The Securities and Exchange Commission (SEC) is cracking down once again on crypto exchanges. Early last week, the SEC took aim at Binance and Coinbase — two of the most powerful forces in the world of cryptocurrencies — for allegedly breaching its rules.
In this episode, Dylan unpacks the cases against Binance and Coinbase and what their outcome could mean for the crypto sector.
- [01:42] A recap of why the crypto exchange FTX went bankrupt
- [04:26] Whether crypto passes the Howey Test
- [08:21] What it means to trade
- [12:46] Why the SEC is suing Coinbase and Binance
- [14:49] The similarities between FTX and Binance
- [16:31] What is Binance’s Sigma Chain?
- [20:45] What is happening to Coinbase and Binance now?
- [22:59] On the SEC’s apparent hostility to cryptocurrencies in general
- [25:37] Why forcing crypto exchanges into the regulatory framework might not be a good idea
[00:00:00] Intro: Forget the civilized path. It’s time to break the chains of debt and dependency, take control of our financial lives, and live free. This is the Fiscally Savage Podcast.
[00:00:16] Dylan Bain: Hello and welcome to Fiscally Savage. I’m your host, Dylan Bain. Happy Friday, everybody. And if you’re new here on these Friday shows, this is where we take something in the news and go one step deeper. And I’ve been on a tear talking about different schools of economic thought, doing a series on that. Did a three-part series. Totally should go back and take a listen to it. And then of course last week, I did an ask me anything or AMA where I took some of the listener questions and then did my best to try to explain them. But today, we’re actually gonna talk about something in the news. And the reason being is because like a bad penny, crypto continues to turn up in my life. That’s right, ladies and gentlemen, we are going to talk about the SEC’s lawsuit against Coinbase and Binance. Now, it’s probably no big secret that me myself personally, I’m not the biggest fan of cryptocurrencies, mostly because they have yet to actually prove value in doing anything other than departing people who are hyper-excitable from their money. They don’t operate in any of the forms of money, that is, being a unit of exchange, a store of value and a unit of account. It fails in all of those tests. And while cryptocurrency and blockchain technology specifically has a lot of promise, the current incarnations of them typically operate is either pump-and-dump schemes or Ponzi schemes, and in the best-case scenario are just really fancy digital collectibles. But let’s just get into this lawsuit and start talking about some of the arts and crafts that are around it because I do think it’s kind of interesting.
[00:01:42] Now, if you’ve been with me for a while, you know that back in December, I did a four-part series on cryptocurrency. You can go back and take a listen to that, but you’re going to want to listen to part three where I talked specifically about the collapse of FTX. FTX, of course, was a cryptocurrency exchange that was owned and operated by a gentleman by the name of Sam Bankman-Fried or SBF. And there were several venture capital firms that had invested in it, like Sequoia Capital. He had also a hedge fund — a quantitative hedge fund without any math in it that was headed up by his girlfriend who was described by Sequoia Capital as — and I’m quoting — a sultry wood nymph. And so when it came out that FTX, their balance sheet, the thing that they were using to say that they could get loans and money, was actually fictitious because it was mostly in a token called FTT. And there was a gentleman by the name of Changpeng Zhao — also known as CZ, also the CEO and the person who owns a majority stake in Binance, the world’s largest cryptocurrency exchange — tweeted out that he was going to be selling the FTT token. And when he did that, it spiked the price, which means that the FTT token went massively down because there was this huge selling. Now, FTX couldn’t cover the customer deposits. This led to a run on the cryptocurrency exchange, which then led to FTX going into bankruptcy, and, well, you can go back and listen to the podcast for all the rest of the details.
