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Counsel Kate Gee and Associate Joshua Ryan explore how the SEC’s crackdown on crypto exchanges may encourage an exodus to jurisdictions with more permissive regulatory environments

Kate and Joshua’s article was published in IFA Magazine on 5 July 2023, and can be read here. 

Increasing divergence between how regulatory bodies in different jurisdictions treat cryptoassets could have significant repercussions for the future of the industry as crypto exchanges explore jurisdictions which provide greater regulatory clarity for their business.
In contrast to the EU – which has chosen to acknowledge digital assets as a new class of assets through its MiCA (Markets in Cryptoassets) framework – US ‘traditional’ financial institutions look set to take control of the industry with digital assets classed within existing regulatory structures such as securities or commodities.

Such institutions are typically less forgiving of non-compliant behaviour, even if that behaviour took place in the past where the regulatory position was unclear. By contrast, the MiCA – scheduled to come into force between mid-2024 and early 2025 – is expected to give crypto exchanges regulatory certainty going forward, and less scrutiny of past behaviour.

Clear examples of this diverging approach are the two recent lawsuits filed [last week] by the US Securities and Exchange Commission (SEC) against Binance and Coinbase, two of the world’s most prominent and powerful crypto exchanges. The complaints allege inter alia breach of SEC rules. Traditional financial institutions – used to operating within a strict regulatory framework – typically separate their different services.

• Binance faces allegations that it operated “multiple unregistered offerings” and combined “the functions of exchanges, brokers, dealers, and clearing agencies” – which in turn led to disproportionate (and concealed) risks and potential for conflict of interest. The SEC allege that Binance has been commingling funds, as well as its functions.
• In the complaint against Coinbase, the SEC takes the position that the crypto tokens traded through Coinbase are effectively securities, and therefore subject to the strict US regulations relating to securities trading. The SEC accuses Coinbase of operating since at least 2019 “as an unregistered broker … an unregistered exchange … and an unregistered clearing agency” thereby defying “the regulatory structures and [evading] the disclosure requirements that Congress and the SEC have constructed for the protection of the national securities markets and investors.” Unlike the allegations against Binance, the SEC do not suggest that Coinbase have been commingling funds, rather just functions, albeit ones which traditional financial institutions would be expected to separate.
  Allegations of this nature are not new in the traditional finance sector, but the complaints filed show the SEC taking control of the industry through enforcement action in the crypto space for breaches of US securities law even though the regulatory position in relation to crypto is still in its nascent stage – and remains largely untested.

These SEC complaints are likely to be very disruptive to the crypto market; an initial indication was news of the SEC charges against Binance sending the price of Bitcoin to its lowest point in almost three months. Regulatory action against rival exchange FTX similarly led to a significant drop in the price of Bitcoin, which fell by almost 25% in the days following FTX’s collapse. The lawsuits raise the likelihood that other exchanges which also allow US investors to trade such cryptocurrencies might face similar regulatory action.

These lawsuits underline the crypto industry’s need for a robust, consistent and reliable regulatory regime in order to grow sustainably. As regulatory certainty becomes increasingly important for the digital asset industry, the sector may see crypto companies shift away from the US to markets with a more permissive regulatory environment such as the EU or other jurisdictions which are developing bespoke crypto regulatory frameworks such as Gibraltar, the UAE, or Switzerland.

The SEC’s complaint may therefore serve as a catalyst for an exodus of this nature, and / or for the US regulators to progress their draft bill in the US – which, for example, includes proposals for the treatment of tokens as commodities instead of securities – one step towards clarifying the position.

Here in London, it is unclear which direction the UK government will take. The prime minister, Rishi Sunak, has historically been a supporter of the sector, stating that his goal is to make the UK “the jurisdiction of choice for crypto”. However, finding a balance between effective regulation without damaging innovation is not always straightforward. In February 2023 the UK Treasury launched a consultation and call for evidence on a series of proposals for the future financial services regulatory regime for cryptoassets.

The consultation sets out proposals to regulate certain categories of cryptoassets and related investment activities with the intention that crypto assets which carry similar investment risk to ‘traditional’ asset classes are subject to the same regulatory oversight. In this respect the Treasury’s proposal treats all cryptoassets as specified investments for the purposes of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“RAO”) meaning any specified activities performed in relation to cryptoassets will be captured by the regulatory regime. \

The proposed scope of the proposal is that persons carrying on certain activities in relation to cryptoassets will need to be authorised to do so under the RAO. It would be sensible for companies engaged in such activity in the UK to consider whether their activities might fall within the scope of the proposed regulated and designated activities and seek advice if they have questions on how they can review the governance of their businesses – as well as their client and asset protection – so they are well placed once the result of the UK Treasury’s consultation is published. The consultation closed on 30 April 2023, and it is anticipated that the UK government will implement the new regulatory proposals ahead of the EU’s expected launch of MiCA in 2024.