On Thursday, the office of New York Attorney General (NYAG) Letitia James filed a lawsuit against KuCoin’s parent companies Mek Global Limited and Phoenixfin PTE Ltd for “engaging in the offer, sale and purchase of securities and commodities” in violation of the state’s General Business Law and Executive Law.
James says the Seychelles- and Singapore-based KuCoin violated the Martin Act “in at least three ways,” including failing to register as a securities broker or dealer while selling, offering to sell, purchasing and offering to purchase “cryptocurrencies that are commodities and securities,” including ETH, LUNA and TerraUSD (UST).
KuCoin also issued and sold KuCoin Earn, “a security in which KuCoin pooled investors’ cryptocurrencies to generate income for both itself and investors.” Finally, KuCoin “wrongfully represented itself as an ‘exchange’ without appropriate registration or designation in violation of New York law.”
The NYAG is seeking a permanent injunction against KuCoin selling and buying securities and commodities to and from New Yorkers, aka “a complete ban on the underlying conduct that gave rise to the illegal activity.” The NYAG also wants KuCoin to implement geo-blocking to prevent New Yorkers from accessing the cryptocurrency exchange in future.
Finally, the NYAG seeks a full accounting of all of KuCoin’s New York customers along with the sums the exchange earned from each customer over the past six years. KuCoin should be forced to “disgorge all revenue obtained” from New Yorkers and also pay the NYAG’s court costs.
The NYAG notes that KuCoin “has not responded” to a subpoena and has “demonstrated no effort to comply with New York law, while continuing to provide its services to New Yorkers. Indeed, KuCoin has been the subject of repeated regulatory action internationally, and yet continues to flout its registration obligations.”
In a statement, James called the KuCoin suit “the latest in our efforts to rein in shadowy cryptocurrency companies and bring order to the industry. One by one my office is taking action against cryptocurrency companies that are brazenly disregarding our laws and putting investors at risk.”
The NYAG has previously targeted CoinEx, Celsius, Nexo, Coinseed and, in perhaps its most prominent action to date, the company behind both the Bitfinex exchange and the Tether stablecoin. In 2021, those two firms reached an $18.5 million settlement with the NYAG and agreed to halt all operations in New York after being caught cooking their books to mask “massive financial losses.”
Let’s just set LUNA/UST aside and get to the most intriguing aspect of the KuCoin suit, namely, the NYAG’s assertion that the Ethereum network’s ETH token is a security. The NYAG’s press release notes that the suit represents “one of the first times a regulator is claiming in court that ETH, one of the largest cryptocurrencies available, is a security … ETH, just like LUNA and UST, is a speculative asset that relies on the efforts of third-party developers in order to provide profit to the holders of ETH.”
Relying on the efforts of others is one of the key planks of the Howey test, along with investing money in a common enterprise with an expectation of profits. The lawsuit states that “ETH’s development and management is largely driven by a small number of developers who hold positions in ETH and stand to profit from the growth of the network and the related appreciation of ETH.”
The suit details Ethereum’s origin story, which includes the fact that Vitalik Buterin and other Ethereum developers “received a portion of the funding raised” in ETH’s initial coin offering (ICO) and “also received significant quantities of ETH in the ICO and are believed to retain significant positions of that ETH today.”
Ethereum’s infamous pre-mine did indeed enrich Ethereum’s developers and early investors, to the tune of nearly 10% of the total sum raised via the ICO. A similar slice went to the Ethereum Foundation, whose ranks included Virgin Griffith, currently doing time in federal prison for assisting North Korea’s sanctions-dodging efforts.
ETH’s status as a security was further burnished by the network’s recent transition from a proof-of-work consensus mechanism to one based on proof-of-stake. The so-called ‘Merge’ benefited individuals/entities with large stashes of ETH, including those pre-mine beneficiaries, who stood to gain even more ETH by serving as validators on the post-Merge network.
