WASHINGTON—Regulators tried to police the crypto market using the strongest weapons they have. Now they are likely to lay down their arms.
The Securities and Exchange Commission sued crypto exchanges Binance, Coinbase and Kraken last year, accusing the platforms of dealing assets that are illegal to trade without regulatory supervision. Crypto executives had refused to comply with financial rules that they said were a bad fit for digital currencies.
The SEC, under the leadership of Chair Gary Gensler, mounted the legal campaign in lieu of the industry’s request to craft new crypto-specific regulations that embraced a lighter touch. Had the commission won in court, the victories would have compelled the freewheeling market to follow longstanding agency rules that protect investors who buy securities. But litigation can take many years to resolve, and with Donald Trump’s election to a second term, Gensler has run out of time before his biggest cases reach the finish line.
Trump’s return to the White House will mean a new era for crypto—with fewer government hurdles. The president-elect, shedding previous skepticism of crypto, has pledged support for the digital-asset industry, whose leaders embraced his campaign. He also wants to curb the independence of agencies such as the SEC and the Federal Reserve.
SEC Chair Gary Gensler ran out of time before his biggest cryptocurrency cases reached the finish line. - Justin T. Gellerson for The Wall Street Journal
The next SEC chairman is likely to offer crypto exchanges a favorable settlement. Lawyers considered as candidates to succeed Gensler have positioned themselves as critics of his litigation. One who has been considered, former SEC General Counsel Robert Stebbins, said the agency should pause most of its crypto lawsuits while clearing a path for the firms to do business without the overhang of litigation. “To the extent there are no fraud claims involved, my sense is the commission would be likely to dismiss those cases in the future,” Stebbins said.
Others candidates who are on Trump’s shortlist include former SEC commissioner Paul Atkins and ex-Coinbase Chief Legal Officer Brian Brooks. They declined to comment.
Dismantling the litigation would spell the end of an adversarial approach to crypto that began in 2017, during Trump’s first term, when the market was flush with new digital assets that were being sold to the public without any restrictions. Trump was critical of crypto during his earlier tenure, once saying its value was “based on thin air.”
At the end of Trump’s first term, the SEC filed a lawsuit against Ripple Labs, which sold $1.3 billion of a cryptocurrency known as XRP. The SEC last year lost part of that case, dealing the agency its one big litigation setback.
The rise of crypto exchanges in the early days of the pandemic gave a new wave of amateur traders easier access to the market, driving digital coin prices to new highs.
Amateur traders got easy access to digital coins as a result of the rise of cryptocurrency exchanges. - Joe Raedle/Getty Images
Gensler flipped the SEC’s attention away from the hundreds of coin issuers to those exchanges and similar middlemen. He reasoned it was a more efficient way to deal with the noncompliance he believed was rampant. The SEC’s earlier probes produced dozens of settlements with smaller market participants but didn’t sway the exchanges from adding many new coins to their platforms.
The sudden collapse of crypto exchange FTX and cascading failures of crypto lenders in 2022 seemed to confirm Gensler’s warnings about the fast-growing, unregulated market. Individual investors lost billions of dollars on their holdings because of fraud and the industry’s poor risk management.
Months after FTX’s implosion, the SEC fired its biggest shots, accusing Coinbase, Kraken and Binance of operating unlicensed exchanges because they sold securities without following investor-protection laws.
While smaller firms settled with the SEC, the exchanges didn’t see that as a viable option. For them, settling on the SEC’s terms meant losing. Coinbase, for instance, would have had to delist many of the digital coins it trades and stop offering other programs such as staking, a way for traders to earn extra money from tokens they own. Other SEC rules forbid exchanges from holding investors’ assets, raising the prospect they would have to separate their functions into separate companies.
Crypto companies have argued that investment regulations written for Wall Street just don’t work for digital tokens designed to run over peer-to-peer computer networks. Coinbase, for example, says most cryptocurrencies are akin to commodities or collectibles, comparing them to baseball cards or Beanie Babies.
Smaller crypto firms settled with the SEC, but the exchanges didn’t see settling as a viable option. - Farrah Skeiky for The Wall Street Journal
Gensler’s exit next month comes as some of the SEC’s legal arguments have been accepted during preliminary phases of litigation. Among his recent victories, a federal judge in Seattle roundly rejected one of Kraken’s arguments and accepted the SEC’s view of how to apply a legal test for determining which investments are securities.
Gensler said in a recent speech that “court after court has agreed with our actions to protect investors and rejected all arguments that the SEC cannot enforce the law when securities are being offered—whatever their form.”
Other judges have expressed reservations.
“The agency’s decision to oversee this billion dollar industry through litigation—case by case, coin by coin, court after court—is probably not an efficient way to proceed, and it risks inconsistent results,” U.S. District Judge Amy Berman Jackson in Washington, D.C., wrote this summer when she dismissed a portion of the SEC’s claims against Binance.
Some experts say the SEC wasted valuable time by positioning itself like a beat cop and should have rallied around a set of new rules that could have produced more immediate protections for investors and consumers. “It wasn’t the right approach,” said Sarah Hammer, executive director at the University of Pennsylvania’s Wharton School.
Gensler said in a speech in November that he simply continued the tactics used by former Chairman Jay Clayton, who ran the SEC during the first Trump administration.
Others say Gensler didn’t have better options than using his enforcement division to go after crypto firms he believed were violating securities laws. If he had instead offered the industry new regulations, firms likely would have challenged them, landing the two sides in court anyway, said Marc Fagel, a former director of the SEC’s San Francisco office.
“Anything short of rules that were 100% embraced by crypto would have been litigated into oblivion,” he said.
