After the crypto crash comes the SEC crackdown

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It’s been a rough few months for some people who have had it easy for a long time. A growing number of cryptocurrency operations may eventually face 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 came 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 days earlier, the FBI and a U.S. District Attorney in New York indicted three former Coinbase employees for insider trading.

Which agency is responsible for regulating cryptocurrency is unclear. 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 within its purview, which appears to be most of them.

“The SEC is in the midst of an ongoing attack against crypto companies from all directions,” cybersecurity expert and former SEC attorney John Reed Stark told Recode. Stark noted that the agency has expanded its crypto unit and that SEC Chairman 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 soared to $3 trillion, helped by new platforms that made it easy for almost anyone to invest. 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 the value will recover significantly anytime soon. The accident has devastated some of the companies that operate in this space, and also their customers.

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 traditional banks, when crypto lending platforms go bust, there are no safeguards to ensure 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 shown to be not very stable. Last May, the value of the stablecoin Terra plummeted, dragging with it the coin Luna, whose value was tied to that of Terra. Luna was once worth as much as $116. Now, it’s worth a fraction of a penny.

But as investor losses mount and the extended crypto arms of enforcers go to work, it appears that a day of reckoning is finally coming for some of these companies, which have been operating in a space with few rules. The scams obviously didn’t follow the rules at all. But some of the more legitimate companies have also allegedly played fast and loose with them.

“The hubris and hubris in the crypto realm is way beyond measure,” Stark said. “They’re always belligerent, combative and yelling at the SEC incomplete.”

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

Again, the SEC is just one of several government agencies pursuing crypto. And when many people lose a lot of money, the government will pay even more attention. But there may not be much it can do for some people, since crypto is not regulated like banks and traditional securities, something many crypto investors didn’t realize until it was too late.

“With so much new money driving up token values, so many people wanted to get in without understanding anything about the space,” said Matt Binder, a Mashable reporter 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 apparently so flush with cash that they could buy advertising space at the most expensive show in town. It also didn’t help that crypto was as easy to buy as an ATM transaction. And it really didn’t help that many people jumped into crypto knowing little, but assuming they would have the same protections as more regulated institutions like traditional banks and investment firms.

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

“When companies start getting involved in this kind of thing, you get people who want to be whistleblowers or become whistleblowers,” Stark said. “And when prosecutors start looking, people can become informants very quickly.”

Molly White, who has chronicled several Web3 missteps in Web3 Is Going Just Great, is still not so sure that increased scrutiny, investigations and charges will make a real difference.

“Insider charges feel like a drop in the bucket compared to the amount of insider trading that is known to be happening on Coinbase and elsewhere, but at least it’s something,” he said. “I’m concerned about the slowness of these actions in an industry where people can perpetrate scam after scam in the meantime.”

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

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

“I think these crackdowns can help keep the public away from crypto,” Binder said. “There will be some companies that will try to ‘go legit’, but at the end of the day, they are still a crypto company, selling the dream of getting rich by trading speculative assets, without any real product or service.”

This won’t do much, however, for people whose dreams have already turned into nightmares. White said that while some of the previous crypto loss stories were funnier and the victims less sympathetic (see: “All My Apes Gone”), this one is no longer the case. “Now we are seeing people writing letters to a bankruptcy judge about how they are financially ruined and contemplating suicide,” he said.

Or as Binder put it, “We have some people who hit the lottery and a bunch more who lost it all.”

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

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