by Stephen T. Gannon and Madison J. Breshears

The first quarter of 2023 may go down in history as one the most intensive periods of enforcement activity and related oversight in the history of the SEC and the bank regulatory agencies.[1] While digital assets have never been free of regulatory scrutiny, this most recent escalation could have an existential impact on an industry which has been subject to repeated disruptions since mid-2022.[2] The market has made quick work of separating the wheat from the chaff, sparing not even key, widely-respected players­. Such conditions, coupled with increasingly aggressive regulatory action, could result in an increase in the number of firms who choose to seek shelter off-shore, or protection through acquisition by larger, traditional incumbent financial institutions. What follows is a brief summary of this recent regulatory activity, but there is surely more to come. This article will also reflect on the causes and consequences of this regulatory initiative, and what lessons might be learned.

Enforcement activity in the digital asset space was somewhat spotty and confusing prior to the second half of 2022. While there had been a series of enforcement actions in 2018 against initial coin offerings (“ICOs”),[3] those were relatively easy pickings for the SEC (not least because so many were blatantly fraudulent.[4]) Take for example, the SEC’s 2018 action against Titanium Blockchain Infrastructure Services. The ICO raised 21 million dollars through what the SEC dubbed a “create and inflate scheme,” (though the less-technical term, “big-fat-scam,” may do just as well). The choice to fundraise through an ICO was perhaps the only thing ‘new’ about Titanium’s business, that novelty aside, what remained was plain, old, time-tested fraud— an aggressive fundraising campaign rife with false statements about the company’s legitimacy and success—among the most audacious being claims that the company had corporate ties with the likes of Apple, Microsoft, PayPal, General Electric and Boeing (when, of course, no such ties existed).[5] After it filed suit, the SEC promptly obtained a preliminary injunction, freezing the company’s assets, and, four years later, CEO Michael Alan Stollery pled guilty to fraud in a criminal follow-up case initiated by the DOJ.[6] The common theme throughout these early actions against ICO’s was that the ICO itself frequently served merely as a jurisdictional foothold for the SEC to pursue companies engaged in obvious scams, and the cryptocurrency tokens themselves were little more than shiny bait for credulous investors. In retrospect, the ICO craze of 2017 played-out not unlike the dot-com bubble of the late-nineties—most ICO’s were flops at best, and scams at worst, and only a small number made investors money (though, if you were fortunate enough to bet on one of those handful of successful firms, you almost certainly made a lot.) A 2018 report by Forbes painted the grim picture with the following hypothetical—had one invested 100,000 dollars in the ten largest ICO’s of 2017, that investment would have been worth 160,936 dollars by the end of 2018 (an impressive 60% ROI, compared to 13% for the S&P 500.)[7] The catch, of course, is that those returns would have been attributable to only three out of the ten firms—six of them never generated positive returns, while another suspiciously vanished.[8]

Things began to change in late 2020 when Ripple was sued by the SEC.[9] This was the first major piece of litigation which likely will turn on the question that continues to trouble the sleep of many a tech-firm general counsel, “what is the definition of a security?”[10]  The SEC contends that the well-known Howey test[11] perfectly accommodates all forms of digital asset sales, especially Ripple’s sale of its native token, XRP.[12] However unlikely such necessary conclusions might be, there is still no clear indication about who will prevail. For its part, Ripple contends that XRP lacks the fundamental character of a security elaborated over time in the Court’s application of Howey. While the company has disputed the SEC on every prong of the Howey test, the most challenging for the SEC seems to be that XRP customers had no “reasonable expectation of profits,” in other words, Ripple did not intend XRP to be a security, and customers who purchased XRP did not believe they were purchasing one.[13] Each party argues that the so-called “economic realities” of XRP support a ruling in their favor.[14]

Along with Ripple’s argument about customer expectations and economic realities is a broader fair notice rebuttal[15]— i.e., the law surrounding this issue is so unclear and/or contradictory, that enforcement violates due process. Ripple’s Chief Legal Officer, Stuart Alderoty, tweeted a quote from a Forbes article by Roslyn Layton which read, “Not only is the future of the U.S. crypto industry at stake, but the arrogance of unrestrained regulators making policy through enforcement is on trial as well.”[16] Not only is there a lack of consensus among relevant agencies, but outright incompatible conflict (for example, the IRS defines crypto-assets as “property,” not as securities, and GAAP defines them as “intangible assets” (for the SEC, the fact that GAAP standards are issued by the industry authority FASB,[17] which itself is overseen by the SEC, via the PCAOB, is particularly inconvenient).[18] Neither side shows any sign of backing off. The decision, which will likely come in spring from the District Court in Manhattan, will inevitably be appealed to the Second Circuit, and likely finally determined in the U.S. Supreme Court.

