Is it Possible for Insider Trading to Affect NFTs?

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Headline:  What’s happening with the Ex-manager of Opensea who has been convicted of NFT Insider Trading?

Body:  OK, let’s take a hypothetical.  There is a youngish woman (let’s make her a blonde), who had a pretty good career on Wall Street, but then wanted to do something else fulltime.  For the sake of this hypo, let’s say that she decided to start her own brand of home accents and cooking apparatus.  At the same time, she enjoyed managing her own portfolio of stocks and bonds, and maintained some relationships built up during her days on Wall Street.  One high-flying tech stock drew her eye, and she purchased a few shares.  Some time later, her friend at that company warned her of some very disappointing news about to be released.  She quickly opens her stock-trading app and sells her entire inventory of that stock.   The bad news breaks the next day, and that stock tanks 30%.   Great for her, she protected a bunch of money.   Not so great, she might’ve engaged in insider trading.

This fact pattern might be repeating itself with NFTs.   This is the crux of many of the articles I have read.   But, prosecution of insider trading on the stock market, seems to me, to be trying to provide a more even flow of information amongst potential investors.  NFTs on the other hand, (think of the bored ape yacht club) seems by its very nature to be unknowable.   Just think, you might know the date of the offering, and the price, but there is so much that you don’t know.   In the bored apes, you don’t know what eyes to expect, you don’t know what pose to expect, you don’t even know to expect the facial expression.  Further, you can’t know which combination of these and other traits will in the future bring  the highest price.  This is all a long-winded way of saying, that I don’t believe that traditional understandings of  insider trading can apply.  (In point of fact, the jury was warned that this wouldn’t look like a regular insider trading case at all.)  So, we shall see together.

So, what exactly happened?

Allegedly, a manager at OpenSea, Nathaniel Chastain, found out ahead of time which NFTs were to be featured, and purchased many of them on the theory that when they were featured, their prices would naturally rise a lot.   At that point, he would sell his at the now inflated price, and make a tidy profit.  Using this system, he made more than $50,000 in only 4 months, in 2021.  He is being charged with insider trading and wire fraud.   (Per a Special Agent I personally know, “wire fraud” is often a catch-all term used by the Federal Government for any illicit use of the Internet.)

“Nathanial Chastain exploited his advanced knowledge of which NFTs would be featured on OpenSea’s website to make profitable trades for himself,” U.S. Attorney Damian Williams said in a statement. “Although this case involved novel trades in crypto assets, there was nothing particularly innovative about his conduct – it was fraud.”

After 3 days of deliberation, the jury found him guilty on both counts.   He faces up to 40 years in prison.

OK, so why is the US government so interested?

Let’s get just a bit more exact with our diction.   The SEC is VERY interested in this topic, and we are asking why THEY are so interested in fighting in this arena.   The long and short of it is, I don’t know.   What I DO know is there is a proposed law called the Digital Commodity Exchange Act of 2022.   If this law passes, the lion’s share of regulation of cryptocurrency industry activities will fall under the purview of the Commodity Futures Trading Commission.  If this happens, the SEC misses out on the increasing budgetary sausage allocated to regulation of cryptocurrency.  But, if they can prove how incredibly “successful” they are in prosecution of novel cases, lawmakers might think twice before passing this law.  I’m not saying that this is the only consideration, but, the facts seem coincidental.  I leave it to you to use your own judgement.

The Verdict

The SEC took on  a difficult assignment here, no doubt about it.  To prove a new application of insider trading is really risky, and they did it.  So, we are left to interpret whether the outcome was good or bad.  I was not a member of the jury, but I do have a few thoughts.   First, when the prosecutor told them to focus on the wire fraud, I became instantly distrustful that the government had a good case for insider trading.  Second, something about OpenSea doesn’t make sense to me in this context.  Assuming that he was guilty of insider trading, one would be forced to presume that OpenSea holds enough of the cards (on a very opaque market) that a manager of the site is able to see what will be placed in the “featured” category AND the discernment needed to understand which examples will become valuable based upon consumer whim.  I don’t buy it.  What do you think?

REFERENCES

https://finance.yahoo.com/news/ex-opensea-exec-convicted-wire-211531049.html

https://www.binance.com/en/feed/post/486540

https://cointelegraph.com/news/sec-reportedly-launches-investigation-into-insider-trading-on-exchanges

https://today.westlaw.com/Document/I1939d37ce68d11ec9f24ec7b211d8087/View/FullText.html?contextData=(sc.Default)&transitionType=Default&firstPage=true

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

A Ripple Might Become a Wave?