[00:03:11] But it’s interesting to me because one of the points that I made at the time was, well, Binance is operating a very similar scheme to FTX. That is, FTX has its own internal token, FTT. They value a lot of their balance sheets and different accounting functions based upon their own internal token. It’s kind of like if I just created money inside of my household and then went over to the bank and said, “No, see? I’ve got 40 million Bain bucks over here, and you should give me some money as a loan against that value” and the bank, for whatever reason, decided, yeah, I’ll take a bit of that action. And one of the other points that I made on Binance is that it would be interesting considering that the CEO of Binance, CZ, was a rival of the CEO of FTX, SBF, and that they were running similar operations. So if FTX collapses, I kind of thought it was only a matter of time before Binance collapses. And now, we’re in this situation where we should be asking lots of questions. You know, like, what do these things do? What is this lawsuit, and why is it that we have a tendency to follow CEOs that don’t seem to have any understanding of what they’re doing but they have their initials as their moniker, and so for some reason we think they’re smart?
[00:04:26] So let’s actually start getting into this. But one of the things I said with FTX is that the trial of Sam Bankman-Fried is going to hinge very heavily on the idea of whether or not cryptocurrency is a security or not. And if it is, well, they’re all pretty much dead to rights. And if it’s not, we have a very different conversation. There is a legal test. And if you’ve studied case law in the United States at all, you know that typically the Supreme Court will come up with a test in how do we test if something’s this legal animal versus this other legal animal. In this particular case, it’s a test called the Howey Test. The Howey Test has four prongs to it. So something is considered a security if number one, there’s an investment of money; number two, that investment of money is in a common enterprise; number three, there’s an expectation of profit; and then number four, it’s derived from the efforts of others. And it’s interesting to see that this is an “or” not an “and” which means we don’t have to consume all four attributes. There is also some of the understanding that securities also come with ownership interest and the ability to make decisions, which really calls into question things like governance tokens. So does cryptocurrency, in general, pass the Howey Test? And the answer is yeah. From a legal standpoint, most legal scholars agree that cryptocurrency easily qualifies as a security for the sake of the legality of it.
[00:05:55] But what’s interesting here is that something can be a security and still not be allowed to be traded on a publicly available exchange because the definition of security has a legal definition. But the SEC has its own definition of securities that allow them to be registered. So for example, if you wanted to go buy some shares of Tesla, you’re buying stock in Tesla. That’s the security. But that security is also registered to the SEC as a security that will trade on an exchange, in this case, the New York Stock Exchange or NASDAQ. I actually don’t know which one Tesla trades on, but you get the idea. The thing about cryptocurrency though is that there is no actual underlying substantive anything that’s behind it. Tesla can point to its output for its factories. It can point to its worker base. It can point to its technology, its patents, all of its assets. It has things that are substantive that you can go point to and put your hands on, but cryptocurrency doesn’t have that. And so if I’m analyzing the stock of Tesla, I have a whole bunch of of publicly available data that I can use to make my assessment. That is one of the things about being a publicly traded company is that when you register your security, you have to agree to the SEC’s rules around making that information public and transparent. But if you’re a cryptocurrency, even if you wanna register as a security, you couldn’t do it because there’s no underlying business behind it, which means that volume of transactions is really the only data point you have to go on, and that’s gonna come up here in just a second.
[00:07:29] But it’s worth noting that from a legal standpoint, crypto could actually be completely separated from Bitcoin. And I say Bitcoin specifically because Bitcoin is the thing that the SEC or at least Gary Gensler, who is the chair of the SEC right now, has stated is a commodity and not a security. And again, legal terms matter here. Bitcoin doesn’t have an underlying economic purpose. There’s no common enterprise. Yes, there’s an expectation of profit, but it’s a thing like corn or oil, and we trade it back and forth almost like it’s a collectible, and that’s governed by a completely different set of rules than, say, securities are. And so the question that’s going to come before us is: what is a security when it comes to crypto? Bitcoin’s probably excluded from this already. And if it is, to what degree do we wish to regulate it?
[00:08:21] So there’s one other piece of information that we need before we can really dig into this lawsuit, and that is: what does it mean to engage in trading? So if you spent any time on the exchange, so let’s say for example that you decided to go open an account with M1 Financial and you go to M1 Financial and you say, “I wanna buy one share of VTI” — that’s Vanguard’s Total Market Index ETF. So you, say, put in your money, you then buy that, and then you get a confirmation from a company called Apex. And you’re like, “Wait. Who’s Apex? I don’t understand this.” There’s actually three entities involved in that trade. So anytime that you are doing this, whether it’s through Vanguard, Charles Schwab, Robinhood, M1 Financial, you name it, there are three entities by law that are required to be involved.
