databases or computer systems.
Recently, Change Healthcare, a healthcare transaction processor under UnitedHealth Group, received a second ransom demand paid in cryptocurrency. The company paid $22 million in ransom to recover information including payment data and medical records of thousands of patients.
The cyberattack on Change Healthcare’s database disrupted healthcare reimbursement payments nationwide, forcing some providers to lay off staff or even shut down completely due to cash flow shortages.
The new ransom demand apparently came from a ransomware group that believed it had been cheated by its partners, who may have fled with the initial ransom payment.
Crypto's Crazy March
Of course, the most dramatic blow came on March 28 with the sentencing of convicted crypto fraudster Sam Bankman-Fried, who was found guilty last October on seven counts of fraud related to the collapse of the FTX cryptocurrency exchange.
Federal Judge Lewis Kaplan sentenced Bankman-Fried to 25 years in prison and ordered the forfeiture of more than $11 billion. Kaplan observed that SBF showed almost no remorse for his crimes. He justified the lengthy sentence by stating that without it, there was “not an insignificant risk” that SBF “could do something very bad in the future.”
But beyond SBF’s sentencing, an even more impactful ruling came just one day earlier when federal Judge Katherine Polk Failla allowed the U.S. Securities and Exchange Commission (SEC) to proceed with its lawsuit accusing Coinbase—the giant crypto broker and exchange—of conducting unlicensed securities trading.
The significance of Failla’s decision lies in her swift rejection of Coinbase’s argument that cryptocurrencies are a new class of assets outside the SEC’s jurisdiction—in short, that they aren’t “securities.”
Crypto promoters have long made the same argument in courtrooms and congressional halls, urging lawmakers to create an entirely new regulatory framework for cryptocurrencies—one that would ideally be looser than the existing rules imposed by the SEC and the Commodity Futures Trading Commission.
Ironically, SBF himself made similar arguments while testifying before congressional committees, where he was once seen as the last seemingly honest crypto advocate—before it emerged that he had illegally misappropriated customer funds to finance his companies.
Judge Failla saw through this argument. “The term ‘cryptocurrency’ may be recent,” she wrote, “but the transactions at issue fit comfortably within the framework courts have used for nearly eighty years to identify securities.”
Failla also delivered a sharp rebuke to the crypto lobby by rejecting Coinbase’s claim that the case should fall under the “major questions doctrine”—an informal principle requiring that regulatory actions with “significant economic and political consequences” must have clear authorization from Congress. Coinbase argued that because Congress hasn’t passed specific crypto legislation, the SEC’s lawsuit should be dismissed.
The judge found this argument deeply unpersuasive. She noted that “while the cryptocurrency industry is undoubtedly large and significant, it is far from constituting a ‘part of the American economy’ with such vast economic and political significance.” Cryptocurrencies simply “cannot be compared to other industries the Supreme Court has deemed to trigger the major questions doctrine,” she wrote—including the U.S. energy sector and the traditional securities industry itself.
Failla’s ruling followed another decision in a New York federal court that treated cryptocurrencies as securities. In that case, Judge Edgardo Ramos refused to dismiss the SEC’s charges against Gemini Trust Co., a crypto trading platform run by Cameron and Tyler Winklevoss, and Genesis Global Capital, a crypto lending firm.
The SEC alleged that Gemini’s program—pooling customers’ crypto assets and lending them to Genesis while promising high returns—constituted an unregistered securities offering. Like the case against Coinbase, the SEC’s action will now move forward.
Both rulings undercut a 2023 decision by New York federal Judge Analisa Torres in the SEC’s enforcement action against Ripple, the developer of the XRP crypto token. Torres ruled that in certain circumstances, the token might not qualify as a security. But her opinion has since been overshadowed by a series of rulings from her peers holding that crypto marketers and exchanges are engaged in unregistered securities trading—which is illegal.
Crypto’s April
The fallout from March carried into April. On April 5, a New York federal jury found Terraform Labs and its CEO and majority shareholder Do Kwon liable in what the SEC called a “massive cryptocurrency fraud.” The case centered on Terraform’s so-called stablecoin UST, a crypto token pegged 1-to-1 to the U.S. dollar. Do Kwon did not appear for the verdict. He remains detained in Montenegro, with U.S. and South Korean authorities vying for his extradition.
Terraform claimed that if the value of the UST coin fell below $1, software algorithms would automatically “self-correct” it. This supposedly happened in May 2021. When the token indeed recovered to $1, Terraform and Kwon boasted that the recovery was a triumph of “human agent decision-making during periods of market volatility,” according to the SEC.
In reality, the algorithm had nothing to do with it. According to trial testimony beginning in late March, Terraform received secret financial support from trading firm Jump Trading, which may have invested tens of millions of dollars propping up UST—and possibly profited over $1 billion from the trades. The SEC said failing to disclose this arrangement violated securities laws.
The SEC also alleges that Kwon and Terraform lied to the public, claiming that Chai, a South Korean financial services firm similar to Venmo, was using Terraform to process transactions—when in fact Chai had stopped using Terraform back in 2020.
These deceptions painted a picture of internal strength at Terraform—but it all unraveled in May 2022, when UST broke its dollar peg again and failed to recover. The SEC says the value of UST effectively collapsed to zero, “erasing over $40 billion in total market value… and sending shockwaves through the crypto asset world.”
Terraform is now bankrupt. No charges have yet been filed against Jump Trading.
Tighter Regulation Ahead?
These developments should give U.S. lawmakers pause about how best to regulate cryptocurrencies. At a hearing held by the Senate Committee on Banking, Housing, and Urban Affairs, committee chair Senator Sherrod Brown warned that cryptocurrencies pose a potential threat to national security.
“Bad actors turn to cryptocurrency not because they saw an ad and believed the hype,” Brown said. “They use it because they know it’s a workaround. They know it’s easier to move money in the shadows without safeguards like know-your-customer rules or suspicious activity reporting. We must ensure crypto platforms follow the same rules as other financial institutions.”
Treasury Deputy Secretary Wally Adeyemo echoed Brown’s concerns, urging Congress to adopt Treasury-proposed reforms to strengthen sanctions against “foreign digital asset providers that facilitate illicit finance.”
Meanwhile, Massachusetts Democratic Senator Elizabeth Warren—the perhaps most uncompromising critic of cryptocurrency on Capitol Hill—targeted stablecoins, warning the House Financial Services Committee against advancing any rules that would “more deeply embed stablecoins into banking.”
She cautioned that given stablecoins and their ilk could “undermine consumer protections and the safety and soundness of the banking system,” any so-called reform “could amplify and entrench these risks rather than mitigate them.”
What drives politicians to champion an asset class that has proven valuable only for enabling fraud or theft? As is often the case, it’s money—the green, foldable kind.
Crypto promoters have ramped up lobbying efforts in Washington. According to data from watchdog Open Secrets, crypto firms spent nearly $20 million on lobbying in the first nine months of 2023 alone.
With renewed pushes for new regulatory approaches—especially by House Republicans—and with this being an election year, even more spending appears imminent. It’s a win-win for politicians and crypto promoters—but potentially a double loss for everyday investors and the overall economy.
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