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Headline: What is going on with Ripple?

Body:  It is said that if you drop a pebble into a still pond, the ripples could spread out almost without end.  Such seems to be the case with the cryptocurrency, Ripple.  Let’s take a look.

OK, what IS happening in the grand scheme?

In the grand scheme, two men (Mr. Larsen and Mr. Garlinghouse) started Ripple then engineered an ICO.   They used their own coin (XRP) to gain goods and services to expand Ripple; Allegedly, the two made over $1.3 Billion USD selling these “unregistered securities.”

I think I’ve seen that movie before.  Why is the SEC making such a big deal?

Alright, time to get into the wayback machine, destination, the 1930s.  The stock market was a fairly new thing, and people were of an opinion to like the new-fangled thing  So did fraudsters, and often for the same reasons.  So, Congress passed the Securities Acts of 1933 & 1934.   In short, the 1934 Act started the agency the SEC, and outlined the attributes of a security.   It was mandated that when  a security is offered, several disclosures have to be made, in a Registration Statement.   There are some regulations that will render an offering exempt from these registration requirements, but Ripple appears not to qualify for these exceptions.                                                                                                    

“Issuers seeking the benefits of a public offering, including access to retail investors, broad distribution and a secondary trading market, must comply with the federal securities laws that require registration of offerings unless an exemption from registration applies,” said Stephanie Avakian, Director of the SEC’s Enforcement Division. “We allege that Ripple, Larsen, and Garlinghouse failed to register their ongoing offer and sale of billions of XRP to retail investors, which deprived potential purchasers of adequate disclosures about XRP and Ripple’s business and other important long-standing protections that are fundamental to our robust public market system.”

So, what is the big question here?

The big question is whether or not the XRP tokens constitute a security under existing law.  For sure, there are exceptions to registration, but it would appear that they do not fall under the requirements for either of these very few exceptions (loopholes?)  We shall see.  The silent part that is not to be read aloud, is that the SEC, after a win, would be the sheriff of future cryptocurrency offerings.    This would  naturally lead to an increased budget for the SEC, and that is worth fighting for.   Isn’t it?   If it is instead classed as a commodity, the dreaded CFTC would get a sizable piece of this new federal pie.

So, who else is involved in this circus?

In the ring nextdoor is the Chamber of Digital Commerce (The other CDC) which filed an amicus brief to support Ripple.   In the brief  they explain to the Court how incredibly important it is to finally answer this most vexing question. Many third parties have offered supporting documents to the court, including The Blockchain Association, Coinbase and  ICAN.  Others are piling on in social media forums, especially Twitter.   Ripple’s counsel went online and made the case that XRP tokens do not satisfy all of the 4 prongs of the Howey test, as prescribed in the Supreme Court decision.  (I promise to not go too deep here.) 

The Howey test consists of four elements often referred to as prongs. According to the test, a transaction is a security if it is (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, or (4) to be derived from the efforts of others. All four test conditions must be met, and the test can only be applied retrospectively.  See?  Not too bad, right?  (Now, you know why Howey might rhyme with “owie.”)

The Verdict

It would appear that the case continues to be fought.   But, before the case is actually “heard” there will definitely be years of “motion practice” where procedural details related to the case are ironed out, and it would appear that Ripple just won a pretty major victory in one of these small duels.  I guess the moral of the story is that the law is a continually evolving thing, unfolding as it has to in response to new business practices.  This is likely as it should be, and we should all be patient to see what happens.   BTW, I think there’s going to be an upcoming, exciting ICO!!  It’s called “K-coin.”     My slogan might be, “Have your K, and eat it too.”  (My marketing materials are being worked on right now.)  What do you think?

 REFERENCES

SEC.gov | SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering

SEC vs. Ripple (investopedia.com)

The SEC vs. Ripple lawsuit: Everything you need to know (cointelegraph.com)

Why the lawsuit against Ripple and XRP is a landmark case (cryptoforinnovation.org)

 Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

I’m a Seoul Man…

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Headline: 

Body:  So, the cryptocurrency battles within the U.S.  have seemed operatic enough.  There are large companies involved, large banks going under, and a large variety of celebrities of all types involved.   Should we be at all surprised that this is happening in other developed nations, like South Korea?  Probably not, but, let’s tempt fate and engage in just a bit of schadenfreude, shall we?

In a nutshell, what happened?

South Korea has its own financial regulators, and it seems that a lawmaker has engaged in a series of transactions that evidence a  potential conflict of interest.  One lawmaker, Kim Nam-kuk allegedly withdrew about $4.5 million of tokens over a month long period.    This would violate the “travel rule”  and require disclosure of this transaction series to the authorities, but for the fact that the “travel rule” was added just after the withdrawals.    The financial Services Commission enforcement unit was notified.