Things turned considerably negative for the industry, however, in May of 2022 with the failure of TerraLuna.[19] That project was one in which an algorithmic stablecoin was supposed to have the ability to automatically rebalance itself to maintain a steady “peg” of $1.00 per coin. However, the algorithm failed, and Terra collapsed within days, taking with it the funds of numerous entities who invested in it, perhaps most significantly, Three Arrows Capital (3AC). The major crypto hedge fund purportedly invested $200 million in the project, but some reports have estimated the loss to be closer to $560 million.[20] Whatever the number, the hedge fund was unable to satisfy the subsequent deluge of margin calls from its lenders. Many of the most significant players in the crypto-asset ecosystem were entangled with 3AC in some way.[21] Voyager Digital filed for bankruptcy just days after 3AC’s July filing— reports indicate it had loaned 3AC more than $650 million in crypto.[22] Roughly a week after that, crypto-lending giant Celsius also folded, and has since been hit with lawsuits alleging the firm was no more than a Ponzi scheme.[23] Not only had Celsius lent to 3AC, but it had also invested half a billion dollars in Anchor, Terra’s lending platform.[24]

It is worth pausing here to ask the question how the TerraLuna collapse and the subsequent downstream failures happened. We think the answer is simple— driven by greed, or by FOMO, those who participated with Terra and or Three Arrows simply didn’t do their homework. The market was so hot that minimal due diligence was undertaken prior to committing significant funds to almost any digital asset project.[25] Moreover, Terra was obviously based on an algorithmic model. Remarkably, it appears that no one actually asked to see the stress tests for that model, but if they had, they would have found that none existed. The same would have been the result if they had asked for a demonstration of the risk controls. Even the most basic safety precautions were seemingly ignored in the frenzy to jump in. One positive result may be that Profs. Reinhardt and Rogoff now have material for a new chapter to their 2011 book “This Time It’s Different: Eight Centuries of Financial Folly.”[26]

There was a different approach which could have been taken, but was inconsistent with the popular mantra at the time of “move fast and break things.” Firms involved could have performed stress tests of their algorithms. They could have identified control gaps and closed them.  They could have undertaken the difficult work of extensive third-party vendor management. They could have installed more robust, cyber-security and privacy controls. Most importantly, they could have carefully examined the risk indicators in each part of their business and designed controls and monitoring for each one.[27] Such measures aren’t cheap to implement— it’s also onerous work, often less exciting than the kind that attracts young tech engineers to budding startups in the first place. This criticism is not merely a case of Monday morning quarter-backing—it’s become quite clear that the governance frameworks for some of these firms were not just lacking, they were non-existent. That was apparent when former FTX CEO Sam Bankman-Fried tweeted what appeared to be a screen-shot of a sparsely populated excel sheet as proof of FTX-US’s solvency (FTX US filed for bankruptcy the next day.)[28] After Bankman-Fried’s resignation, John J. Ray III, the attorney appointed to shepherd the firm through bankruptcy stated, “[n]ever in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” (notably, John J. Ray III also guided Enron through its bankruptcy).[29] Nonetheless, the absence of such prudence and effort by project promoters and VC investors has wiped out billions of dollars of market value, venture capital, and chunks of the savings of a large cadre of individual American digital asset purchasers.

At the same time, the market for Bitcoin was melting down. The most popular cryptocurrency had peaked in value at over $61,000 in early 2022, but by mid-year it had slid to $20,000 and then later in the year slipped as low as $17,000, a decline of more than 70%.[30] Funding for new projects began to dry up, and other projects came under pressure.[31] With the industry in retreat regulators increased the pressure. The SEC was not idle during this time period,[32]and the regular cadence of bad planning and business failure helped its cause. In a matter of months, crypto had transitioned in the public’s perception from the herald of a golden age of innovation to a risky and dangerous casino, populated mostly by fraudsters and criminals.