[00:09:07] Number one: the exchange. The exchange is the marketplace. It matches buyers and sellers. The New York Stock Exchange, NASDAQ are the ones in the United States that we point to, but there’s, you know, exchanges globally and worldwide. So all the exchanges purposes is to be one place where buyers and sellers can meet to find each other. Now, I don’t know about you, but I’ve only been in New York City one time in my life, and I don’t want to have to — every month when I get my paycheck that then goes into my 401(k) — I don’t want to fly to New York City, go to the New York Stock Exchange, show up, and then exchange my money. Instead, I hire somebody to do that on my behalf. This is called the broker-dealer so — and this is the person who then makes the trades for me. In this case, it would be Vanguard, M1, Robinhood. You typically have your investment account at the broker-dealer who then goes on your behalf to the exchange to make your purchases and your sales. But — and this is a pretty important piece — the broker-dealer just does the deal for you, and the exchange is just the place that happens. But the actual exchange of money and securities — so I put in my money, I get one share of whatever — that’s done by a clearing house. That’s, again, that’s the third party here. And that clearing house moves the money, the securities, and keeps all the records. So if you’re working with M1 Financial, it’s Apex Clearing. And to be clear, Robinhood has, within it, there’s the corporate Robinhood umbrella and inside of it, it has its broker-dealer arm, and then in a separate corporate entity, it has its clearing house. So there is ways to be able to do this in-house, but one of the things that the SEC is saying is that, well, Coinbase and Binance are operating as illegal exchanges, and part of the what makes them illegal is number one, they didn’t register with the SEC as an exchange; number two, what they’re exchanging are unregistered securities; and then number three, they’ve combined the exchange, the broker-dealer, and the clearing house all into one entity — in this case, called Binance and Coinbase. This is the crux of the SEC’s argument for Coinbase.
[00:11:19] And one of the things that people have started saying is that Coinbase has been — they’re a publicly traded company. And so well the SEC then clearly signed off on their business plan because now they’re doing exactly what they said they were gonna do when they listed. And this is really a misunderstanding of how companies end up listing on the public exchange. When companies go to list on an exchange to go public, what they do is they have to submit themselves to an examination by the SEC. But that examination is really just to make sure that they meet the reporting and compliance standards. And, you know, when I worked in public accounting, I’ve been part of these meetings. That’s all they do. They might ask like, what do you do for business? And you can explain it, but they’re not gonna go check that, and none of that is required to be audited. Nikola Motors is a great example of this. They went through — they went public through a SPAC transaction. And then, it turned out that most of their technology was completely fraudulent; that they were rolling vehicles down a hill to show that they, quote unquote, worked. And Trevor Milton was arraigned and convicted of fraud because of it. That was the former CEO and majority stakeholder in Nikola Motors. And one of the things that came with being a public company is the SEC actually gave them notice. “Hey, heads up! You’re operating an illegal exchange. We’re going to serve you unless you register as an exchange,” which gave Coinbase an opportunity to actually do so. But let’s just put a pin in that for a second ’cause I’m gonna talk about why Coinbase, even if it wanted to, really couldn’t.
[00:12:46] So basically Coinbase and Binance — because this is the commonality between these lawsuits — were operating without the rules and safeguards that everyone else has to follow to prevent fraud. They also were not requiring publicly available information to be disseminated broadly among investors, meaning that, you know, some investors got some information and other investors got other information. What information would be underlying a cryptocurrency? Nobody really can say, but there are reporting requirements if you’re running a security. And then, of course, there was the conflicts of interest and the requirement for recordkeeping. But hey, this sounds familiar. I feel like, Dylan, you’ve talked about this before. Well, yes I have because during the collapse of FTX after Sam Bankman-Fried stepped down as CEO and was subsequently arrested, they brought in a man who’s famous for unwinding very big, large, and complicated companies that have failed. That is, of course, my boy, John Ray III, who is famous for his unwinding of Enron back in the early 2000s. What did John Ray III say about FTX’s records? It was, quote, the worst he’s ever seen in his career, unquote. Holy shit! That’s bad. And so one of the things that would’ve protected FTX was if the SEC had actually acknowledged them as an exchange and then said, “No, you must subject yourself to an audit that’s going to help make sure that you are keeping adequate records, have adequate controls, are making your information publicly available, and you’re doing everything to prevent conflicts of interest and fraud.” One of the things that Sam Bankman-Fried in fact did is he tried to get regulation for the crypto space, and mostly because he felt it would add legitimacy to the cryptocurrency exchanges, but also because on some levels it would’ve meant that they actually knew how to make this work. As we’re gonna talk about in a second, Sam Bankman-Fried was probably more prophetic than he knew just in how the SEC was gonna deal with this.