When approached, the lawmaker opined that there was no reporting requirement for virtual asset transactions within the Ethics Act they have to follow.  What made this, shall we say “interesting”, is that Kim just co-sponsored an amendment to their Tax Code which would defer taxation on gains from transactions within virtual assets.

The Verdict

As interesting as all of this is (to me, at least) I do have to report something of an observation.   When reporting on this, I went to several trustworthy sources, and I found an unnaturally similar  tone, structure and even phraseology to many of the articles.    This reminded me of another issue I have read about, that sometimes media outlets overly depend upon press releases.   In a roiling marketplace of ideas, there is an immense pressure to publish first, and sometimes, shortcuts are taken.  In these cases, whole sections of the release are woven into the articles with paltry attention paid to doing extra reporting work.  I’m not saying that this necessarily happened here, but, I do detect a familiar scent in many of the articles.   So, “let the buyer beware” even (and especially)  when getting your news and information.    Said another way, don’t believe EVERYTHING you read on the Internet.  

REFERENCES

South Korea Lawmaker Kim Nam-kuk Investigated by Prosecutors Over Suspicious Crypto Transfers: Report (coindesk.com)

South Korean Lawmaker Under Investigation for Crypto Transaction (cryptotimes.io)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

DC v. DCG

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Headline:    Is DCG at risk of default?

Body:  Ok, I’m pretty sure that DCG is not a company that you think about on a daily basis, many probably have not heard of it.     This is so common in business.     I myself didn’t believe how central it was to nearly everything, until I mapped it out on a blank piece of paper.  FTX was at the center, and DCG was just beside it.   Now that FTX is gone, DCG will likely make it into the center of my next mapping exercise.  Gemini was a company in the cryptocurrency space, and they had a lending arm, Genesis Capital (remember them?) represented a subsidiary that undertook lending activities.  To be frank, their fall was only as catastrophic as it was because they were so successful to that point.   DCG itself might be facing a similar fate.

Why is DCG facing these issues?

One could cite a bunch of issues including incestuous lending (receiving loans from subsidiaries and then collateralizing these loans with their own cryptocurrency) and rather opaque reporting requirements.  But, when one peels away the layers (lawyers too, I suppose) it seems to boil down to a loss of trust from the Public.

This seems very academic and hard to grasp…

The entire monetary system runs on trust (remember, we keep coming to that conclusion??)  To keep that trust, the government has regulations and the powers necessary to enforce these regulations.  As it regards publicly traded companies, the trust is kept by requiring them to publish financial statements and disclosures, and these are in turn, audited by companies that are supposed to be disinterested 3rd parties.    In this way, if the company decides to “disclose” a set of transactions in a misleading way, the auditor will be able to require them to edit the report, to be more clear, and compliant with accounting rules.  If the company decides to refuse, the auditors have the option to edit their opinion letter.     In this manner, the public can feel that their money invested is fairly safe.

Normally, these companies have an Initial Public Offering (IPO) where their stock is first sold on the market.     But, often, these cryptocurrency firms will forgo this IPO, and have an Initial Coin Offering (ICO) instead.  Within the accounting field, it is pretty clear that when there is an IPO, there are a set series of disclosures to be made, thus keeping important policies and actions transparent.  But, the ICO is a newish beast on this block, and the regulations are still being set.  This lack of comprehensive regulation allows for some of the poor management decisions made.   

Well, what about “activist investors?”

This is very prescient of you to bring up.   In the publicly traded world, if there is an investor who is disenchanted with decisions made, they can do a variety of things that can force the company to change its ways.  In a similar vein (though not the same) the Winklevoss twins, who led Gemini, are doing what they can to make   the DCG wrongdoings very public.   They wrote a public letter to the board, asking them to remove Barry Silbert as CEO.  In turn, Gemini Capital creators, Tyler and Cameron Winklevoss were accused of mischaracterizing the entire balance of a $1.1 Billion promissory note as an asset.  The back and forth accusations seem to be a continuing thing, as the CEO of DCG responded over Twitter.

Why does this Three Penny Opera matter?

DCG also owns several large companies.  They own media group Coindesk, a bitcoin mining outfit, called Foundry, and the Grayscale Bitcoin Trust.   All are significant participants within the cryptocurrency environment.  The breakup or bankruptcy of DCG could mean the loss of significant money for a lot of people.   Real money, mind you.  The government is taking this seriously too as the US Attorneys’ Office has opened an investigation into DCG.

