Myth of Money: The CFTC / SEC Tug Of War
Welcome to this week’s edition of Myth of Money, a weekly newsletter on the digital asset markets read by 12,000+ investors.
Disclaimer: The following is not intended as investment advice. Do your research.
According to Fortune Magazine:
The Securities and Exchange Commission charged on Thursday a former Coinbase product manager and two associates with securities fraud.
The trio had allegedly made off with over $1 million in illicit profits based on sensitive and confidential corporate information. Two of them have been arrested—one while he was attempting to leave the country—and are now held in U.S. law enforcement custody.
There’s just one problem.
Coinbase says the men could not have possibly committed securities fraud, because Coinbase doesn’t even offer clients the ability to trade securities. More to the point, the Justice Department and the Commodity Futures Trading Commission appear to think so as well, the crypto exchange claims.
“The DOJ reviewed the same facts and chose not to file securities fraud charges against those involved. As CFTC Commissioner Caroline Pham stated, this is a ‘striking example of regulation by enforcement’ by the SEC,” wrote the company’s chief legal officer, Paul Grewal in a post published on Friday entitled “Coinbase does not list securities. End of Story”.
The case, SEC vs Wahi, is shaping up into a regulatory tug-of-war pitting the CFTC against the SEC, and reopens the debate over which regulatory bucket a digital coin or token falls into and which U.S. agency will win the high-profile task of providing oversight.
So who is in charge here? The CFTC or the SEC?
U.S. regulators’ imposition of sensible regulation on digital assets is essential for the longevity of digital assets. Although new legislation may prove necessary in the future, regulators must begin using their existing statutory authorities to address many of the harms that digital assets cause.
Because digital assets have largely been unregulated, their prices are frequently manipulated, market participants are too often defrauded or simply exploited, assets are stolen outright, and taxes owed are often not reported, let alone paid.
The Security and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Financial Crimes Enforcement Network (FinCEN), the federal banking regulators, and the Federal Trade Commission all have potential jurisdiction and roles to play in regulating the digital asset markets.
Today, the digital asset markets look very similar to the capital markets of the 1920s, with rampant speculation, market manipulation, deception, and out-and-out theft.
In the lead-up to the Great Depression, the capital markets of the Roaring ‘20s were far from functional, experiencing “excessive and unrestrained speculation,” “false, inaccurate, or incomplete information,” ”market manipulation, and “negligent and fraudulent practices”. When the speculative bubble burst, it significantly harmed the real economy, resulting in an unemployment rate above 25 percent.
SEC Oversight of Digital Assets
In response to the Great Depression, Congress charged the SEC with regulating the nation’s capital markets and securities industry, providing it jurisdiction over both the offering of securities—including stocks, bonds, investment contracts, notes, and derivatives based on securities—and anyone who issues securities, as well as securities brokers and dealers, securities exchanges, and companies that invest in securities.
Courts use two primary tests to determine whether financial assets qualify as securities under the securities laws: the Howey Test and the Reves Test. Many, though not all, digital assets appear to meet both the Howey and Reves tests. As William Hinman, former SEC director of corporation finance, acknowledged: “Promoters, in order to raise money to develop networks on which digital assets will operate, often sell [digital assets] rather than sell shares, issue notes or obtain bank financing.”
Currently, SEC Chair Gensler appears to be exploring whether more digital assets should be deemed securities, as well as whether more participants in the digital asset industry should be subject to SEC oversight.
CFTC Oversight of Virtual Currencies
According to "The CFTC's role in monitoring virtual currencies," the commission and federal courts have found that virtual currencies are commodities under the CEA. While its regulatory oversight authority over commodity cash markets is limited, the CFTC maintains general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity in interstate commerce.
The Commission has not formally defined virtual currency via regulation. The Commission, however, adopted a broad definition of the term “virtual currency” for purposes of its March 2020 Final Interpretive Guidance for Retail Commodity Transactions Involving Certain Digital Assets.
In the context of that interpretation, virtual currency was referenced as:
a digital asset that encompasses any digital representation of value or unit of account that is or can be used as a form of currency (i.e., transferred from one party to another as a medium of exchange);
may be manifested through units, tokens, or coins, among other things; and
may be distributed by way of digital “smart contracts,” among other structures.
However, the Commission noted that it did not intend to create a bright line definition given the evolving nature of the commodity and, in some instances, its underlying public distributed ledger technology (“DLT” or “blockchain”).
Since 2008, the markets for digital assets have grown to more than $2 trillion, while lawmakers have struggled to keep pace with the rate of innovation. Perhaps there is a bigger question at play - is our government model outdated? And are they no longer capable of regulating this new landscape?
I, for one, will be sitting by the screen with popcorn, while Congress decides the biggest question this week - Who regulates what in crypto, the SEC or the CFTC?
This Week By the Numbers 📈
Markets are hanging in the balance ahead of the July 27 FOMC meeting, where it is widely expected that the Fed will raise interest rates by 0.50 to 1% to curb continued inflation.