For example, the well-known lending and staking platform BlockFi settled a charge of an operating as an unregistered exchange and agreed to pay a penalty of $100 million, register as an exchange and register its product as a security.[33] Ultimately, however, that burden became too great, and in the wake of the FTX collapse BlockFi also sought bankruptcy protection.[34]

The Commission made regular enforcement filings in the second half of 2022,[35] including charges against 11 defendants for running an alleged $300 million dollar crypto pyramid scheme,[36] another for market manipulation against a FinTech and the CEO of its “market making” firm, which allegedly provided the firm with custom software designed to generate the appearance of active market demand for its token “Hydro.”[37]  Of the 30 actions brought by the SEC in 2022, 70% contained allegations of fraud.[38] Fittingly, the year closed out with the collapse of FTX in November, and the SEC managed to squeeze in its charges against Sam Bankman-Fried and his associates in the last weeks of December.[39] The FTX saga appears to be the biggest shock yet to the crypto-market’s system. Not only did that collapse send shock waves through the industry (as of this writing, approximately $8.6 billion of monies entrusted to FTX are still missing[40]) but it was done through various instruments of fraud and concealment. Consequently, political, media, and public anger rose markedly.

At about this juncture, financial regulatory agencies across the government had already begun to issue joint releases and speak in terms of a “whole of government“ approach to crypto. In addition to President Biden’s March Executive Order on digital assets[41] and the solicited reports from multiple financial agencies that would be published months later, by the end of 2021 and throughout 2022, there was a flurry of statements from bank regulators, including crypto interpretive letters from the OCC,[42] the FDIC,[43] and the Federal Reserve.[44] To ring in the new year, the Federal Reserve, FDIC, and OCC issued their first-ever joint statement on the risks posed by crypto-assets to bank stability.[45] This was characterized by author and managing partner of Castle Island Ventures, Nic Carter, as “Chokepoint 2.0.”[46] Given the events of late, namely the rapid collapse of Silvergate Bank, Silicon Valley Bank, and Signature Bank, all of which were deeply involved in the fintech and crypto spaces, it is unlikely that banking authorities are planning to retreat any time soon.[47] However, this rather furious effort by the regulators has begun to attract growing opposition, many of whom argue that the activity violates, among other things, constitutional principles of due process and separation-of-powers, further codified by the Administrative Procedure Act (APA).[48]

Against this backdrop, here are a few of the examples of that activity:

• The action against Kraken in connection with staking

SEC brought suit against crypto exchange Kraken for failing to register its staking program, whereby customers can “stake” their crypto to earn increasing returns the longer they are willing to lock up their assets. Kraken agreed to shut down its US staking services and pay  $30 million in penalties. [49] The SEC published a light-hearted video[50] featuring Chair Gary Gensler explaining why staking-as-as-service implicates the securities laws, but many firms in the crypto-sector utilize staking in some way, and without further guidance, the commenters wonder if the SEC’s interpretation could harm the crypto markets by hindering staking’s important liquidity function.[51]

• New York Attorney General has called Ethereum a “security” in the latest lawsuit against KuCoin

According to the lawsuit in Supreme Court of New York, KuCoin operates an unregistered cryptocurrency exchange platform in New York, failed to register as a broker-dealer, and issued an unregistered security called “KuCoin Earn.” Within these allegations detailed in the complaint, the AG casually states that “the tokens were securities” referring to ETH, along with LUNA, and UST.[52] This, of course, despite the statements from the SEC going back as early as 2018, that ETH was not a security.[53]

• Actions against the Wahi brothers by the SEC for insider trading[54]

Notably, the SEC sued the Wahi brothers for securities fraud (in a separate action by the DOJ, the brothers pled guilty to wire fraud[55]). In defense to the SEC’s claim, the Wahi’s have filed a motion to dismiss based on the “Major Questions” Doctrine. Supporting briefs point out the SEC’s “pattern of alleging legal conclusions adverse to token creators who are not parties to a case,” constitutes an effort by the SEC “merely to backdoor a precedent that can be used in other cases.”[56] Further, the Wahi’s brief notes that, despite a 2019 SEC framework suggesting otherwise,[57] the SEC now seeks to disregard the fact that “…when a token is sold on an exchange [i.e. in the secondary market] there is […] no contract between the buyer and the promoter,” and therefore, there can be no “investment contract”[58].[59] A brief in support of the brothers submitted by the Blockchain Association argues that the SEC’s tactics exceed “regulation by enforcement” having entered “regulation by unchallengeable allegation.”[60]  

• Public statements by senior officials threatening institutions such as crypto exchanges, investment advisors and custodians

Speaking at an Investor Advisory Committee early this month, SEC Chairman Gary Gensler suggested that crypto exchanges may not be “qualified custodians” (a legal classification that permits them to handle their customers’ funds).[61] Chairman Gensler offered such statements knowing full-well that lack of such qualification would significantly damage if not destroy any exchange, since custody services are a necessary aspect of their business models.[62]

• Proposed rulemaking by the SEC which could have the effect of cutting off institutional funds being held at crypto custodians[63]