The Verdict

So, there you  have it.   This is another cryptocurrency firm that is facing governmental scrutiny, and will likely wind up in Court.   Beyond the government investigation, the Winklevoss brothers also appear to be rather serious.

Unless Barry and DCG come to their senses and make a fair offer to creditors, we will be filing a lawsuit against Barry and DCG imminently.

— Cameron Winklevoss (@cameron) January 20, 2023

This suggests to me yet another reason to  be very careful in investing in cryptocurrency, of any variety.

REFERENCES

Digital Currency Group’s Genesis implosion: What comes next? (cointelegraph.com)

Cameron Winklevoss asks DCG board to remove CEO Barry Silbert, escalating dispute (yahoo.com)

Crypto Trader Auros Global Misses Payment on DeFi Loan as FTX Contagion Spreads (coindesk.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

This One Might Be Taxing.

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Headline:  Crypto Mining taxation

Body:  Taxes are nobody’s friend, and when a new one is added, there is an outpouring of outrage.  I very well remember being in Philadelphia when there was a new “soda tax” added to the panoply of taxes.  People complained bitterly (especially if they had  kids at home) and bottlers were up in arms.  The rationale was simple: The government needed more money (when do they not) and soda is unhealthy for you, so, this could dissuade casual use.  Now it would appear that the government might be trying to impose a separate tax on mining bitcoin.  It would appear that the rationale is similar.  So, how does this new proposed tax work?  Let’s  plumb the depths a bit and find out.

What exactly is the reasoning?  After all, bitcoin mining doesn’t rot your teeth.

No, your teeth are likely to be ok.   But, the current administration is proposing that they would tax up to 30% of a miner’s electricity costs.  Many of these “rigs” are bootstrapped supercomputers, and the heat they create is intense.   So, the cooling needed to compensate is HUGE as well.  Essentially, the government (thru its green initiative) wants to really make people think twice before taking this on, and placing themselves in danger and using massive amounts of electricity. (It’s true that some industries take FAR more electricity, but the claim is that these industries contribute a lot more to the national economy, usually in many industries.) The DAME tax would go toward compensating the American People.  Despite the name, the tax would mainly affect the Bitcoin area as the other major cryptocurrencies use the proof of stake consensus model.  Per the White House estimates, the DAME tax could derrive revenues of $3.5 Billion over 10 years.

What are the arguments against the DAME tax?

Cryptomiers will quickly claim that they use sustainable sources of electrical power that do not pull significantly from the grid, thus denying one reason for the tax.    They also suggest that since cryptocurrency is global, if the tax is set too high, the miners will simply decide to go to another country that offers a better deal.

The Verdict

Tax policy is not sexy.   It shouldn’t be, really.   Going back to fundamentals, we have to remember the 2 large reasons to have taxation.   First, it funds our government (cue all the jokes about saussage-making, etc.)  This is well known, but the second prong is not oft-remembered.    The tax code is written to change behavior of the citizens.  Fraud is considered especially heinous, so, there is a code section that lays out large penalties if caught.  The government is trying to change the behavior of some citizens, in order to make life better for all.  There are thousands of other mechanisms like this one, and each one is designed to modify behavior.  So, the DAME tax, to me, is not as much of a stretch as some make it out to be.

REFERENCES

Biden Wants 30% Crypto Mining Tax, But Can It Work? (investopedia.com)

Riot Platforms (RIOT), Marathon Digital (MARA) Could Face Hefty U.S. Crypto Mining Tax (coindesk.com)

How Crypto Taxes Work In New Zealand | CoinLedger

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

Cryptocurrency is Here to Stay. Bank on it!!

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Headline:  Cryptocurrency has to interact with Traditional Finance

Body: 

Imagine that you were a marijuana grower, certified legal within the State, but you could only sell your products in exchange for cash.  The tricky part is that you tried to find a bank that would setup an account for your legal enterprise, but due to the stigma against marijuana nobody will accept your deposits.  The outfall is that you have a very serious safe with an ever-growing amount of cash piling up in it.  Cryptocurrency firms are currently facing a version of this. In recent years, Silvergate and Signature, especially, had become integral parts of the digital asset ecosystem by offering both traditional banking services as well as speedy payments networks.  Now that both banks have gone bankrupt, there is some question of how crypto firms are supposed to be banked within the framework of Traditional Finance.

It’s a Conspiracy, I Tells ‘Ya.

