Big news dropped in the past few weeks, which sent shockwaves across the industry: according to a recently filed lawsuit, the SEC has classified the second largest cryptocurrency, Ether, as a security in certain ongoing investigations for over a year now. While many expected such a revelation to come out eventually with the looming Ether spot ETF approval deadlines approaching, the scope and duration of the SEC’s investigation was news that the industry is still trying to come to terms with. There were also multiple developments related to criminal cases against digital asset privacy-preserving protocol developers worth noting, and the SEC is likely to bring enforcement action against the popular trading platform, Robinhood, related to its digital asset trading platform. 

These developments and a few other brief notes are discussed below.

MetaMask Wallet Developer Sues SEC: April 25, 2024

Background: Consensys, developer and provider of leading self-custody digital wallet MetaMask, has sued the SEC for declaratory and injunctive relief in the Northern District of Texas. The complaint is available here. The suit alleges that the SEC issued a Wells notice which warns of a very likely lawsuit against Consensys. The Consensys lawsuit seeks a declaration that (1) the purchase and sale of Ether are not securities transactions subject to the SEC’s jurisdiction; (2) the MetaMask wallet’s swapping functionalities are not subject to the agency’s broker-dealer registration requirements; and (3) the MetaMask wallet’s staking functionalities are not securities transactions.

Summary: Consensys appears to expect the SEC’s Wells notice process would not result in lack of prosecution, suing the SEC in a favorable 5th Circuit instead of allowing the SEC to bring a lawsuit first. Similar to the Coinbase lawsuit, this lawsuit appears to be part of a larger play to create a potential circuit split if the rulings differ from the Coinbase case in S.D.N.Y. (2nd Cir.), Binance case in D.D.C. (Fed. Cir.), or Kraken case in N.D.Cal. (9th Cir.). The SEC must be running into a resource allocation issue at this point, as it is unclear whether the agency will have the resources in the crypto enforcement unit to litigate lawsuits against the above entities plus Uniswap plus the other outstanding litigation the agency has going on simultaneously.

Various Developments in Blockchain Privacy Protocols Raise Questions on Permitted Levels of Privacy Preservation: April 24-27, 2024

Background: Samourai Wallet and associated Bitcoin mixing protocol developers were arrested and charged with conspiracy to commit money laundering and conspiracy to operate an unlicensed money-transmitting business. Relatedly, after those charges were filed, the FBI issued a warning that “[u]sing a service that does not comply with its legal obligations may put you at risk of losing access to funds after law enforcement operations target those businesses.” Also related, the DOJ has responded to Roman Storm's motion to dismiss regarding his involvement with Tornado Cash.

Summary: Developments in the above cases will set legal precedent on when individuals can create privacy-preserving technologies that can be used for legal and illegal purposes alike. In Tornado Cash, for example, the DOJ takes issue with the defendants’ failure to program a backdoor for law enforcement into the protocol’s code. The most frustrating part of this response is the government (potentially intentionally) linking together the actions of disparate actors (developers, validators, relayers, and TORN token holders) into a single entity. It is also interesting that the DOJ seems to be taking the position that lack of control over funds at issue is not relevant to the “accepting value that substitutes for currency” aspect of the rules and regulations. All of the above could lead to U.S. citizens having fewer privacy tools available, putting their safety and funds at risk.

Robinhood Served Wells Notice for Crypto Trading Services: May 6, 2024

Background: Robinhood Crypto has received a Wells notice from the SEC indicating the agency staff will recommend that the SEC file an enforcement action related to Robinhood’s crypto trading platform. You can read the Robinhood response here and the 8-K filing update here. Robinhood is the latest major operator in the space to receive such a notice, with the notice to Consensys discussed above and the Uniswap notice discussed in our previous update. Robinhood Crypto also lists less than two dozen digital assets and is far more selective with its listings than exchanges like Coinbase, Kraken, and Binance which were previously sued by the SEC.

Summary: The combined actions indicate that offering retail participants access to any digital assets, other than Bitcoin, is viewed by the agency as a violation of applicable securities laws. The fact that the SEC seems to be keen to bring an action against Robinhood even after Robinhood removed some of the tokens alleged to be securities in the Coinbase/Binance suit from the Robinhood crypto trading platform shows that merely delisting assets which the SEC claims to be securities is not sufficient. It also is troubling if Robinhood’s CTO’s Congressional testimony on this subject is part of what led to this action. The Digital Chamber of Commerce and other industry groups have condemned this latest action by the agency. Robinhood’s founder has indicated he plans to fight the allegations if a lawsuit is brought by the agency.

Briefly Noted:

Custodia Appeals Master Account Loss: Custodia has appealed the decision to uphold the Federal Reserve Banks’ denial of access to a Master Account. Custodia’s novel business plan of charging customers for keeping 100% reserves instead of lending amounts deposited to third parties, along with their willingness to custody digital asset,** appear to be the primary reasons for the denial of Master Account access.

Industry Groups Challenge Dealer Rule: The Blockchain Association and Crypto Freedom Alliance of Texas filed a lawsuit against the SEC challenging the new dealer rule which would have a huge impact on DeFi. It looks like the crypto bar has chosen Texas as its fighting ground for challenges to potential administrative overreach. 

Binance Founder Sentenced to Four Months in Prison: Binance founder gets 4-month sentence after earlier pleading guilty to anti-money laundering violations. This timeline of legal issues that Binance and CZ have run into is phenomenal. Also a good article about the effect of the SEC case here which quotes Polsinelli attorneys Stephen Rutenberg and Jonathan Schmalfeld.

Exodus Movement, Inc. Listed on New York Stock Exchange: Self-custodial digital wallet provider Exodus announced that its common stock has been approved for trading on the New York Stock Exchange. Available for desktop, mobile, and browser, the Exodus wallet allows users to secure, manage, and swap cryptocurrencies like Bitcoin, Ether, and others. It became the first company to have its common stock tokenized for blockchain-based trading.

Conclusion:

As the landscape of cryptocurrency regulation continues to evolve, recent actions by the SEC, including its classification of Ether as security and the issuance of a Wells notice to major platforms like Robinhood, underscore the complex interplay between innovation and regulation. These developments, coupled with ongoing legal challenges and enforcement actions, highlight a period of significant uncertainty and adjustment for the industry. As stakeholders navigate these turbulent waters, the outcomes of these legal battles will likely shape the future of digital asset regulation and the broader financial ecosystem. The industry's response, as well as the legal precedents set, will be critical in determining how technologies that preserve privacy and enhance user autonomy can coexist with regulatory frameworks designed to ensure market integrity and protect investors.

**CORRECTION: An earlier version of this post incorrectly stated that Custodia accepts customers’ digital asset deposits. This has been corrected to clarify that Custodia offers digital assets custody services for customers but those assets are not accounted for as deposits on Custodia’s balance sheets.