The proposed rule would amend the Investment Advisors Act and broaden the Commission’s authority under section 411 of Dodd-Frank to require crypto custodians to abide by new minimum custodial standards, expand government monitoring and examinations, and enhance record-keeping requirements.[64]

• Actions by banking regulators against Silvergate Bank for its relationship with FTX

As of February, U.S. prosecutors were investigating the bank for alleged fraud in its dealings with FTX and Alameda.[65] This month, the crypto-focused bank announced it will be shutting down and liquidating its assets.[66] Combined with previous statements by regulators that it is “highly unlikely” that banks could have crypto firms as customers in a way that is consistent with “safety and soundness,” the wind-down of Silvergate, and the recent shut down of Silicon Valley Bank and Signature Bank, has the potential to further impede the flow of liquidity to nearly all crypto projects by restricting on and off-ramps for the conversion of crypto to fiat. Further, the recent collapses may reaffirm the widespread reluctance among banks to provide their services to the industry, in addition to the disincentives already created via “Operation Chokepoint” style regulatory activity.[67]

What are the likely net effects of this and what are the lessons to be learned?

First, it is a signal example of the extraordinary power of agency officials, politicians, and the media to identify new targets and execute a campaign of withering attacks. Those in the digital asset industry who perceived regulators as “incompetent” and easily put off, may now be regretting that hubris.

Second, it pays to invest early and prudently in risk management tools — people, processes and technology. That is hard work. Moreover, it takes leadership within companies in order to drive those results. Those leaders who think of a company only as a shell within which brilliant new technology is housed have found, and will find, that such misplaced assumptions end only in tears. Unlike suit jackets and ties, or the many business customs the tech industry has been celebrated for discarding long ago, corporate governance is not optional—a fact with respect to which one would assume that an institutional investor handing billions of dollars to a 20-something-year-old startup founder would be aware. Author and corporate law professor Jonathan Macey put it well when he said simply,“[g]ood corporate governance is about keeping promises.” [68]

Third, expecting that legislation or regulation will “solve” an industry’s problems ignores the timing mismatch and places faith on a last minute “cavalry charge” to save the day. No doubt, there ultimately will be some form of legislation providing reasonable oversight and governance of the digital asset industry. However, that is cold comfort today to an industry that is the subject of a whole-of-government embrace. By the time legislation has passed (in two or three years?), very many innovative projects will either exist only outside the United States, or will have long been abandoned. In 2023, the “cavalry” is not coming.

Fourth, it’s important to do it right the first time (one never gets a second chance to make a first impression). For years, the  industry was given slack, safe havens, and billions of dollars to innovate and build—unfortunately, many took that slack and found just enough to hang themselves. Several years ago, the industry had an opportunity to build risk systems, and to engage with regulators in a way that may have resembled the building of Alternative Trading Systems to accommodate internet trading during Arthur Levitt’s SEC Chairmanship. That opportunity has been lost.[69]

Finally, history repeats itself, and pride cometh before a fall. The rise of the digital asset industry was extraordinary and thrilling. However, such excitement tends to blind those involved no matter what the situation. Charles Ponzi used to have huge crowds waiting outside his office on School Street in Boston (two blocks from where one of the authors used to live — the building still stands) hanging on his every word. The mere fact that a crowd is following a particular dream does not mean that the dream will come true. In the end, when new economic ventures are being born and developed, they must be accompanied by thoughtful and robust risk management and be driven by talented people who can operate those tools while also accommodating innovation and forward thinking. There has never been another way, and there never will be.

Footnotes

[1] See Jamie Redman, US Crypto Lawsuits Reach All-Time High With 42% Increase in 2022; SEC Cases Dominate Legal Battles, Bitcoin.com (Feb. 13, 2023).

[2] Genesis Global Capital, its holding company, as well as its Asian subsidiary filed for Chapter 11 Bankruptcy in January. The bankruptcy of the major crypto-lending firm owned by VC firm Digital Currency Group (DCG) followed an unprecedented year for crypto-bankruptcies in 2022—the collapse of TerraUSD and its companion token LUNA, which prompted the July bankruptcy filing by Three Arrows Capital, followed within days by Voyager Digital and Celsius. The stunning collapse and bankruptcy of FTX in November set off yet another series of cascading bankruptcy filings, among the biggest players to fall at the end of 2022 being BlockFi and Core Scientific (See Stephen Alpher & Danny Nelson, Genesis’ Crypto Lending Businesses File for Bankruptcy Protection, CoinDesk (Jan. 20, 2023); Factbox: Crypto’s String of Bankruptcies, Reuters (Jan. 20, 2023)).