Yeah, some people do believe that it is a conspiracy of traditional financial institutions to hold on to power.  “It’s hard to look at this and not see a coordinated effort to choke off the industry,” said Ryan Selkis, CEO of crypto research firm Messari.  Others seem to believe that the problems faced by these institutions were mainly due to poor risk management practices (Such as loaning a crypto firm  money and taking as collateral, the tokens they themselves created.  One State regulator was quite pithy.  “When you lose depositor confidence,” Williams said, “not even the strongest bank can stand up.”

“I think if it hadn’t been for FTX and the extreme nervousness about crypto, that this wouldn’t have happened — even to [Silicon Valley Bank] or to us,” said the Massachusetts Democrat who was a key architect of new rules enacted in the aftermath of the 2008 crisis. “And that wasn’t something that could have been anticipated by regulators.”   Now that 20% of Americans own cryptocurrency, this nexus with traditional finance has to be  figured out.  In 2008, the financial crisis spiraled out of control due to unchecked risk-taking by financial institutions that were highly interconnected with each other. Innovative derivatives that were largely unregulated, complex and opaque connected one financial institution to another. Underlying assets that were not high quality represented resulted in hidden exposures and vulnerabilities.  This generally outlines both the hopes of and potential dangers of cryptocurrency, and it greatly overlaps with other assets.

Digital assets have recently shown to have financial stability risks with similar themes as in 2008. In May, there was the collapse of TerraUSD, an algorithmic stablecoin, and related crypto-asset Luna which was critical to Terra’s peg. TerraUSD, the then-third largest stablecoin with an $18 billion market capitalization, broke the buck, triggering redemptions across the Terra ecosystem. Those controlling a Luna-related foundation may have liquidated as much as $3.5 billion of Bitcoin, placing downward pressure on Bitcoin, affecting all with exposure. Tether, the largest dollar-based stablecoin, also broke the buck, reducing its total market capitalization by almost $9 billion.   Given that these were supposed to be tied to the value of the dollar, this seems very important.

Novel Risks for Crypto Assets that Could Increase Financial Stability Risk

Novel technology brings novel risk. The anonymity that can be associated with crypto assets has led to the use of cryptocurrency for terrorist financing, money laundering, and dark-net illegal transactions. Fraudulent scams abound. Cyber hacks and thefts pose significant risk. Legitimate crypto-related exchanges and other companies well aware of this dark history say they want to be regulated. However, their business may be structured in a way that is different to what financial institutions are used to seeing, particularly if customer assets are not segregated, and there are unresolved conflicts of interest. Any financial institution interested in crypto should undertake substantial due diligence to determine vulnerabilities in the following areas, and even then, may find these novel risks difficult to assess.  This difference can cause traditional banks to stay away from firms representing cryptocurrency and other sources of wealth.  Beyond this different source of wealth, many people point to the disproportionate level of frauds related to cryptocurrency   All of these considerations make it difficult to reconcile cryptocurrency with traditional finance.

The Verdict

The question must be asked out loud is , “Now that we know we have a fundamental problem, what is the solution?”  There are a few things I might suggest.

  1.   Banks need to display some level of courage.–>  Cryptocurrency is to a bank what steroids can be to an athelete; In the short term, they can really help an athelete’s performance, but when used chronically, there can be big problems.  In a career, each individual must decide what he or she is willing to risk for performance, and then take that stand.    I argue that banks should be forced to take a similar line.
  2. There should be some way to weigh the risks of cryptocurrency projects.–> When selling off Mortgage Backed Securities, a bank might organize them into tranches of  increasing probability of default.   To compensate the buyer for this risk, the interest percentage must be much higher.    In a similar manner if a client’s holding is above a certain percentage in cryptocurrency, the bank charges a higher level of interest.

Whatever the mechanism, traditional finance (banks) must develop a model to properly evaluate the true value of cryptocurrency firms.   Or, if they so choose, they can take the stand that they do not risk their clients’ money in this way, and doubtless, they would receive some new,  more traditional clientns,

REFERENCES

Crypto feared being walled off from traditional finance. The banking crisis is fueling those worries. – POLITICO

Remarks of CFTC Commissioner Christy Goldsmith Romero before the International Swaps and Derivatives Association’s Crypto Forum 2022, New York | CFTC

Case Study: Should We Embrace Crypto? (hbr.org)

Is Wall Street Killing Cryptocurrency? (investopedia.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

The SEC is Going After Binance.

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Headline:  The SEC goes after Binance

Body: 

Ok, what you need to know here is that Binance has tried all this time to be an outsized example of how powerful a cryptocurrency firm can be.  This is not surprising given the outsized personality of its founder Mr. Changpeng Zhao, going by the initials “C.Z.”   The thing to keep in mind is that the 136-page complaint levies charges against 3 parties: Binance, BinanceUS and C.Z. himself.  At its core, charges center around fraud and deceptive practices.

