Things Are Getting Real, but Not Real Good, for Crypto

Rather than enjoying a spring thaw, crypto’s 2022 winter is transitioning to an ice age.

This, as New York Attorney General (NYAG) Letitia James on Thursday (March 9) alleged that the popular cryptocurrency ether is a security in a freshly filed lawsuit against KuCoin, one of the largest crypto exchanges by transaction volume behind similarly embattled peers Binance, Coinbase and Kraken.

The suit brought by James joins a spate of other recent actions, including the collapse of the crypto-catering Silvergate Bank, that have sent the digital asset market tumbling. Bitcoin, widely viewed as a sector barometer, fell 8% to trade below $20,000 while the broader market has shed around $70 billion in the past 24 hours alone.

The filing by James represents the first time a regulator has claimed in court that ether, one of the most valuable digital assets behind crypto’s nominal bitcoin, and which has long been treated as a commodity by state and federal regulators, including the Commodity Futures Trading Commission (CFTC), is a security.

According to the lawsuit, the NYAG also believes the luna (LUNA) token and terraUSD (UST) stablecoin, both traded on the KuCoin exchange, are securities as well.

The crux of the suit rests on the allegation that if the digital assets are proven in court to be securities, then KuCoin will have been operating illegally in New York state.

It could have far-reaching implications on crypto markets and dramatically change how cryptocurrencies are traded in the U.S.

An Elaborate Simulation of Finance That Produces Gains and Losses

“[This] action is the latest in our efforts to rein in shadowy cryptocurrency companies and bring order to the industry. All New Yorkers and all companies operating in New York have to follow our state’s laws and regulations. KuCoin operated in New York without registration and that is why we are taking strong action to hold them accountable and protect investors,” Attorney General James said in a release announcing her office’s action.

The lawsuit alleges that “KuCoin, a cryptocurrency trading platform, violated the Martin Act in at least three ways,” and seeks to direct “KuCoin to implement geo-blocking based on IP addresses and GPS location to prevent access to KuCoin’s mobile app, website, and services from New York, an accounting, restitution, disgorgement, and costs against KuCoin.”

The petition underscores the NYAG office’s belief that ether, along with the LUNA and UST tokens, are speculative assets that rely on the efforts of third-party developers, including Ethereum founder Vitalik Buterin, to provide profit to the token holders.

Ever since the Ethereum network switched last year from a “proof-of-work” architecture to a “proof-of-stake” blockchain network where investors can “stake” their coins in exchange for rewards, speculation has been simmering around what that shift might mean for its regulatory status.

Industry observers have noted that the new “staking” protocol is not too far away in practice from the interest that is paid out on bonds.

The recent NYAG action is far from the first time KuCoin has faced regulatory pressure around its operations.

The exchange was accused by South Korean regulators last August of conducting “illegal business activities” without proper registration, and this past December faced similar allegations from the Dutch Central Bank, which alleged the crypto platform was operating without a license.

KuCoin was most recently valued at $10 billion during a funding round last May that saw the exchange land $150 million in a Series B led by Jump Crypto.

Do the Benefits of Crypto Outweigh the Costs of Regulating Them?

Observers critical of crypto are wary of granting the industry the validatory halo that proper regulation might bestow, preferring to bring legal actions against it and let the sector dissolve in far-flung jurisdictions.

The thought being that regulating crypto might encourage deeper and more difficult to disentangle relationships between the digital asset ecosystem and the traditional financial sector, generating greater systemic risks.

Federal Reserve Chairman Jerome Powell earlier this week (March 7) called crypto “a mess,” adding that, “what we see is quite a lot of turmoil, we see fraud, we see a lack of transparency, we see run risk.”

The specter of a security designation has long hung over the crypto sector’s various digital assets, and US Securities and Exchange Commission (SEC) Chair Gary Gensler has hinted that he considers all tokens to be securities.

Despite that, and as reported by PYMNTS, only nine crypto firms have registered successfully with the SEC — and more than half of them are no longer in business. None of the nine registered during Gensler’s own tenure as SEC head.

PYMNTS has also covered how crypto crime hit an all-time high of $20.6 billion last year — a number that represents a “lower bound” estimate.

As the industry struggles to right itself and mature, it is becoming increasingly difficult for even the most ardent observers to find a bright spot to light the way.