Headline:  What happened between Kraken and the SEC?

Body:  For thousands of years, sailors wrote stories of their fears of the giant Kraken, a sea monster with a reputed taste for human flesh and the ability to sink ships with a single thrash.  We now know that  these apocryphal stories were about the giant squid which is usually very content to remain undisturbed in the vast depths of the ocean.  For some reason, a crypto exchange was started with the name Kraken.  (Ostensibly it has its tentacles everywhere?)  Because of the wide spread of its tentacles, the SEC took them to court, claiming that they were working as an unregistered securities exchange. 

I hear yawning!  This is actually really interesting as it gets to some of the thorniest questions concerning cryptocurrency.  In short, without registering with the SEC, Kraken has made hundreds of millions of dollars fostering these deals, acting as broker, dealer, exchange and clearing agency.  (Anybody want to guess a secondary reason that the SEC wanted to be the one who had success against this entity?)  They further claim that poor recordkeeping was an endemic problem.  Finally, they are accusing Kraken of trading in their own interest, and co-mingling customer funds to do so.  Kraken disagrees with all of these assertions, and is prosecuting its own campaign thru social media.

The more complete picture.

The first thing to see is that Kraken was put on the radar of the SEC because they were fulfilling so many roles for their customers.  In normal securities dealing, these functions are kept separate and distinct to ensure that there is limited opportunity for self-dealing.  Making this self-dealing worse, the SEC alleges that recordkeeping is deficient, and this deficiency allows them to use customer funds  in trades for their own profit.   So, let’s unpack this one a bit because it’s important.

Let’s pretend that you had a portfolio of securities with Morgan Stanley.    In this case, several different entities need to interact to make a transaction work.  The company needs to work with another entity that has the securities.  A clearinghouse needs to be involved to prove that all property has been handed properly from one party to another.  Having this many entities involved, each one looks over the work for the others, and the whistle can be blown if there is any wrong-doing.    In this case, the SEC is saying that Kraken was playing all of the different roles, so there was no check on what they were doing.   Now, it’s possible that the brokerage (let’s stay with Morgan Stanley) already has the securities that a customer wants.  All that it has to do is transfer the shares from its portfolio to the account of its customer.  To ensure that this is done correctly, there are onerous recordkeeping regulations to follow, to prove that the transaction was done correctly.   In this case, the SEC is claiming that Kraken’s recordkeeping was so deficient, it was impossible to prove that the transfer was done correctly.

In the words of the SEC,

We allege that Kraken made a business decision to reap hundreds of millions of dollars from investors rather than coming into compliance with the securities laws. That decision resulted in a business model rife with conflicts of interest that placed investors’ funds at risk.  said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “Kraken’s choice of unlawful profits over investor protection is one we see far too often in this space, and today we’re both holding Kraken accountable for its misconduct and sending a message to others to come into compliance.” 

 The Response

Kraken disagrees with all levels of this accusation.  Most interesting I think is the position of Kraken that it is not dealing in securities.

The Verdict

Once again, when a cryptocurrency firm tries to do too many things, it invites a lot of scrutiny.   We’ve seen it in FTX, 3AC, many times over.   Interestingly, one of the major investors in  Kraken is DCG, which we’ve seen before, involved in both FTX and Genesis.  Perhaps this scrutiny is a good thing.  We shall see.



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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