“Zhao and Binance entities engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law,” SEC Chair Gary Gensler said in a statement.    Since the fall of FTX the accusations against Binance are the most sweeping yet.   Binance has denied these allegations in a blog post.  (I have to wonder if this is the death knell for them.   I listen to a great podcast called Legal Eagle, and the attorney-host has repeatedly  noted how communications written electronically are often the most potent evidence in many civil suits.)

Binance was founded in 2017, and setup a U.S. affiliate in 2019, though the U.S. government claims that they had been doing business in the U.S. since their inception.  In point of fact, a 2018 e-mail was uncovered that confessed they had been doing business in the U.S. all along.  Among the many accusations, the SEC is claiming that Binance is acting as an unregistered broker of securities, and C.Z. himself is being accused of artificially increasing trading volumes by  using a trading firm he owns, to complete wash-sale like transactions.  (These are when a firm sells, say 500 shares of Apple, only to buy 500 shares of Apple a week later.)  In an interesting turn, the SEC chair, turned down a previous offer to be an advisor to Binance.  Nor is this the end, there are rumors that the DoJ is considering their own prosecution as well.  But in today’s filing, the S.E.C. says the company and its chief executive “subverted their own controls to secretly allow high-value U.S. customers” to trade on its international exchange.

Cryptocurrency exchange Binance and its U.S. affiliate were hit with more than $790 million in withdrawals in the 24 hours after the Securities and Exchange Commission (SEC) filed a lawsuit against them.

OK, I’m interested.  Tell me some colorful details?

There is a part of the SEC suit that makes reference to the “Tai Chi” documents.  These documents detailed a plan for Binance itself to officially move out of the U.S. sphere,  while allowing them to keep control of an affiliate that would stay within the U.S.  It goes further to quote Binance employees  conversing on the topic of keeping their U.S. customers in the face of a move away from the U.S.  Finally, it is alleged that Binance had access to the wallets and passwords of the Binance, US customers.

So, how mixed up is this?

Plenty.   A few points to ponder:

  1. Gary Gensler, SEC Chair, was previously asked to be an advisor for Binance.  (This was when he worked for MIT.)
  2. A former official in the Comptroller of the Currency office was a CEO for Binance, US, for a few months.

So, is the SEC the only federal agency after Binance?

No, there are many.  Previously, the CFTC went after Binance for  issuing their own coin, which looked to them, like a security.    It seems that the SEC was cribbing off of their notes, because this is one of their chief accusations as well.    Finally, the DoJ is rumored to have their own complaint coming against Binance.

All of this seems kind of confusing, doesn’t it?

Well, yes, it does.   But, there were some very naked things happening too.   In one instance, Sigma Chain (the trading firm) purchased an $11 Million yacht with customer funds.   This is pretty blatant.

What are the penalties being sought against Binance?

OK, the first thing to note is that these are all civil charges and nobody appears to be going to prison, all sanctions are economic.  That said, some of the penalties can be kind of severe.   If convicted, Binance will have to pay restitution to its victims and face additional civil penalties.  C.Z. himself might be barred from being an officer or director for any securities issuer.

The Verdict

Things do not look good for Binance.  But, should we be surprised?  I would argue no, because it follows a now too-familiar formula.    Cryptocurrency firm forms an exchange, and they are fine, but then they branch out to have their own investment activities, and they are not so fine anymore.  (Imagine if the company that ran the NYSE had its own trading firm?)  But, in the world of crypto, we have seen this film before.   FTX had its Alameda Research, Genesis had its own trading group added, and then they got into trouble.   Now, Binance seems to be following in their foul footsteps.

The more interesting question, I think, is, is Coinbase any different than Binance in this regard?  Ah, this is SUCH an interesting thing, that I shall have to follow up with another entry.  Please stay tuned.

REFERENCES

SEC sues world’s largest crypto exchange – POLITICO

The SEC sues Binance, unveiling 13 charges in sweeping lawsuit : NPR

Binance Users Withdraw Almost $800 Million After SEC Lawsuit (investopedia.com)

SEC Sues Crypto Exchange Binance and CEO Changpeng Zhao, Alleging Multiple Securities Violations (coindesk.com)

Why is the SEC suing Binance BP.docx

32.7kB

REFERENCES

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Can Crypto Even Make it to First Base?