[3] In 2017, the SEC first announced that it would be regulating ICOs. (See SEC, Press Rel., SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities (July 25, 2017). By May of 2018, the SEC had initiated six enforcement actions in connection with ICOs for failure to register under § 5(c) of the Securities Act of 1933 and other violations of the securities laws (See Juliana Debler, Foreign Initial Coin Offering Issuers Beware: The Securities and Exchange Commission is Watching, 51:1 Cornell L. J. 245, 247 (2018)).

[4] See e.g. SEC, Press Rel., SEC Halts Alleged Initial Coin Offering Scam (Jan. 30, 2018);  SEC, Press Rel., SEC Halts Fraudulent Scheme Involving Unregistered ICO (April 2, 2018); SEC Litigation Rel., No. 24160, SEC Obtains Preliminary Injunction in Fraudulent Coin Offering Scheme (June 7, 2018); SEC, Press Release, Two ICO Issuers Settle Registration Charges, Agree to Register Tokens as Securities (Nov. 16, 2018); SEC. Press Rel., Executives Settle ICO Scam Charges (Dec. 12, 2018).

[5] See SEC v. Titanium Blockchain Infrastructure Services, Inc., et al., No. 2:18-CV-04315-DSF (C.D. Cal., 2018).

[6] See DOJ, Press Release, CEO of Titanium Blockchain Pleads Guilty in $21 Million Cryptocurrency Fraud Scheme, (July 25, 2022); See also Menji Sun, Titanium Blockchain CEO Pleads Guilty to Fraud, Wall Street J. (July 25, 2022).

[7] See Jeff Kauflin, Where Did the Money Go? Inside the Big Crypto ICOs of 2017, Forbes (Oct. 29, 2018).

[8] Id.

[9] SEC, Press Release, SEC Charges Ripple and Two Executives with Conducting $1.3 Billion Unregistered Securities Offering (Dec. 22, 2020).

[10] Though great fodder for law review articles, it may be more accurate to say that tech-firms and their lawyers are preoccupied with the more urgent question, “how do I ensure my company doesn’t inadvertently offer one?”

[11] The 1946 case SEC v. Howey expounded what continues to be the preeminent legal test for the existence of an “investment contract,” (and therefore subject, along with stocks, bonds, and other specified instruments, to the securities laws enforced by the SEC).The so-called “Howey Test” is comprised of four prongs, all of which must be satisfied to find the existence of an “investment contract” : (1) an investment of money, (2) in a common enterprise (3) with the expectation of profit (4) derived from the efforts of others. Countless efforts to interpret these prongs has led to the development of a series of prong-specific sub-tests, some of which vary by jurisdiction. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

[12] The SEC contends that the securities laws and their own policy have been sufficiently clear as to the fact that XRP was and remains a security and points out that any uncertainty Ripple faced could have been resolved through the submission of a no-action letter. It’s worth noting that while this is a frequent assertion by the SEC to defendants, there has been criticism of the practice among the Commission. A 2021 joint statement by Commissioner Peirce and former Commissioner Roisman, In the Matter of Coinschedule, stated:

“We agree with our colleagues that touting securities without disclosing the that you are getting paid, and how much, violates Section 17(b). We nevertheless are disappointed that the Commission’s settlement with Coinschedule did not explain which digital assets touted by Coinschedule were securities… [T]here is a decided lack of clarity for market participants around the application of the securities laws to digital assets and their trading, as is evidenced by the requests each of us receives for clarity and the consistent outreach to the Commission staff for no-action and other relief.” (See Comm’r. Hester M. Peirce & Comm’r. Elad L. Roisman, Statement In the Matter of Coinschedule, Sec.gov (July 14, 2021).

The fact that a firm like Ripple, which partners with numerous major financial institutions including Bank of America and PNC, and whose advisory committee and board has touted the likes of a former U.S. Treasury Official and the former Chief Regulatory Affairs Officer at JP Morgan, indicates just how pervasive this uncertainty might be. See Penny Crosman, How will SEC Complaint Affect Banks’ Relationship with Ripple?, American Banker (Dec. 29, 2020); Former Treasury Official, Michael Barr, sat on Ripple’s advisory board since 2015. In 2022 he was confirmed by the senate to sit as a vice-chair of the Federal Reserve. See Team Ripple, Press Rel., Former Treasury Official Michael S. Barr Joins Ripple Labs, Ripple.com (Jul. 29, 2015); Jesse Hamilton, Former Crypto Advisor Michael Barr Confirmed as Top US Financial Watchdog, CoinDesk (Jul. 13, 2022); “Board of Directors: Sandie O’Connor,” Ripple.com, (visited Mar. 20, 2023).

