Can virtual currency continue to grow wildly in the USA after transactions are regulated?

Last week, the SEC officially announced the indictment against Binance and Coinbase. Some people finally expected the regulatory authorities to officially intervene in various gray areas. Some people believe that related trading platforms can provide better investor protection. Some people believe that platforms and institutions should work together to maintain the ecological balance of the virtual asset market...

As for the scale of future supervision, let’s listen to the analysis of Sister Sa’s team.

Putting aside the "selfish" motives of the SEC or CFTC to sue, let's first look at the potential risks of unregulated virtual asset trading platforms:

One lot of trading, one lot of market making:

Exaggerated trading volume, false liquidity?

Last week, the SEC filed multiple charges against Binance and Coinbase, including that they combined traditional financial services such as exchanges, brokers and clearing agencies without registering these functions with the SEC as required by law, and that CZ, as the actual controller of Binance, also violated relevant regulations on functional registration.

It is conceivable that in the absence of legal regulation and institutional supervision, regardless of whether the attributes of virtual currency are identified as commodities, securities or other, when the virtual asset trading platform interweaves trading, agency, clearing and other businesses, the opaque operating system can allow it to manipulate the market and rob users.

Take the SEC’s allegations against Binance as an example:

Binance.US’s undisclosed major market maker Sigma Chain (also owned by CZ) is likely to have conducted targeted wash trading:

CZ directed BAM Trading (the parent company of Binance.US) to take on two market makers he owns and controls, Sigma Chain and Merit Peak, both entities operated by several Binance employees working at the direction of CZ. Merit Peak traded on the platform from at least November 15, 2019 to June 10, 2021. Until April 2022, Sigma Chain was a frequent spot trader on Binance.US, and it also continues to serve as a counterparty to certain OTC transactions and Convert and OCBS services on Binance.US. Sigma Chain and Merit Peak’s activities on Binance.US and their undisclosed relationship with CZ and Binance involve a conflict between CZ’s financial interests and the interests of Binance.US customers.

By 2021, at least $145 million had been transferred from BAM Trading to Sigma Chain's account, and another $45 million in funds had been transferred from BAM Trading's Trust Company B account to Sigma Chain's account. From this account, Sigma Chain spent $11 million to buy a yacht. The SEC implicitly implied that the yacht was purchased by misappropriating Binance.US user funds, although no substantial evidence has been provided. All of this is for the SEC to accuse Binance of manipulating the market by artificially creating the illusion of increased trading volume, liquidity, and trading interest in the relevant assets through wash trading.

At the same time, the SEC accused BAM Trading and BAM Management of misleading Binance.US customers and stock investors into believing that they had the ability to monitor the market and detect and prevent manipulative trading in Binance.US's crypto asset trading volume. CZ's remarks in 2019 that credit is the core competitiveness of trading platforms and that fake trading volume will bring down credit platforms provided a landing point for the SEC's allegations of making false statements and misleading investors, and also sounded the alarm that virtual assets are still outside the legally regulated entities.

Liquidity of virtual platforms may be a problem

The collapse of FTX last year has verified the high risk of asset liquidity problems under this operating paradigm.

FTX, as a virtual asset trading platform, claims to have complex and comprehensive risk control measures to protect investor assets. However, FTX's largest customer is Alameda, a hedge fund actually controlled by FTX CEO Sam Bankman-Fried. The fund is able to partially conceal this activity because the assets it trades never touch its balance sheet. Alameda does not hold any funds, but instead holds a large amount of overvalued illiquid assets (such as FTX's affiliated token FTT). In other words, Alameda borrowed billions of dollars from FTX users without FTX making any disclosures or avoiding risk reduction measures, and then made high-risk, high-leverage bets, which ultimately led to financial water injection and bankruptcy. In this case, FTX has long trapped the platform in a liquidity trap by commingling customer assets and illegally misappropriating them, and engaging in related transactions with Alamdeda.

However, Binance and Coinbase are currently in a much better situation than FTX. Not only are there no allegations of financial crimes such as fraud, but the virtual currency market is also relatively stable: According to Fortune, Coinbase's stock price took a hit this week, falling by about 13%; Bitcoin's trading price from last Monday to Friday was still around $27,000, and other major cryptocurrencies were also in relatively stable trading.

It is difficult for investors to assert their rights according to law

FTX, Binance and other companies have mixed company assets with customer funds to falsify transaction amounts and private investments, which undoubtedly makes ordinary investors bear the high risk of transactions unilaterally. However, when the platform misappropriates user assets due to fraud or negligence, or freezes user assets due to platform reasons, the legal attributes of cross-border transactions and virtual currencies make the application of laws unclear, and the lack of supervision makes it difficult for investors to compete with virtual asset trading platforms with strong funds and global trading networks and obtain compensation.

Future regulatory possibilities and directions

When the US courts decide what crimes Binance and Coinbase have committed, the nature of virtual currency is an unavoidable issue. Only when it is determined that virtual currency is a "commodity" or "security", or falls within the scope of other definitions, can the relevant laws be applied.

According to CNBC, Coinbase’s CCO responded to the SEC’s lawsuit: “The SEC is harming the U.S. economic competitiveness and companies like Coinbase that have publicly committed to compliance by relying on the only enforcement method in the absence of clear rules for the digital asset industry... (Faced with regulatory difficulties,) the solution is to legislate fair rules to make the industry more transparent and equal, rather than litigation (to expand legal interpretation). In the meantime, we will continue to operate our business as usual.”

According to its statement on its official website, Binance believes that the SEC is trying to unilaterally define the structure of the virtual currency market by marking specific tokens and services as securities. On the contrary, the SEC's move is a rush to compete with other regulators (such as the CFTC) for virtual asset jurisdiction, and protecting investors is not a priority.

According to the New York Times, US lawmakers do not all have a sense of urgency to legislate the virtual asset trading industry, and regulation will be a long and slow process. Enforcement actions may be carried out before the relevant bills are passed, and hot issues such as property characterization may be decided by the federal courts first. However, from the industry's perspective, this indirect path may eventually succeed. The US Supreme Court has shown a willingness to limit institutional power, and cryptocurrency lobbyists are well aware of its impact. In the next term, the justices will reconsider the current theory that requires courts to obey professional institutions, which may further curb administrative power.