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Headline:  The SEC goes after Coinbase

Body:  In the 1980s, there was the War on Drugs, where punishments for holding small amounts of drugs and paraphernalia  were sanctioned with significant prison terms.  Well,  some might argue that there is now a “War on Cryptocurrency” being waged by the federal government.  ( In point of fact, an official in the counsel function for Coinbase said, “The SEC’s reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance,” Whether or not this is true is, of course, rather dependent upon the viewer’s identity.  We just had an entry on Binance, now we present the attack (?) of the SEC upon Coinbase.

Who is Coinbase and what were they charged with?

OK, just a quick review.   Coinbase is a publicly owned entity (in full disclosure, I own a few shares.   It is in no way material with respect to my net worth.)  The point is that BinanceUS and most of those related entities were setup as LLCs and functioned somewhat like partnerships.  So, even if Coinbase did something criminal, it could be very difficult indeed to pierce the corporate veil.  That said, the federal government is quite good at putting these cases together.

They have been charged with many of the same abuses that Binance is accused of.   Among the charges are acting as an unregistered broker and clearing agency, which is quite serious as the registration orders them to disclose significant information to the public and undergo periodic audits by the SEC.  They were also accused of doing something wrong with their staking-as-a-service enterprise.(This one is a new one on me too.  Coinbase was acting as an intermediary and putting together groups to fund the validation of certain transactions.) Said Mr. Gurbir S. Grewal, director of SEC division of Enforcement:

You simply can’t ignore the rules because you don’t like them or because you’d prefer different ones: the consequences for the investing public are far too great, As alleged in our complaint, Coinbase was fully aware of the applicability of the federal securities laws to its business activities, but deliberately refused to follow them. While Coinbase’s calculated decisions may have allowed it to earn billions, it’s done so at the expense of investors by depriving them of the protections to which they are entitled. Today’s action seeks to hold Coinbase accountable for its choices.”

The SEC’s complaint alleges breakage of several registration provisions of both the 1933 and 1934 Securities Acts.  Like Binance, they are also  in trouble for their staking-as-a-service program, linking various individuals  to fully stake a validator.  (So many interesting wonky things have been omitted here because, sigh, normal people probably won’t be interested in the intricacies of definitions of securities and the like.)  In an interesting twist, Coinbase started the Crypto Rating Council which ruled on how “security-like” each asset was.   Per the SEC, even by their own definition, Coinbase went on to offer dozens of assets that were at very high risk of being “security-like.”  In an ironic twist, the staking activity was started to allow small investors to profit from the entrepreneurial efforts of others, and thereby democratize finance.    Now, the SEC is pressing for this to be a trial by jury, ostensibly made of those same citizens.

Kraken faced a $30 Million fine and a demand from the SEC to stop its staking-as-a-service function.

Does all of this really matter to Coinbase?

Well, maybe.   It is true that only 3% of their revenues come from staking activities.   But, it is also true that staking activities have been increasing a lot and will likely become more substantial in the future.

The Verdict

Well, Coinbase certainly has its work cut out for it.   But, there seems to be a conservative bent to most of the judiciary right now, and they usually sway towards less regulation.   Further, I have great faith in Coinbase’s ability to come up with a different description of their service that will render the service suddenly legal.

REFERENCES

SEC.gov | SEC Charges Coinbase for Operating as an Unregistered Securities Exchange, Broker, and Clearing Agency

SEC charges Coinbase for illegally operating an unregistered securities exchange – MarketWatch

Coinbase’s Staking Service Faces Questions After Kraken’s SEC Settlement (coindesk.com)

Crypto exchange Coinbase is reportedly facing an SEC investigation over securities – The Verge

REFERENCES

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

I’ve been Shanghai’d.

Uncategorized,

Headline:  What is the Shanghai hard fork in Ethereum?

Body:  Ok, just a bit of a reminder of what a “hard fork” is.   Hey, HEY, don’t go there, this is a family show.  A fork indicates that a change has been made.  Let’s take cellphones.   When you restart your cellphone, this is like a soft fork.  But, assume that you always had Apple products, but  you got a really good deal on a Droid phone.  Suddenly, you’re in a new cellular ecosystem.    This is akin to a hard fork.  (Though, I grant you, the Shanghai Hard Fork DOES sound like some sexual position, only achieved by circus performers.)

So, what IS the Shanghai Hard Fork?