[13] See Defs’. Rep. Mot. Supp. Sum. J., Dec. 2, 2022. (Securities and Exchange Commission v. Ripple Labs Inc., 20-CV-10832 (AT) (SN) (S.D.N.Y. 2022)).

[14] The so-called “economic realities” test is an outgrowth of the Supreme Court’s Howey Analysis, often attributed to the Reves v. Ernst & Young (494 U.S. 56 (1990)).

[15] See Defs’. Rep. Mot. Supp. Sum. J., 64-54, Dec. 2, 2022. (Securities and Exchange Commission v. Ripple Labs Inc,  20-CV-10832 (AT) (SN) (S.D.N.Y. 2022)).

[16] See Stuart Aderoty (@s_alderoty) Twitter (Mar. 16, 2021). See Roslyn Layton, SEC Stumbles in Ripple Case, Lost in a Maze of its Own Making, Forbes (Mar. 11, 2021).

[17] Further, in 2015, in an uncovered settlement agreement between Financial Crimes Enforcement Network (FinCEN) and Ripple, the regulator described XRP as a “currency.” See FinCEN, Press Rel., FinCEN Fines Ripple Labs Inc. in First Civil Enforcement Action Against a Virtual Currency Exchanger (May 5, 2023). See also, fasb.org.

[18] See Id.,  Defs’. Oppo. Mem. Pl’s. Mo. Exclude, 22, Jan. 13, 2022.

[19] See Krisztian Sandor & Eric Genc, The Fall of Terra: A Timeline of the Meteoric Rise and Crash of UST and LUNA, Coindesk (Dec. 22, 2022).

[20] See Serena Ng, Crypto Hedge Fund Three Arrows Capital Considers Asset Sales, Bailout, Wall Street J. (Jun. 17, 2022).

[21] A 2022 report issued by the US Financial Stability Oversight Counsel (FSOC) provides a startling graphic which demonstrates this interconnectedness. (See  FSOC, Report on Digital Asset Financial Stability Risks and Regulation (2022) “Figure B-1” at 39).

[22] Factbox: Crypto’s String of Bankruptcies, Reuters (Jan. 20, 2023).

[23] See Arjun Kharpal, Embattled Crypto Lender Celsius is a ‘Fraud’ and a ‘Ponzi Scheme’ Lawsuit Alleges, CNBC (Jul. 8 2022).

[24] See MacKenzie Sigalos, From $25 Billion to $167 Million: How a Major Crypto Lender Collapsed and Dragged Many Investors Down With It, CNBC (Jul. 17, 2022); Shaurya Malwa, Three Arrows Capital Confirms Heavy Losses from LUNA’s Collapse, Exploring Potential Options: Report, Coindesk (Jun. 17, 2022); Sam Bourgi, Three Arrows Capital Weighs Bailout as Kyle Davies Breaks Silence: Report, CoinTelegraph (Jun. 17, 2022).

[25] Despite the fact that CEO Sam Bankman Freed was openly playing League of Legends during his pitch to the venture capital firm, the partners at Sequoia ultimately invested  $214 million in FTX (which they would later have to mark down to zero) See Britney Nguyen, Sam Bankman-Fried Was Once Caught Playing the Video Game ‘League of Legends’ During a Pitch Meeting for FTX, Business Insider (Nov. 10, 2022).

[26] Carmen M. Reinhart & Kenneth S. Rogoff, This Time Is Different: Eight Centuries of Financial Folly (Princeton Univ. Press 2011).

[27] For a view of what such a risk control framework would look like, one can visit the site of Strategic Risk Associates (srarisk.com) which describes an array of  tools which exist to craft such controls and assessments. In full disclosure, one of the authors serves as outside counsel for SRA.

[28] See Sam Bankman-Fried (@SBF_FTX) Twitter (Jan. 17, 2023).

[29] See Emily Cheshire, Could Two Common Financial Controls Have Prevented the Fall of FTX?, Aprio.com (Jan. 2, 2023).

[30] See Nicole Goodkind, Bitcoin Drops Below $20,000 as Crypto Meltdown Continues, CNN Business (June 20, 2022).

[31] See e.g. David Yaffe-Bellany et al., Cryptocurrencies Melt Down in a ‘Perfect Storm’ of Fear and Panic, New York Times (May 12, 2022).

[32] According to an excellent report by Cornerstone Research, the agency brought 30 enforcement actions related to digital assets in 2022 (a 50% increase from 2021). See Cornerstone Research, SEC Cryptocurrency Enforcement: 2022 Update (2023)).

