US Projects At Risk Of The SEC’s Wrath

Introduction

The crypto industry is facing its toughest challenge yet. Following a tough 2022 beset by market collapse and regulatory violations, all hopes for an accelerated recovery this year have been dashed as US regulators and the SEC ramp up their efforts to rein in the wild west of crypto assets.

As such, many crypto projects are finding themselves in the crosshairs of investigations, fines, and other legal actions. Some of these projects could face existential threats, while others could emerge stronger and more resilient.

Already, rumors abound that some major DeFi projects have received Wells Notices of the SEC’s intention to file charges against them, having found sufficient evidence of wrongdoing. The panic surrounding this caused Lido’s $LDO token to drop by 10% after the rumors surfaced. Lido denied it, and David Hoffman who started the rumor recanted, but he stood by the claim that some notices have indeed been distributed, even if no one can tell who received it or when.

So, the apprehension in the crypto community remains palpable, especially after the SEC eventually won its nearly two-year-long case against LBRY some months ago after a US district judge ruled that the latter violated securities laws by selling LBRY Credits (LBC) without registering them. Investors and observers are closely watching how another lawsuit, brought against Ripple, plays out in the coming days.

SEC Chair, Gary Gensler has repeatedly commented on the legal status of crypto tokens, denying the utility or functionality of other tokens besides Bitcoin. This undermines the arguments of Ripple, LBRY, and several other crypto projects that their tokens are not securities. Lawyers continue to dispute Gensler’s approach, insisting that only the courts can determine which asset is a security or not.

Regardless, such an opinion coming from the SEC chair could have serious implications. Since securities are held to more stringent regulatory requirements than commodities, it’s a position that may stifle innovation and drive crypto businesses out of the US. In a recent talk, Garry Gensler further pointed out that any crypto token backed by entrepreneurs is likely a security, and lending and staking platforms will come under securities laws.

Projects at Risk

Ethereum

Ethereum’s case is a bit complicated and controversial, especially considering the upcoming Shanghai upgrade. The main feature of the Shanghai upgrade is that it will implement EIP-4895, which allows validators to withdraw staked ETH. As for how this will affect Ethereum’s regulatory status, it is hard to say for sure.

On one hand, it could make Ethereum more decentralized and less dependent on any central issuer or promoter, which could strengthen its case for not being a security. On the other hand, it could also create more complexity and uncertainty for users and regulators alike, who may have different interpretations of what constitutes security or not.

Lido

Lido is a decentralized autonomous organization (DAO) that provides a liquid staking service for Ethereum 2.0 and other proof-of-stake blockchains, such as Polygon. Lido’s tokenized stake for Ethereum 2.0 is called stETH, which represents one-to-one the value of ETH staked with Lido.

LDO is the governance token of Lido, and LDO holders also benefit from a share of the revenue generated by Lido’s staking service. On the Bankless podcast, a rumor was started that Lido had received a Wells Notice, causing the project to dump 15%. This rumor was later walked back. This doesn't change the fact that Lido could still be a target for the SEC.

Uniswap

Uniswap is a decentralized exchange (DEX) that uses a set of smart contracts called liquidity pools to execute trades automatically and provide liquidity for the market. If the SEC concludes that some of the tokens traded on the exchange are securities, then Uniswap would be subjected to federal securities laws and regulations.

Second, the SEC may view Uniswap’s governance token, UNI, as a security by arguing that UNI holders are expecting profits from their participation in the protocol’s governance and that Uniswap Labs has a significant influence over UNI’s value and distribution. Note that the SEC launched a probe into Uniswap Labs back in 2021 and this might heighten the concern about Uniswap again this time.

Terra

Terra is a layer-1 blockchain created by Terraform Labs and their Founder Do Kwon. What made Terra attractive was its algorithmic stablecoin Terra USD (UST). Earlier, Do Kwon was accused by the SEC of masterminding a multibillion-dollar fraud. The complaint also made clear that the SEC deemed Luna (LUNC) and UST to be a security.

After the UST lost its peg in 2021, Terraform was accused of manipulating the peg by having a third party purchase the asset. In addition, the lawsuit hinged on the central argument that UST is security due to its ties to Anchor.

This part of the suit could have implications for other cryptocurrencies. Based on the SEC’s findings, USTC and LUNC are considered unregistered securities. This is because Anchor was promoted as a lucrative investment opportunity.