In  this change, the Ethereum blockchain transitions into a proof-of-stake network.  This is important as before the fork, this was a proof-of-work network, and that was highly inefficient.   Going forward, the validators are now able to make substantial money as they validate transaction blocks.  This transition will be rather gradual, but the biggest changes have already been made, per the co-founder of Ethereum.  The next challenge seems to be scalability.  Currently, the validators will have to stake 32 ETH (roughly $58,000) but with liquid staking, MANY investors can pool their ETH  with a 3rd party and collectively obtain an interest in a validator.  As of the present date, Lido, a liquid staking firm, along with Coinbase, Kraken and Binance control almost half of Bitcoin.

This all sounds good, but, the fear is that the ETH being used to stake the transactions within the Beacon Chain will now be available to withdraw.   This is happening at the same time as several exchanges in the US are being liquidated, and with this many potential withdrawals, a panic is not out of the question.

The Shanghai hard fork also introduces several changes in policy that add up to lower gas fees for developers.   One could imagine that this will encourage development of applications within the environment.

The Verdict

As time goes on, the only constant is change.   This has always been true, and remains true in cryptocurrency.  Some changes are good, some are not.    But, I think I would have to argue that the Shanghai hard fork is good for everybody, as proof of stake is eminently more sustainable for the environment.  Just, if you do decide to play in the Ethereum sandbox, please do your level best to not be the one who gets forked.

A D V E R T I S E M E N T

REFERENCES

Ethereum’s Shanghai Upgrade Is Complete, Starting New Era of Staking Withdrawals (coindesk.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

Who is Cuscal?

Uncategorized, ,

Headline:  Who is Cuscal and why did they withdraw support from Binance-AUS?

I remember back in the early days of E-bay, one had to send a paper check by mail before the item was shipped.  Now there’s Paypal and SquareTrade.  This makes payments much easier to make a quicker to process.  But, as HUGE as Paypal is, it is not a Bank.  It is a payments processing mechanism.    CUSCAL seems to be an Australian version of PayPal. 

In fact, they have a rather impressively long  history, since the 1970s.

  • 1977. Launched Australia’s first ATM, in collaboration with Queensland Teachers’ Credit Union**.
  • 2012. Started switching transactions for all our clients through our own payment switch.
  • 2014. Acquisition of Strategic Payments Services Pty Ltd (SPS) on 13 November.
  • 2018. Inaugural Curious Thinkers client conference.
  • 2020. Open Banking Collaborative Data Exchange.

So, they have an impressive track record.  What are they doing in the future?

Binance Australia on May 18 announced it would be suspending Australian dollar fiat services in Australia after a decision from a “third-party payment service provider” — this turned out to be a financial services company Cuscal.   “Following recent media attention in relation to the impact of scams and fraud in Australia with particular focus on account fraud, ID takeover and crypto activity, Cuscal reiterates its commitment and important role in identifying and implementing detection services for our clients across the Australian payments system,” a statement from Cuscal wrote.  Binance said Zepto and Cuscal are continuing to support users wishing to withdraw Australian dollars.  And it would appear that Bank  of America will be responsible for managing the distribution of funds.

This all seems like some pretty great surprise because Cuscal seemed to be doing well, until recently.   The company had revenues of $182 million in the last financial year, and has grown net profit at 12 per cent over the past 10 years on a compounded basis. Cuscal reported net profit after tax of $23.4 million for the year to June 30.  Potential shareholders are being  encouraged to think of Cuscal as providing necessary financial infrastructure, and thus being robust enough to believe in.

In March, Cuscal acquired Basiq, a Sydney-based start-up backed by investors including Westpac and National Australia Bank.  Following completion of the deal, Basiq will continue to operate as a stand-alone business within the Cuscal Group, while it is expected that there will be no material change to the current structure of the team at Basiq or to Cuscal’s regulated data business.

The Verdict

A very fair question is, “Who cares?”     This is important because Binance seems to be on the ropes in so many countries.   It seems to be under substantial scrutiny in the US, and now, it is being severely pressured in Australia.    I am not sure how long Binance will be able to continue in operation.   This is significant, as  FTX is gone and the owner is facing federal charges.   Signature Bank (helped Binance get on the SWIFT network) is pulling its support, mostly, and Silicon Valley Bank is gone completely, and they were the holders of large amounts of cryptocurrency, and fiat money to back up fintech firms.  Gemini appears to be having their own problems.  We might well be down to 1 or 2 centralized exchanges for cryptocurrency.    This could be very interesting.

REFERENCES

ASX float looming: payments group Cuscal appoints Bank of America as lead manager (afr.com)

Binance Australia partner hints at rising ‘scams’ after debanking exchange (cointelegraph.com)

Australia’s Cuscal acquires Open Banking platform Basiq | Open Banking Expo

Meet the CEO of one of Australia’s fastest growing unicorns – Forbes Australia

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

 

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