[33] SEC, Press Rel., BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product (Feb. 14, 2022); See Sam Sutton, SEC, States Hit Crypto Lender with $100M Penalty, Politico (Feb. 14, 2022).

[34] See Allison Morrow, BlockFi Files for Bankruptcy as FTX Contagion Grips Crypto Markets, CNN Business (Nov. 28, 2022).

[35] According to research by HedgewithCrypto, 2022 saw a 46% increase in the total of crypto-related lawsuits, 19 were filed by the SEC, while 22 were class-action. (See Aaryamann Shrivastava, SEC Responsible for 46% of All Crypto Lawsuits in 2022; Unregistered Offerings Rack Up Most Cases, FXStreet.com (Feb. 2, 2023)).

[36] See SEC, Press Rel. SEC Charges Eleven Individuals in $300 Million Crypto Pyramid Scheme (Aug. 1, 2022).

[37] See SEC, Press Rel., SEC Charges The Hydrogen Technology Corp. and its Former CEO for Market Manipulation of Crypto Asset Securities (Sep. 28, 2022).

[38] See Cornerstone Research, SEC Cryptocurrency Enforcement: 2022 Update, 5 (2023)).

[39] See SEC, Press Rel., SEC Charges Samuel Bankman-Fried with Defrauding Investors in Crypto Asset Trading Platform FTX (Dec. 13, 2022); SEC, Press Rel., SEC Charges Caroline Ellison and Gary Wang with Defrauding Investors in Crypto Asset Trading Platform FTX (Dec. 21, 2022).

[40] See Andrew R. Chow, Where did FTX’s $8 Billion Go? Crypto Investigators Offer New Clues, Yahoo News (Dec. 21, 2022).

[41] Executive Order 14064: Ensuring the Responsible Development of Digital Assets, 87 Fed. Reg. 14143 (March 14, 2022) (view the executive order at whitehouse.gov). Three of responding reports may be viewed at Treasury.gov,

[42] OCC Interpretive Letter 1179 “Chief Counsel’s Interpretation Clarifying: (1) Authority of a Bank to Engage in Certain Cryptocurrency Activities; and (2) Authority of the OCC to Charter a National Trust Bank” (November 18, 2021).

[43] See FDIC, FIL No. 16, “Notification and Supervisory Feedback Procedures for FDIC-Supervised Institutions Engaging in Crypto-Related Activities: (April 7, 2022).

[44] See Federal Reserve SR 22-6 / CA 22-6: “Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations,” (August 16, 2022).

[45] See Marina Olman, et al., Federal Reserve, FDIC, and OCC Issue the First Joint Statement on Crypto-Asset Risks to Banking Organizations, National Law Review (Feb. 1, 2023).

[46] Remarkably, there even have been articles suggesting that a condition for sale of Signature Bank would be that the buyer agreed to dispose of all crypto deposits (See e.g. David Z. Morris, The Reality Behind the Crypto Banking Crackdown: ‘Operation Choke Point 2.0’ is Here, CoinDesk (Mar. 22, 2023)); If that were the case, it would appear especially problematic since government action that has the consequence of depriving legitimate businesses of their rights to bank accounts is in violation of constitutional due process. Community Financial Services Ass’n. of Am. Ltd. V. FDIC, 132 F. Supp. 3d 98, 124 (D.D.C. 2015) (denying Motion to Dismiss due process claim). To the extent that this would amount to the legislative act of an administrative agency whose powers were delegated by Congress, the Bill of Attainder clause (Article 1, Section 9, Clause 3 of the Constitution) could also be implicated. See Nic Carter, Operation Chokepoint 2.0 is Underway, And Crypto is in Its Crosshairs, Pirate Wires.com (Feb. 8, 2023).

[47] See Sabrina Toppa, Silvergate, Signature, and Silicon Valley Bank: Crypto Industry Loses Major Banks, The Street (Mar. 14, 2023). The FDIC announced on March 19 that it would be selling Signature Bank’s deposits and loans to Flagstar bank, a subsidiary of New York Community Bancorp. Notably, the roughly $4 billion worth of digital assets deposits were not included in the sale, but will purportedly be transferred back directly to customers. (See FDIC, Press Rel., Subsidiary of New York Community Bankcorp, Inc. to Assume Deposits of Signature Bank, N.A., from the FDIC, (Mar. 19, 2023); Brayden Lindrea, FDIC Sells Signature Bank Deposits to Flagstar, Crypto Not Included, Coin Telegraph (Mar. 20, 2023)).

[48] See e.g. Cooper & Kirk LLC, Operation Choke Point 2.0: The Federal Bank Regulators Come for Crypto (2023).

