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John Martin 23 Aug 2023 ◦ 8 min read

Crypto Regulation: Is It a Fight Against Fraud or Just Pressure

Crypto Regulation: Is It a Fight Against Fraud or Just Pressure

Regulators in developed countries are paying increasing attention to the cryptocurrency industry. At the dawn of the digital age, the authorities cannot effectively regulate the fast-growing market due to the lack of clear legislation that requires time and jurisprudence skills. The legal struggle between the authorities and the crypto world has been going on for several years in many countries. In such legal disputes, a legislative basis for regulating digital currencies in the future is emerging.

Since the beginning of the year, US regulators, primarily the Securities and Exchange Commission (SEC), have filed several lawsuits against some of the leading players in the crypto market or issuers of their assets. At the same time, banks providing accounts and payment processing services for cryptocurrency platforms also came under attack.

The first ones to feel the pressure of regulators this year were the Genesis trade group and the Gemini exchange. The general charge was that the companies did not register a general lending scheme in crypto assets and a program for accruing income to Gemini Earn users as an activity falling under the securities law.

A month later, Kraken Exchange, one of the leading players in the Ethereum cryptocurrency stack niche, fell under a similar lawsuit and a fine of $30 million. It was forced to curtail the stacking program for users from the United States. According to regulators, the exchange "promised" more than 20% per annum in the form of income from the service.

Stocks and Crypto: The Difference 

Stock markets are tightly regulated. There are many rules and regulations order to prevent securities fraud. They describe what companies and investors in the stock market should and should not do. For example, the rules prohibit trading based on insider information (internal information that can affect the price of a company's shares). In other words, the investor cannot use the data available to him (but not to the general public) for profit. 

However, in the cryptocurrency market, there are no such restrictions. This can be illustrated by the example: Robert works for some ABC company. It issued shares circulating on the stock exchange and tokens trading on crypto exchanges. Robert learns that ABC has developed a super-efficient and revolutionary technology, the announcement of which is scheduled for Wednesday. If Robert buys shares on Tuesday, he could be held liable for trading based on insider information. However, if Robert buys tokens, it will be impossible to punish him - and he will be able to make good money by selling them after the announcement on Wednesday.

Another difference between stocks and cryptocurrency is that stocks make it possible to receive dividends. Usually, successful companies pay dividends to shareholders annually. As a rule, their value does not exceed several percent of the value of shares. The Board of Directors shall submit the amount of dividends for discussion at the general meeting of shareholders. In the cryptocurrency world, the concept of dividends does not exist (except in a couple of cases - for example, platform tokens KuCoin). It should be noted that sometimes cryptocurrency is divided into two or more varieties. This process is called "fork" and in some respects resembles dividends.

Terra Crash

Last spring, the community and investors faced the consequences of the situation around the Terra ecosystem. The culprit of the hyperinflation of the asset was considered the management of the project tied to only a few people. This small group, probably understanding the consequences, continued to issue the LUNA token until the price of the asset fell thousands of times.

The US regulator sued blockchain platform Terra Labs and its founder Do Kwon, claiming that they raised billions of dollars from investors by selling them securities under the guise of cryptocurrencies.

Kwon, a native of South Korea, founded the Terraform Labs blockchain platform and was the main developer of the UST stablecoin and the Luna cryptocurrency (LUNA) that supports its binding to the US dollar. Both tokens depreciated in May 2022, which led to major losses for the entire market.

Before its collapse, stablecoin TerraUSD had a market capitalization of more than $18.5 billion and was the tenth cryptocurrency in this indicator.

Since April 2018, Kwon has raised billions of dollars from investors by selling cryptocurrencies issued by Terraform and several other digital assets, many of which were unregistered securities, the SEC said. The lawsuit says Kwon misled investors about UST's stability and argued that his company's tokens would grow in price.

"We argue that Terraform and Do Kwon failed to provide the public with complete and truthful information about the assets being sold, primarily about LUNA and TerraUSD, as required for the many crypto assets that are securities," said SEC Chairman Gary Gensler.

The commission also claims that the Terraform ecosystem was not decentralized. According to Gurbir Grewal, director of the SEC's enforcement department, it was "just a fraud supported by the so-called algorithmic stablecoin, the price of which was controlled by the defendants, and not by any code."

In September 2022, a South Korean court issued an arrest warrant for the founder of Terraform and the developer of the Luna cryptocurrency and stablecoin TerraUSD Do Kwon in September 2022. He's accused of fraud. According to the analytical company Elliptic, investors in Terraform projects lost about $42 billion.