The NYAG’s KuCoin lawsuit notes the influence that Buterin and the Foundation had in making this transition. The suit states that “one developer who worked on creating the software necessary for the transition stated that his team was ‘granted permission by the Ethereum Foundation’ to work on the shift.”
The suit also relates that “ETH no longer relies upon competition between computers but instead now relies on a pooling method that incentivizes users to own and stake ETH. The shift to proof-of-stake significantly impacted the core functionality and incentives for owning ETH because ETH holders can now profit merely by participating in staking.”
The suit details how Ethereum developers promoted ETH as an investment opportunity that was “contingent on the growth of the Ethereum network.” The Foundation’s website claims Ethereum users see ETH “as a digital store of value because the creation of new ETH slows down over time.”
CFTC to the rescue!
On Wednesday, Rostin Behnam, chairman of the U.S. Commodity Futures Trading Commission (CFTC), told the Senate Agriculture Committee that ETH is a commodity. Behnam said ETH has “been listed on CFTC exchanges for quite some time” and “we would not have allowed the Ether futures product to be listed on a CFTC exchange if we did not feel strongly that it was a commodity asset.”
The CFTC’s embrace of certain digital assets and crypto firms hasn’t always painted the regulator in a positive light. One year ago, CFTC commissioner Caroline Pham tweeted (then deleted) a photo with her arm around Sam Bankman-Fried (SBF), disgraced founder of the FTX exchange. Before his fraudulent fall from grace, SBF pushed hard to give the CFTC the leading role in overseeing digital asset regulations.
SBF’s preference was in part due to the CFTC having a far smaller budget and less resources to monitor for malfeasance, at least, when compared to the much larger U.S. Securities and Exchange Commission (SEC). The SEC’s view is that all of crypto falls under its purview and appears willing to throw some sharp elbows to ensure it gets its way.
The CFTC isn’t giving in without a fight, however. Behnam said Wednesday that his view of ETH as a commodity gave the CFTC a “direct jurisdictional hook for us to police, obviously, the derivatives market but also the underlying market as well.”
Not so fast, says Gensler
Behnam may feel somewhat under the gun, given that the SEC has seriously ramped up its efforts to rein in crypto operations that deal in unregistered securities. On Thursday, SEC chairman Gary Gensler wrote an op-ed in The Hill in which he reiterated the SEC’s view that “most crypto tokens that are backed by entrepreneurs, among other features, are likely to be securities” and that “platforms listing crypto securities must register with the SEC.”
And yet, Gensler said “crypto intermediaries aren’t exactly lining up to register with the SEC and comply with the laws enacted by Congress. Maybe it’s simply that their business models rely on being noncompliant. At times, it has felt like some have sought a stamp of approval for noncompliant activity, rather than changing a fundamentally non-compliant business model rife with conflicts.”
The SEC’s recent crypto crackdown has drawn plenty of criticism, with pro-crypto factions claiming that regulators lulled them into a false sense of security and anti-crypto types saying the SEC should have reined in crypto bros’ excesses before retail investors were made to suffer.
Gensler clarified that “enforcement actions take time and resources. This is especially true in crypto, as firms often are non-cooperative, claim overseas jurisdiction despite offering products to U.S. investors, and are well-funded for protracted litigation, including potentially using money raised from investors in and on their platforms. We will, however, remain steadfast in our mission to root out wrongdoing in the marketplace.”
All that’s left now is for Gensler to acknowledge a similar level of centralization at the heart of the BTC network, which for too long has been awkwardly cosplaying as the Bitcoin described in Satoshi Nakamoto’s 2008 white paper. If there’s an exception to Gensler’s ‘everything’s a security’ maxim—as well as a working model of Satoshi’s peer-to-peer electronic cash system—it’s Bitcoin SV. Worth checking out, Gary, once you’ve finished taking out the trash.
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Ethereum, FTX and Tether—who have co-opted the digital asset revolution and turned the industry into a minefield for naïve (and even experienced) players in the market.
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