[00:14:49] So that basically covers Coinbase and most of the accusations against Binance. But Binance, that lawsuit’s going further because now, like I said at the beginning of the show, and I’ve talked about with FTX previously, FTX had the FTT token, which was their own internal cryptocurrency, and Binance has their own one that they use, and CZ — that is, the CEO of Binance — tweeted at SBF that he was gonna be selling the FTT token, and then of course that dropped the price and destroyed the company. So I made the point at the time that like they’re kind of the same company, and it’d be interesting to see what would happen if somebody came after CZ. Well, it turns out, at least according to the SEC allegation, that they are accusing Binance of taking customer funds from its US branches and transferring them to offshore accounts and non-regulated spaces. Hey, does this sound familiar? ‘Cause it’s FTX 101. They were taking US funds from consumers and transferring them to Bermuda. So we’re right here. But wait, you’ll say you might say, “Well, hold on a second. FTX had its own like crypto hedge fund, the Alameda research,” and you would be right. Turns out, another part of the SEC’s allegation is that Binance had this same exact type of thing that they were funneling customer deposits to, and that’s just kinda weird. Like, this is so similar that I’m expecting CZ to have his equivalent of a sultry wood nymph to come prancing out to show us how their quantitative hedge fund doesn’t use any math.
[00:16:31] But the one thing that Binance really did innovate on here, though, that was above and beyond what FTX was doing was something called Sigma Chain. And Sigma Chain was a wholly-owned subsidiary of Binance completely controlled by CZ, who hold most of the shares. And what they were doing was they were taking US customer money, offshoring it into Sigma Chain, and then Sigma Chain was then buying back into Binance against Binance’s crypto holdings, who would then turn around and sell them at the exact same price right back to Sigma Chain. And if you’re thinking to yourself, “That makes no sense” because if I take one token and I sell it to — take it from my right hand to my left hand for a dollar, and then from my left hand to my right hand for a dollar, you might think, “Well, nothing actually of substance occurred” and you would be right except when you have no other underlying data, how do you assess a cryptocurrency? Volume. So every time I move that token from my right hand to my left hand and back, that counts as two trades. And if I do that enough, it looks like this currency, this crypto asset or whatever you wanna call it, is suddenly being in demand in the market. So I’ll buy into it because I want to be able to take advantage of that enthusiasm. But you might notice the price really isn’t going anywhere because these sales are what are called wash sales. The only reason Sigma Chain existed was to buy into Binance and buy up their assets to pump the volume to make it look like something was actually going on. And for some assets, the SEC is claiming that 99% of all volume on the crypto was actually just Sigma Chain trading with Binance and back and forth. And this has actually been a known problem in the crypto space because wash sales are not illegal because it’s this unregulated space. People are pumping up those volume numbers. But if you did this with securities, you’d be going to prison because it’s illegal to do that because that’s manipulation. And, you know, Bitcoin, even though it’s a commodity, it actually suffers from the exact same problem because, again, the only thing that we can judge it based upon is the volume. So if I’ve got two wallets that just continue to transfer back and forth between the wallets and the blockchain registers that as volume, which then gets reported to the exchanges.
