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  • Writer's pictureThe San Juan Daily Star

Government cracks down on crypto industry with flurry of actions

Sam Bankman-Fried, left, founder of the FTX cryptocurrency exchange, leaves a federal court after his release on a $250 million bond, in Manhattan, Dec. 22, 2022.

By David Yaffe-Bellany

Cryptocurrency executives hoped that 2023 would herald a new beginning after a year of disastrous setbacks. Instead, the industry has found itself on the receiving end of an aggressive government crackdown.

Last month, the Securities and Exchange Commission levied fines and other penalties against crypto lending firms, while federal banking officials issued policy statements that appeared calculated to make it harder for crypto companies to participate in the mainstream finance system.

In the past few days, the pace has accelerated. Two high-profile crypto firms — including a popular exchange where people buy and sell digital coins — came under intense pressure from state and federal regulators. After announcing a settlement with the exchange, the SEC also fined a crypto promoter and sued a startup that issued digital coins, for a total of three enforcements in just over a week.

The actions are likely a prelude to a protracted spell of legal wrangling, as regulators respond to the market turmoil that caused prominent crypto companies to file for bankruptcy last year and cost investors billions of dollars. And the enforcement signals a growing urgency in Washington to address the threat posed by cryptocurrencies, an experimental technology that enables new forms of financial speculation.

“I’ve been referring to it as the crypto carpet bombing,” said Kristin Smith, executive director of the Blockchain Association, a crypto industry trade group. “Every couple hours we hear of some new enforcement action.”

For years, regulators were criticized for failing to come to grips with the crypto industry, even as it grew into a multitrillion-dollar business. In November, the FTX crypto exchange, once regarded as one of the most reliable firms in the freewheeling industry, failed practically overnight, and its founder, Sam Bankman-Fried, was charged with orchestrating a yearslong fraud.

That put regulators under intense pressure to act. Crypto companies have long existed in a legal gray area, with legislators and government officials debating how they should be classified for regulation. The industry’s growth has outstripped the slow-moving federal bureaucracies that oversee the other parts of the finance industry, like traditional banks and publicly traded companies.

After FTX filed for bankruptcy in November, the SEC, the Justice Department and the Commodity Futures Trading Commission, another regulator, all brought cases against Bankman-Fried and two of his top lieutenants.

But the activity against the broader industry picked up last month when the SEC fined crypto lender Nexo $45 million and charged one of its competitors, Genesis, with offering unregistered securities.

Last week, the SEC announced a settlement with the Kraken crypto exchange that removed one of its popular investment products from the U.S. market, which could have broad ramifications for the industry. The agency also sent Paxos, a company that issues so-called stablecoins pegged to the U.S. dollar, a warning of a potential lawsuit over securities violations.

This week, the SEC sued Terraform Labs, the company that developed the digital coins Luna and TerraUSD, which collapsed last spring and triggered a broader meltdown in cryptocurrency prices. On Friday, the agency announced that former NBA star Paul Pierce had agreed to pay $1.4 million to settle charges that he marketed a cryptocurrency without the proper disclosures.

Beyond the SEC, three top financial regulators sent a letter to banking organizations last month, warning them to exercise caution in their dealings with cryptocurrencies. Also last month, the Federal Reserve denied an application from Custodia Bank, a crypto company, to join the central bank’s payment system.

The enforcement wave has caused outrage and anxiety in the crypto industry. Some industry advocates have labeled the government efforts “Operation Choke Point 2.0,” alluding to a law enforcement campaign in the 2010s to prevent banks from working with certain businesses.

One industry lawyer said he was advising executives to prepare for as long as five years of high-stakes, expensive litigation with the government. Crypto companies have privately traded tips on which law firms to hire to handle government lawsuits, said the lawyer, who requested anonymity to describe sensitive legal discussions.

“What’s happening today is a coordinated effort that cuts across multiple agencies and seemingly reflects a unitary view that the entire crypto industry needs to be restrained,” said Paul Grewal, the chief legal officer of Coinbase, the largest U.S. crypto exchange. “It’s important for the crypto industry to prepare itself for a long fight.”

Representatives for the SEC and the Federal Deposit Insurance Corp., a banking regulator, declined to comment. Other federal banking regulators did not respond to requests for comment.

Since virtually its inception, the crypto industry has drawn scrutiny from regulators. And in 2021, as the market soared to record heights, some officials in Washington sounded the alarm. Gary Gensler, chair of the SEC, has argued that the vast majority of cryptocurrencies are securities, like shares traded on the stock market, and should be subject to the same strict regulations. His office spent months building cases against crypto firms, some of which are now coming to fruition.

The SEC’s $30 million settlement last week with Kraken, one of the largest U.S. exchanges, alarmed crypto enthusiasts. Kraken agreed to stop offering a service known as “staking,” which allows investors to earn interest on their crypto savings and has been lucrative for the industry. The enthusiasts fear that the SEC might move to block other crypto firms from offering similar services.

On Monday, the New York Department of Financial Services said it had ordered Paxos to stop issuing BUSD, a popular stablecoin that is affiliated with Binance, the world’s largest crypto exchange. That same day, Paxos said it had received a letter from the SEC warning that the company might soon be charged with securities violations over BUSD.

“We’re seeing an arms race between federal agencies in the U.S., competing to show how tough they can be on crypto,” said Jason Weinstein, a lawyer at Steptoe & Johnson who works on crypto matters. “There are a lot of sheriffs in town, and each is trying to assert control over the same town.”

Some of the actions have raised fears that crypto firms may find it harder to develop relationships with the traditional finance system. In January, the Federal Reserve, the FDIC and the Office of the Comptroller of the Currency issued a joint statement that outlined in stark terms the risks of becoming entangled in crypto.

“The administration’s efforts are no secret,” Nic Carter, a crypto investor, wrote in a widely cited blog post last week. He added that “exchanges might be shut off from the banking system entirely.”

As dire predictions have spread, crypto executives have taken to Twitter to attack the SEC. A few days after Kraken settled with the agency, the company’s founder, Jesse Powell, posted an obscene meme about Gensler. It was later deleted. Kraken did not respond to a request for a comment.

“There’s no question that this current moment is different,” said Grewal, the Coinbase lawyer. “Our mindset is that we’re prepared to engage for as long as it takes to get the rules right.”

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