SEC & Ripple

The confrontation between the US regulator (SEC) and Ripple Labs Inc which has been going on for several years, went into the judicial phase last year. The essence of the SEC's claims is that Ripple, through the sale of unregistered securities, under the guise of XRP tokens, raised over $1.3 billion. And founder Chris Larsen and CEO Brad Garlinghouse made illegal profits from the sale of tokens worth about $600 million. In addition, according to the SEC, Ripple used several billion XRP tokens to pay for hired labor, marketing, and other services.

The XRP token is responsive to any changes in this case. Two days after the charges against Ripple were filed at the end of 2020, the price of the coin fell by more than 50%, from $0.52 to $0.23, and then increased by 52% to $0.35. This led to a loss of more than $400 million by traders.

Then, in April 2021, the coin reacted strongly to new data related to this trial: the XRP token rate on the Binance crypto exchange updated the maximum from April 2018 to $1.11. This happened after the court granted access to SEC documents to Ripple. However, along with the entire cryptocurrency market, later the token fell in price.

As you know, corporate litigation in the United States can last for years, and in the such legal field as crypto regulation in the US - even more. For lawyers it’s a mixed blessing, for everyone else - a headache. Litigation is still ongoing.

Former U.S. Securities and Exchange Commission (SEC) official Joseph Hall argues that the lawsuit will not end soon, as the parties are firmly rooted in their positions and will not make a deal. Hall himself, in a regulator dispute with Ripple, supports the issuer of the XRP token. According to the ex-official, the situation looks strange, since the Ripple network worked for years before it was noticed by the SEC which filed a lawsuit.

Why This is Important for the Entire Crypto Industry

With any court decision, a precedent will be created that will be decisive in legal relations between states and the cryptocurrency market. In principle, the very fact of such a legal dispute suggests that the solution to the problem is overdue.

The SEC equates tokens with stocks. There is logic in this - the issuance of tokens is akin to the issue of securities. The user, for market value, receives a digital asset, through which it is possible to profit. On the other hand, tokens can be used as a means of payment.

It's not an easy choice for a judge, but what if the SEC wins? In this case, the state will receive a legal "bridgehead" to strengthen control over the cryptocurrency market. There will be grounds for requiring the necessary license to trade "securities" from any tokenized project. Then, after a few years, it may be legal to classify tokens into gaming, payment, accumulative, etc., but how much water will leak during this time? Representatives of the crypto industry will have to correlate their future startups with regulatory acts and this factor will become a drag on the development of the digital market.

In the event of a judicial victory for Ripple, US authorities will have to review the legal paradigm of securities law. Regulators will measure fervor, the crypto industry will receive a powerful impetus for development, and the XRP course will fly to heaven.

With each trial, crypto markets become more legal. Even in the case of prohibitive or negative verdicts, there is a legislative framework that cannot be crossed, and on the other side of the framework, there is a legal space in which activities can be carried out legally.

In Conclusion

The lack of clear rules regarding cryptocurrencies and the frankly hostile attitude of regulators, in the long run, will lead to America losing the status of a financial center, said Brian Armstrong, head of Coinbase's second largest crypto-exchange, adding that "cryptocurrencies are open to everyone," and the EU and Hong Kong are pulling leadership in the industry.

In Hong Kong, crypto asset trading is introduced into the legal field, despite the ban on cryptocurrency and mining in mainland China. It is this information that Armstrong refers to, and he is not the only industry representative in the United States who sees the actions of Hong Kong and Asia as a whole as a trigger for the expansion of the legal crypto market.

The possibility of a legal purchase of cryptocurrency in Hong Kong, in his opinion, "has a double bottom." Access will be strictly through licensed sites and subject to strict Know Your Customer (KYC) rules and asset listing requirements. At the same time, the authorities of both Hong Kong and China openly declare that they advocate the development of blockchain technology itself and the introduction of Web 3.0. The ban does not apply to the technologies themselves, but to "potentially dangerous" activities.

European regulators are also trying to speed up the withdrawal of the crypto industry into the legal field. The ECB calls on EU banks to apply the rules developed by the Basel Committee on Banking Supervision when working with crypto assets, even before their official entry into force. As a representative of the Central Bank told CNBC, in matters of introducing digital currencies, the regulator fears being "in the position of a sandwich" between the United States and China, not having time to introduce its market regulation.

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