[00:18:51] So engaging in wash trades to pump crypto pricing is illegal, and this is not okay. But it’s something that if you were in a registered exchange, you would have those rules that are ironclad that say “You can’t do this” and you’d have a team of auditors looking over your shoulder going, “Yeah, that’s not really actually okay, and we’re going to all have to sign off on it.” So what the SEC is asking for is to recover the illegal gains from these pumping schemes and then to issue CZ a lifetime ban from holding any executive position in a firm registered to sell securities in the United States, and that would be bad for him. It’d be bad for everybody that’s involved in Binance. But the reality here is that the SEC has a lot of proof to pony up in court, but the chances are good that they’ve got it, considering that they put it in into their allegations.
[00:19:43] If all of this is sounding just horribly familiar to the FTX story, it’s because it is. And one of the things that I’ve been very clear on in my position on is that I believe that cryptocurrency, for the most part, is a lot of people running pump-and-dump schemes, which is they get everyone to buy into it, they pump up the price of the currency, they sell it off at the top, and then you’re left holding the bag. This is I think in part why so many people will talk about HODL — hold on for dear life — because they need you to; because the pump-and-dump schemes only work so long as you’re not selling. And the second you start to sell, the price starts going down. And so they’re going to encourage you to HODL but in reality, they’re just waiting for their target and then they’re gonna sell and they don’t really care what happens to you after that. Or there’s the Ponzi schemes. Ponzi schemes are really common. You can, you know, just go take a look at Celsius or Terra (LUNA) or any of the other crypto firms that have collapsed in the last 24 months that were just exposed as nothing more than technologically enabled Ponzi schemes.
[00:20:45] So what’s happening right now? Well, for Coinbase it’s actually been pretty tame. But for Binance, it’s led to a gigantic run on their funds because the SEC said, “No, no, no. Freeze everything.” And so within the first day or so of this coming out, Binance lost almost a billion dollars’ worth of customer deposits as people went and had a run on the exchange. As it stands right now of this recording, which is on June the 10th ’cause I’m recording ahead of time because I’m gonna be going on a trip here soon, we haven’t seen Binance start to creak in a way that FTX did, which would indicate that they’re going into bankruptcy. But it’s entirely within the realm of possibility because if you remember from the FTX collapse, there was only two days worth of time between Sam Bankman-Fried saying, “Nope, we’ve got all the deposits. It’s not a big deal” and him filing bankruptcy. And the banks are not wasting any time going along with this because they’re starting to freeze funds as soon as Monday. So they’re getting on board with it saying, “We don’t wanna be caught with our hand in the cookie jar,” which makes sense given the fact that Signature Bank, Silicon Valley Bank, and Silvergate Capital all went under in part due to cryptocurrency issues.
[00:22:02] And where this lawsuit goes? Well, I actually think that Binance is in a lot more trouble than they probably want to admit, considering that their chief compliance officer back in 2018 said — and I quote — we are operating a fucking unlicensed securities exchange in the USA, bro — end quote. Like, come on, guys. If you’re going to commit crime, at least make it difficult for people. Like, you know, Sam Bankman-Fried at least had at least some sense of adventure when he had a Signal chat that was listed “Fraud.” And then on his spreadsheet, which is how he was managing all of his assets ’cause that makes sense for a billion dollar company, there was a tab that was literally labeled “Poorly Hidden Fiat account,” which of course was at Silvergate Bank. But you kinda get the idea here. Like, these exchanges are probably in trouble and what it means for crypto is really anyone’s guess.
