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After the crypto crash comes the SEC crackdown

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It’s been a rough couple months for some people who’ve had it easy for a long time. A growing number of cryptocurrency operations may finally be facing some consequences for their alleged illegal actions.

On Monday, the Securities and Exchange Commission charged 11 people behind Forsage, calling it a $300 million Ponzi scheme disguised as a smart contract system. This was less than a week after the New York Times reported that crypto trading platform Kraken was being investigated by the Treasury Department for violating US sanctions against Iran. And just a few days before that, the FBI and a US district attorney in New York indicted three former Coinbase employees for insider trading.

Which agency is in charge of regulating cryptocurrency isn’t clear-cut. Both the Commodity Futures Trading Commission and the SEC claim jurisdiction here. The SEC, however, seems particularly interested in going after crypto schemes that fall under its purview — which seems to be most of them.

“The SEC is in the midst of a continuing onslaught against crypto firms from every direction,” John Reed Stark, a cybersecurity expert and former SEC enforcement attorney, told Recode. Stark noted that the agency has expanded its crypto unit and SEC chair Gary Gensler has made no secret of his belief that many cryptocurrencies are securities, and that he intends to regulate them as such.

So even though it’s hot outside, we’re in the middle of a crypto winter that may never end. During the pandemic, the cryptocurrency market ballooned to $3 trillion, helped along by new platforms that made investing easy enough for just about anyone to do. Since last November, however, the market has plummeted. It’s now worth about a third of what it was at its peak, and there’s no sign that value will bounce back significantly anytime soon. The crash has devastated some of the companies operating in this space — and their customers, too.

Now, the law is coming for certain crypto companies and their leaders. But it remains to be seen exactly what consequences, if any, many of these companies and the people behind them will face.

Unlike with traditional banks, when crypto lending platforms go belly-up, there are no protections in place to ensure that investors are made whole. Two crypto lending platforms, Celsius and Voyager, went bankrupt in July, and their customers may never get their money back. Some supposedly safe crypto investments called “stablecoins,” which are pegged to the value of a fiat currency like the US dollar, have also been proven not to be very stable at all. Last May, stablecoin Terra’s value plummeted, dragging the Luna coin, whose value was linked to Terra’s, down with it. Luna was once worth as much as $116. Now, it’s worth a fraction of a cent.

But as investors’ losses mount and enforcers’ expanded crypto arms get to work, it looks like a day of reckoning is finally coming for some of these companies, which have been operating in a space with few rules. The outright scams, obviously, weren’t following the rules at all. But some of the more legitimate companies, allegedly, have played fast and loose with them too.

“The arrogance and the hubris in the realm of crypto is so beyond measure,” Stark said. “They’re always belligerent, combative, and calling the SEC sketchy.”

“I’ve never seen anything like this and I’ve been practicing for over 30 years,” he added.

Again, the SEC is only one of several government agencies going after crypto. And when a lot of people lose a lot of money, the government is going to pay even closer attention. But there may not be much it can do for some people, as crypto isn’t regulated like traditional banks and securities — something many crypto investors didn’t realize until it was too late.

“With so much new money pumping up token values, so many people wanted in without understanding anything about the space,” said Matt Binder, a reporter for Mashable who also hosts Scam Economy, a podcast dedicated to crypto and Web3 scams. “And the industry took advantage of a lot of those people.”

It didn’t help that some of their favorite celebrities endorsed these projects, or that some of these companies were seemingly so flush with cash that they could buy ad space on the most expensive show in town. It also didn’t help that crypto became as easy to buy as an ATM transaction. And it really didn’t help that many people went into crypto knowing little, but assuming they’d have the same protections as they do from more regulated institutions like traditional banks and investment firms.

Stark predicts that we’ll see more action against these crypto companies in the coming months and years, with the SEC focusing its efforts not on the small-time scammers but on the gatekeepers they use for their scams: “trading exchanges, platforms, whatever you want to call them.” And he thinks it and any other agencies investigating the world of crypto will get a lot of help, possibly from people inside of it.

“When companies start engaging in this kind of stuff, you do get people who want to be whistleblowers or they become complainants,” Stark said. “And when criminal prosecutors start nosing around, people can become informants very quickly.”

Molly White, who has chronicled various Web3 failures at Web3 Is Going Just Great, isn’t so sure yet that the increased scrutiny, investigations, and charges will add up to a real change.

“The insider trading charges feel like a drop in the bucket compared to the amount of insider trading that has been plainly known to be happening at Coinbase and elsewhere, but it is at least something,” she said. “It’s concerning to me how slow these actions are coming out in an industry where people can perpetrate scam after scam in the meantime.”

“I’ll believe there’s progress when I see it,” she said.

If regulators can’t make that progress in court, perhaps at the very least all of the attention the crypto crash has gotten will discourage potential investors from putting money into a volatile market that they don’t really understand and offers them few protections.

“I think these crackdowns can help keep the public away from crypto,” Binder said. “There will be some companies that try to ‘go legitimate,’ but at the end of the day, they’re still a crypto company, selling the dream of getting rich via speculative asset trading, with no actual real product or service.”

That won’t do much, however, for the people whose dreams have already become nightmares. White said that while some of the earlier crypto loss stories were more amusing and the victims less sympathetic (see: “All My Apes Gone”), that’s not the case anymore. “Now we’re seeing people writing letters to a bankruptcy judge about how they’re financially ruined and contemplating suicide,” she said.

Or as Binder put it, “We have a few people who hit the lottery and a ton more who lost everything.”

This story was first published in the Recode newsletter. Sign up here so you don’t miss the next one!





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