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Monthly Market Review - May 2023

This is my third attempt at writing this month’s update as I thought the recent SEC litigation against Binance was the most topical news, causing a rewrite, and then the SEC also charged Coinbase (causing my second rewrite). So, let's look at where we currently stand and what this legal action means for the industry and its role in the US.

Bitcoin

Ethereum

Price (1 May 2023)

$29’380

$1’906

Price (31 May 2023)

$27’219

$1’874

% Return

-7.9%

-1.68%

Binance and Coinbase have approached regulation very differently. Coinbase is a Delaware-registered, US-listed company that Deloitte audits. It has constantly talked with the SEC and other US-based regulators about its licensing, spending millions of dollars trying to achieve compliance. Its interactions have been in good faith with the US regulator. The business is also wholly based onshore in the US, with all its income coming from US-based sources; in terms of compliance (at least in the eyes of the US), it has been the good actor and the industry's North Star.


Binance has been the opposite; it raised initial funding using a digital asset called BNB, has no permanent headquarters, and isolated its US operations into a small subsidiary called Binance.US (BAM Trading). It has also been much more aggressive with its product offering to include derivatives and options and, so far, has dominated the market since its launch.


Firstly, the Binance and Coinbase charges are telling in their similarities and differences. When the SEC charged Binance on Tuesday, it claimed Binance was running an unregistered security exchange and made some claims about lack of controls in the past. The latter claims primarily concern the separation of assets between Binance International and Binance US in 2018. These are serious charges, but crucially there weren’t any charges related to any form of fraud or theft, as would be the case if the SEC thought Binance was stealing funds. In a roundabout way, it's an endorsement of the Binance group as a digital asset exchange, as the SEC would have laid more severe charges if they were warranted. Binance’s BNB and Bitcoin both fell on the news, but there were no noticeable net outflows of assets from the Binance platform. The net outflow of assets from Binance can be seen here, and since the news, less than 5% of funds have been withdrawn.


On Wednesday, the SEC also charged Coinbase with running an unregistered securities exchange since 2019. Charging Coinbase and Binance within 24 hours was a shot across the bow from the SEC to the industry. The perplexing part was that the SEC allowed Coinbase to go public in 2021 with the same business model, so retroactively charging them after approving the business model creates enormous uncertainty in the market.


The SEC’s filing clearly shows that it has targeted certain digital assets. It listed Solana as a security that Coinbase has tradable but not Bitcoin or Ethereum, implying that Solana is a security but not Bitcoin or Ethereum. Solana is an interesting case as it registered its first sale with the SEC and followed best practices when launching its digital asset, where it raised initial capital from venture capitalists and developed a working product before launching its digital asset into an operational network. Ethereum followed the same path where it raised funds from an ICO (worse than a private sale in the eyes of the SEC), and it has a centralised authority, the Ethereum Foundation, that constantly drives technical improvements and periodically sells ETH to fund itself. The only significant difference is their time in the market; Solana is four years younger than Ethereum. So, why wasn’t it mentioned? Has Ethereum become so decentralised that it’s no longer a security and has now become a commodity? The SEC has refused to comment on ETH specifically, but its lack of mention in the filing is telling.


These are questions that Coinbase has already asked the SEC, and so far, it has refused to engage in proactive regulation or guidance on whether a digital asset is a security. Coinbase even developed a good faith internal scoring rubric to rank the likelihood of a digital asset being a security, yet the SEC has still charged it.


The industry is very frustrated at the SEC and its stonewalling. Especially Coinbase, which relinquished its market lead to Binance due to its cautiousness in launching new products that may not be compliant, yet they still both ended up being charged. As an outside observer, Binance’s disregard for compliance was the better strategy. Both companies are well-capitalised and will fight the SEC through the courts, so settlements are unlikely, and an outcome will take time.


In the medium term, the future of digital assets is uncertain in the US. All US-based blockchain companies will look offshore, as there is little benefit in operating in the uncertain environment the SEC has created. The UAE, Switzerland and Singapore have been very digital asset friendly, and these countries seem best suited to benefit from the US’s uncertainty.


The motivation for these cases is also political, as all US regulators are jostling to be the ones who regulate digital assets. Claiming jurisdiction will lead to the growth of a regulator’s budget and importance. I believe the overall outcome will be more political than most realise; the Republican senators have already started drafting digital asset-friendly regulations, while some Democratic senators have been more sceptical regarding digital assets. In the longer term, I believe the US will get the balance right and develop a clear digital asset strategy, but for now, the uncertainty is threatening its current lead within the industry.


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