Top Stories 🗞️
One of the leading crypto hubs in the Middle East, the emirate of Dubai, launches the Dubai Metaverse Strategy that aims to turn it into one of the world’s top 10 metaverse economies. The strategy promotes Dubai’s ambitions to support more than 40,000 virtual jobs by 2030. On Monday, the Emirates News Agency reported o the launch of the Dubai Metaverse Strategy by Vice President, Prime Minister and Ruler of Dubai H.H. Sheikh Hamdan bin Mohammed bin Rashid Al Maktoum. Al Maktoum hopes to transform the emirate into a global tech capital, focusing primarily on artificial intelligence (AI) and Web3. The Dubai Metaverse Strategy goes in line with the objectives of the United Arab Emirates AI Strategy to enhance the nation’s status as one of the world’s leading countries in futuristic sectors by investing in new technologies.
According to Twitter user @DrSoldmanGachs, a self-proclaimed creditor of troubled Singaporean crypto hedge fund Three Arrows Capital (3AC), the now-defunct entity allegedly owes $2.8 billion in claims, as discovered through a recent 3AC creditors meeting. In addition, the claim amount could be understated, as many have either not made their claim or have not disclosed their claim amounts for reasons of confidentiality. As told by DrSoldmanGachs, the meeting voted to elect a creditor committee comprising Digital Currency Group, Voyager Digital, Blockchain Access Matrix Port Technologies and CoinList Lend. These five parties above represent approximately 80% of the current level of claims. Both of 3AC's co-founders, Su Zhu and Kyle Davies, could not be located after the fund's blowup. Ironically, Su Zhu is allegedly claiming $5 million from 3AC, while Chen Kaili Kelly, wife of Kyle Davies, is allegedly claiming $66 million. However, such claims are reportedly quasi-equity and subordinate to the distribution of leftover assets, if any, to creditors.
After five weeks in hiding, the disgraced founders of Three Arrows Capital spoke extensively about the spectacular implosion of their once high-flying hedge fund, saying their bungled crypto speculation unleashed cascading margin calls on loans that should never have been made. Su Zhu and Kyle Davies, both 35, built 3AC into a crypto-trading behemoth before its collapse bankrupted creditors and exacerbated a selloff that foisted steep losses on mom-and-pop owners of Bitcoin and other tokens. They acknowledged the collapse triggered widespread pain, but mostly talked around questions about the effect on others in the industry. Instead, they stressed they suffered deep losses while denying allegations they pulled money out of 3AC before it all blew up.
Residents in nations with volatile economies are more likely to receive their pay in cryptocurrency, according to global hiring platform Deel. In its “State of Global Hiring Report” shared with Cointelegraph on Thursday, the firm found that despite the 2022 bear market, crypto represented 5% of all global payments withdrawn from the platform every month, up from 2% in the second half of 2021. Residents in nations with volatile economic situations and currencies were most likely to make their payments in crypto, according to the report. These included countries in Latin America (LATAM) and Europe, the Middle East and Africa (EMEA).
A probe into possible illegal activity behind the algorithmic stablecoin TerraUSD (UST) and the affiliated LUNA token has deepened with a raid on the Seoul home of the firm’s co-founder Daniel Shin, according to a Bloomberg report citing local media. Investigators also reportedly visited the office of the mobile payment app Chai, which was founded by Shin in 2019. A spokesperson for the Seoul Southern District Prosecutors Office confirmed the reports of the raid on Shin's home, adding that offices of two other firms affiliated with the Chai app were raided as well, declining to provide further detail. The raids are a part of an ongoing investigation into allegations that Kwon intentionally caused the collapse of TerraUSD.
Hashflow Raises $25M!💰
Big congrats to the Hashflow team on closing their $25M Raise. Proud to be on the cap table alongside seasoned investors Jump Crypto, Kronos Research, Electric Capital, Dragonfly Capital, Kraken Ventures, Naval Ravikant, and Meltem Demirors.
Hashflow is a decentralized exchange (DEX) backed by a request-for-quote (RFQ) pricing model that allows for cross-chain interoperability, low transaction or gas fees, high liquidity, and no slippage, a common problem in volatile markets where the price of a trade changes between initiation and completion.
This raise puts Hashflow’s valuation at $400 million. The capital will be used to scale the product, expand the team and launch structured products later this year. Continue reading here.
Check them out on Twitter below:
Thank you for reading this week’s edition of the Myth of Money.🚀
Until next week,
By Tatiana Koffman
Hi there and thanks for reading. If you stumble upon my newsletter, you will notice that I write about money, economics, and technology. I hold a JD/MBA and spent my career in Capital Markets working across Mergers & Acquisitions, Derivatives, Venture Capital, and Cryptocurrencies. I believe in empowerment closing the financial education gap and creating equal opportunity for the next generation. I have invested in 20+ companies and funds. Check out my portfolio here.
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