The Securities and Exchange Commission issued a strong warning to investors, citing cryptocurrencies' volatility, failure to register as securities, and frequent frauds.
A day after announcing it will likely sue Coinbase for selling unregistered securities, the Securities and Exchange Commission issued a stark warning to investors to stay away from crypto.
The Wednesday issuance of a Wells Notice warning of a possible lawsuit to the top U.S. exchange is widely considered the opening salvo of the agency's latest and most direct attempt to prove that all cryptocurrencies, except Bitcoin, should be registered as securities.
"The risk of loss for individual investors who participate in transactions involving crypto assets, including crypto asset securities, remains significant."
The key phrase there being "crypto asset securities."
The Big Battle
In some ways, the investor alert offers a preview of what the SEC sees as the reasons it and its chairman, Gary Gensler, believe that all cryptocurrency issuers and exchanges should register with it — the goals that it will pursue in a likely lawsuit against Coinbase.
"The silver lining, to the extent there is one of this type of development, is that it will force the establishment of case law that will inform how crypto is regulated and it will set some rules of the road for crypto to comply with," Brett Quick, head of government affairs at Crypto Council for Innovation, told CoinDesk TV on Thursday.
As Coinbase has said very clearly it will fight any such lawsuit in court — as Ripple is currently — the result will inevitably be a court precedent as to whether cryptocurrencies are securities.
Keep it Separate
The SEC notice starts with a long section warning that "those offering crypto asset investments or services may not be complying with applicable law, including federal securities laws."
Delving into the many types of information important to investors that must be disclosed by issuers of securities, most notably independently audited financial statements, the SEC then turned to exchanges failing to register.
"Some of those benefits include rules around custody of assets, fees, conflicts of interest, standards of conduct, and minimal capital requirements for broker-dealers," it said.
One of those, the customer protection rule, "requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm's assets – increasing the likelihood that customers' securities and cash can be returned to them in the event of the broker-dealer's failure."
Which is to say, prevents the commingling of assets that has been a big part of recent bankruptcy cases.
Show Us the Money
The SEC also took aim at the proof of reserves reports that many crypto exchanges have been rushing to provide in the wake of the collapse of FTX. It said:
"A proof of reserves is not as rigorous, or as comprehensive, as a financial statement audit and may not provide any level of assurance… or [offer] protections similar to a financial statement audit."
Then there is the commingling of functions — like exchange, broker-dealer and custodian — that "creates conflicts of interest and risks for investors."
Time to Register
Noting that "no crypto asset entity is registered with the SEC as a national securities exchange," the SEC said:
"As a result, investors in crypto asset securities may not benefit from rules that protect against fraud, manipulation, front-running, wash sales, and other misconduct when intermediaries for those products do not comply with the federal securities laws that apply to registered exchanges."
The SEC then delved deeper into warnings of the high risk of volatile crypto assets and the prevalence of fraud and scams, ending with standard investing advice to have an investment plan, have a diverse portfolio of assets and understand the risks.