Compound

Compound is a decentralized finance (DeFi) protocol that allows users to lend and borrow various crypto assets and earn interest. The SEC has not yet taken action against Compound, but it may consider its governance token COMP as a security since it gives holders voting rights and potential profits from the protocol’s fees and rewards.

MakerDAO

MakerDAO is a decentralized protocol that allows users to create and manage a stablecoin called Dai, which is pegged to the US dollar. Users can generate Dai by depositing collateral such as ETH or other tokens into smart contracts called Vaults. Users can also borrow, lend, trade, and save Dai on various platforms that integrate with MakerDAO. MakerDAO is at risk of SEC’s enforcement actions because it may be seen as offering unregistered securities through its collateralized debt positions (CDPs) and DAI stablecoin.

Paxos

Paxos’s PAX token is a stablecoin that maintains 1:1 parity with the U.S. dollar. Additionally, Paxos offers a tokenization service that allows users to create digital representations of real-world assets, such as gold, stocks, and art. This service may involve securities laws and regulations that govern the issuance and trading of these assets. The SEC has already ordered Paxos to stop issuing their Binance stablecoin, BUSD. This charge was much more directed at Binance than Paxos but it doesn't change the fact that this could lead to the SEC later ordering Paxos to stop issuing PAX.

Gemini

Gemini is a platform that allows users to buy, sell, store, and earn interest on various cryptocurrencies. It also offers its own token called GUSD, which is a stablecoin that is pegged 1:1 to the US dollar. Gemini also runs Gemini Earn, which allows users to loan their crypto tokens, including GUSD, to Genesis Trading, a sister company of Gemini, in exchange for interest.

The SEC had alleged that Gemini Earn constitutes an offer and sale of securities under applicable law and should have been registered with the Commission. The SEC also claims that Gemini misled investors about the risks and terms of the program, and failed to disclose its financial condition and operations.

Circle

As the second largest stablecoin in the market, all eyes are definitely on Circle and its USDC token. Circle claims to be fully backed by US dollars held in segregated accounts at regulated banks. However, Circle has also disclosed that it holds some of its reserves in commercial paper, corporate bonds, and other assets.

Initially, rumors swirled that Circle had been handed a Well’s notice but the company denied it, and the reporter who announced it apologized for misleading the public. However, there is still a lot of talk about whether Circle’s USDC stablecoin qualifies as a security under SEC regulations or not.

Yuga Labs

Yuga Labs is a company that created the Bored Ape Yacht Club (BAYC) NFT collection, which consists of 10,000 unique digital images of cartoon apes with various traits and accessories. BAYC is one of the most popular and valuable NFT projects in the market. Last year, there was news that the SEC was probing Yuga Labs over whether sales of its NFTs and ApeCoin, a cryptocurrency issued by the company that can be used to buy exclusive merchandise and access events, violate securities laws. Information concerning the outcome of the investigation is not publicly available, and it remains to be seen whether the SEC will hit Yuga Labs harder this year.

Conclusion

These actions could create more uncertainty and pressure for the crypto industry. Therefore, it is hard to accurately predict how the crypto market will behave in 2023. The only thing that is certain is that it will be a dynamic space to watch. If the SEC is successful in its crackdown on these crypto projects, we could see various impacts on the crypto industry and its participants. Some possible impacts are:

• Reducing the number of fraudulent or illegal activities in the crypto space, such as Ponzi schemes, market manipulation, insider trading, etc. This could increase trust and confidence in the crypto market.

• Affected crypto projects would have to register with the SEC or obtain licenses or exemptions to operate legally. This could affect their business models, operations, innovation, and profitability.
• It could also discourage some crypto users from participating in certain activities that are deemed risky or unregulated by the SEC, such as staking, lending, borrowing, etc. This could reduce the demand and supply of some crypto assets and services and affect their prices and returns.
• Some crypto businesses are planning to relocate to other jurisdictions that are more friendly or lenient towards crypto regulation. This could create more fragmentation and complexity in the global crypto landscape and pose challenges for cross-border cooperation and enforcement.

These impacts may vary depending on how the SEC approaches its regulatory actions, how the crypto industry responds to them, how other regulators around the world react to them etc. However, Flagship FYI will be closely monitoring the latest developments to provide investors and observers with real-time updates.