[49] See Hannah Lang, U.S. SEC Targets Crypto ‘Staking’ With Kraken Crackdown, Reuters (Feb 10, 2023).

[50] See SEC, “Office Hours with Gary Gensler: Staking-as-a-Service,” SEC.gov (Feb. 9, 2023).

[51] See Nikhilesh De, What does Kraken’s SEC Settlement Mean for Crypto Staking?, CoinDesk (Feb. 10, 2023)

[52] See In the Matter of New York AG v. Mek Global Limited and Phoenixfin PTE LTD d/b/a KuCoin, 450703/2023 at 12 (Sup. Ct. N.Y. 2023).

[53] See Rakesh Sharma, SEC Official Declares Ether is Not a Security, Investopedia (Jun. 14, 2018).

[54] SEC, Press Rel., SEC Charges Former Coinbase Manager, Two Others in Crypto Asset Insider Trading Action, SEC.gov (Jul. 21, 2022).

[55] See Dept. of Justice, S.D.N.Y., Press Rel., Tippee Pleads Guilty in First Ever Cryptocurrency Insider Trading Case (Sep. 12, 2022).

[56] See Brief for Blockchain Association as Amicus Curiae Supporting Respondents, SEC v. Wahi et al., No. 2:22-cv-01009-TL (W.D. Wash., Feb. 13, 2023) at 14:16.

[57] See Brief for Blockchain Association as Amicus Curiae Supporting Defendants, SEC v. Wahi et al., No. 2:22-cv-01009-TL (W.D. Wash., Feb. 13, 2023) (“The [SEC’s 2019 Framework] did recognize that tokens qualifying as securities at the time of an initial sale sometimes “should be reevaluated at the time of later offers or sales…”) citing Framework for “Investment Contract” Analysis of Digital Assets, U.S. Sec. and Exch. Comm’n (Apr. 3, 2019), https://www.sec.gov/corpfin/framework-investment-contract-analysis-digital-assets

[58] See Def’s Mot. Dismiss, SEC v. Wahi et al., No. 2:22-cv-01009-TL  (W.D. Wash., Feb. 6, 2023) at 37:10-13 (citing Michael J. O’Connor, Overreaching Its Mandate? Considering the SEC’s Authority to Regulate Cryptocurrency Exchanges, 11 Drexel L. Rev. 539, 582-83 (2019)).

[59] Id. at 25:16-20.

[60] Id. at 15:10-15.

[61] See Nikhilesh De, SEC Chair Gensler Says Crypto Exchanges May Not Be ‘Qualified Custodians,’ CoinDesk (Mar. 2, 2023).

[62] Moreover, Chairman Gensler made these statement also knowing that many exchanges are or have as an affiliate a state-chartered trust, effectively calling into question whether such trusts can be banks, as defined under the Advisers Act, even though the definition of bank specifically references trust companies.

[63] SEC, Press Rel., SEC Proposes Enhanced Safeguarding Rule for Registered Investment Advisers, Sec.gov (Feb. 15, 2023).

[64] See Ryan F. Helmrich, SEC Overhaul of Custody Rule: Implications for Qualified Custodians, National Law Review (Feb. 22, 2023).

[65] See Rita Liao, Crypto Friendly Bank Silvergate to Wind Down After FTX Blow Up, TechCrunch.com (Mar. 9, 2023).

[66] David Hollerith, Silvergate Capital Will Liquidate After Crypto Collapse Wipes Out Bank, Yahoo Finance (Mar. 8, 2023).

[67]See David Canellis, Operation Choke Point 2.0: Is the US Coming for Crypto?, Blockworks (Mar. 7, 2023). So-called “Operation Choke Point” refers to the 2013 through 2017 DOJ investigative initiative into U.S. bank involvement with allegedly high-risk depositors, including firearms dealers and pay-day lenders. The operation was first disclosed to the public in the Wall Street Journal. (See Alan Zibel & Brent Kendall, Probe Turns Up Heat on Banks, Wall Street Journal (Aug. 7, 2013)).

[68] “[I]t is more accurate to characterize corporate governance as being about promises than it is […] about contracts […] because the idea of promise captures the primordial fact that trust rather than reliance on the prospect of enforcement is the focal point of a successful system of corporate governance” See Jonathan R. Macey, Corporate Governance: Promises Kept Promises Broken, 1 (2008).

[69] General Douglas MacArthur once said that every military disaster in history can be summarized in these words: “Too late.” This situation is no different.

Stephen T. Gannon is a Partner and Madison J. Breshears is a Law Clerk in the financial services practice group at Davis Wright Tremaine LLP.

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