[00:22:59] But that brings us to a point that we should really talk about and I’ve kind of alluded to this that we’d be getting to: is the SEC actually dealing fairly? Because remember they told Coinbase upfront, “You’re running in an illegal exchange and we need you to register with the SEC” and I alluded to the idea that they probably couldn’t, which brings us to a man by the name of Gary Gensler. Gary Gensler’s the chair of the SEC and he is a favorite target for conspiracy theories around cryptocurrency. And I’ve heard all sorts of stories, everything from he hates crypto to he was in bed with Sam Bankman-Fried, both literally and figuratively; and two, he doesn’t know what he’s doing and he’s really just trying to go along with the big banks to he’s a shield for Janet Yellen at the US Treasury Department, and so on and so forth. Whether any of that’s true or not, I have no idea and I don’t care. What I do care about is facts, and what we do know as facts is, well, for starters, Gary Gensler himself is the one who classified Bitcoin as a commodity and not as a security, and he’s also stated his hostility to crypto multiple times, mostly because he views them as securities, and therefore should be entitled to the same type of regulations that grant the investors protection. And so while he’s encouraging the exchanges to register with the SEC as per the Securities Act of 1934, it’s interesting that the SEC itself doesn’t have a path for them to actually do that. That is to say that if Coinbase even wanted to do this, they would have to register with the SEC as an exchange, and then they would have to separate out. Remember those three pieces? They’d have to separate out the broker-dealer and the clearing house in order to maintain their status as an exchange. And like Robinhood, they could do this under one mega-corporate umbrella. It’s really just a legal fiction that they would have to organize the deck chairs to make them look like the SEC wants them to look. But the SEC doesn’t have a path for them to do that. More to the point, they have policies that prevent platforms from even separating these three functions for a variety of reasons. And that doesn’t even get into the fact that the SEC’s rules and regulations prevent broker-dealers from actually dealing in cryptocurrency. So that is to say, if Coinbase were to actually register themselves as an exchange, they would no longer be allowed to handle crypto, which is their entire business. And so this really starts to look like the SEC is trying to just take aim at cryptocurrencies in general and shut down the exchanges, hoping to shut down the entire system — at least that’s what a lot of overheated headlines have indicated.
[00:25:37] And ladies and gentlemen, I can’t really tell you that they’re wrong. I don’t know what Gary Gensler’s game is here, but I actually do think that this is a terrible idea to actually go after this lawsuit. I think the whole thing’s silly, and here’s why. For starters, I don’t wanna give a veneer of legitimacy in any way, shape, or form to crypto. By giving it regulations, you’re gonna do just that. By making and forcing them into the regulatory framework, that’s going to give them legitimacy if they can actually get in there. And the fact that Gary Gensler is not allowing a path for them to do the very thing that he’s telling them they have to do really just makes him look like a bully. And it’s terrible optics, which then makes them the underdog. And if there’s one thing that people in the United States love, it’s underdogs fighting against the evil government bureaucrat. So like, terrible politics here, Gary. Like, you should have ran that one past somebody who was something other than a glorified yes-man.
[00:26:36] The other thing about this that I think the reason I think this is silly is that I think it’s pretty clear to most people what crypto is. And that is it’s either a collectible — oh, I’ve got some Bitcoin — or it’s gambling. Like, full stop. And if we classified it as one or the other, there’s an entire set of rules and regulations that they can fit under. For example, if you’re running a gambling establishment, which is essentially what Coinbase is, well, there’s a whole bunch of different rules that like the casinos in Vegas have to actually put up with in order to operate as a legal casino. There’s rules on transparency. There’s rules on accounting. There’s rules on what the odds can be. Like, all coin-operated slot machines, there’s rules that dictate how often the person has to win, and those machines are periodically tested to make sure that they are compliant with those standards. So you get the idea here.
[00:27:32] The only time that I think that it’s appropriate right now for the SEC to be stepping in is in cases where there’s a Ponzi scheme or a pump-and-dump scheme. And this is where it can kind of get tricky because the SEC coming in now to stop this hasn’t stopped almost the billion dollars of fraud that we know about and the probable tens of billions of dollars of fraud that we don’t know about. And so at this point, they’re a little late to the party here but I guess better late than never. And I don’t have a good suggestion on how to stop the Ponzi schemes and the pump-and-dump schemes. But the reality is unless we have a compelling reason to, people should be allowed to gamble with their money as much as I myself personally think that that’s silly. I mean, at the end of the day, it’s not my call. I’m just trying to give you more information.
[00:28:21] And with that, ladies and gentlemen, happy Friday again. I love each and every single one of you. Thank you so much for all your love and support here on the show. Finding me on Instagram, sending me messages, giving me thumbs up, liking my reels. I really appreciate all of it. And with the weekend, go out, have yourselves a great time, go outside, connect with humans, and don’t put all your money into a Ponzi scheme.
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