The blockchain and digital asset universe experienced a series
of unprecedented events from mid-2022 through early 2023 that will
continue to shape the digital asset landscape, including:
- a new “crypto winter” caused by the cascading
collapse of multiple digital asset-related entities; - resultant aggressive enforcement by the Department of Justice
(DOJ), the Securities and Exchange Commission (SEC) and the
Commodity Futures Trading Commission (CFTC); - new executive and agency attention to digital assets; and
- increased focus on digital asset-related legislative
solutions
These events are likely to continue to reverberate in 2023 and
beyond, including through:
- a new effort by bank regulators to “shadow ban”
crypto companies from obtaining banking services, often referred to
as Operation Choke Point 2.0; - continued interagency turf battles;
- continued aggressive enforcement by DOJ, the SEC and the CFTC;
and - a reinvigoration of digital asset legislation in the 118th
Congress.
2022–2023 Blockchain Year in Review
Cascading collapses
2022 saw the onset of a new crypto winter, during which
cryptocurrencies including Bitcoin, Ethereum and others dropped in
value by more than 50%, alongside a similarly significant drop in
the value of many non-fungible tokens (NFTs). Perhaps the biggest
driver of this loss of market confidence was a cascading series of
collapses and investor losses beginning in May 2022, which then
continued through the remainder of the year.
LUNA
If there was a ground zero for the cataclysmic events of 2022,
it was the collapse of the algorithmic stablecoin TerraUSD (UST)
and its sister token LUNA in May 2022, resulting in the loss of
approximately USD40 billion in investor funds, and a more than 99%
reduction in the value of the LUNA token. The crash of UST and LUNA
sent shockwaves throughout the industry, triggering crises at
entities that were significantly exposed to UST/LUNA and at
counterparties of such entities.
Three Arrows Capital
The first domino to fall after the LUNA crash was Three Arrows
Capital (3AC). 3AC had significant exposure to LUNA, and the
collapse of LUNA and the subsequent reduction in the value of
3AC’s investments resulted in a margin call 3AC was unable to
satisfy. As a result, in June 2022, 3AC was ordered to liquidate by
a court in the British Virgin Islands. 3AC subsequently filed for
bankruptcy in the Southern District of New York (SDNY), at which
time the fund owed approximately USD3.5 billion to over 25
creditors, according to court documents.
Voyager Digital
The next month, crypto brokerage firm Voyager Digital collapsed,
due in part to exposure to 3AC. Voyager allowed users to deposit
cryptocurrency in exchange for yields as high as 12%. In turn,
Voyager lent user funds to traders and institutions, including 3AC.
3AC was Voyager’s largest counterparty, and was the recipient
of a USD650 million unsecured loan. Following 3AC’s collapse
and the broader market downturn, Voyager filed for bankruptcy in
the SDNY on 6 July 2022.
Celsius Network
Also in July 2022, virtual currency lender Celsius Network
collapsed. Celsius similarly allowed users to deposit
cryptocurrency, which Celsius in turn lent to others, in return for
a significant annual percentage yield of up to 17%. Following the
LUNA crash and the collapse of 3AC, Celsius Network depositors
began withdrawing funds en masse at a rate Celsius was ultimately
unable to satisfy, resulting in Celsius freezing customer
transactions and filing for bankruptcy.
FTX and Alameda
Four months later, on 11 November 2022, FTX Trading Ltd.
filed for Chapter 11 bankruptcy protection. FTX had formerly
operated one of the largest and most popular cryptocurrency
exchanges, and operated alongside quantitative cryptocurrency
trading firm Alameda Research. The sudden collapse of FTX further
destabilised the crypto industry, and its effects continue to be
felt well into 2023. According to charges later filed by DOJ, FTX
founder Sam BankmanFried misappropriated FTX customer funds to
cover losses incurred by Alameda, among other offences.
The collapse of FTX and the crimes allegedly committed by
Bankman-Fried were particularly jarring in Washington, where
Bankman-Fried had cultivated an image as a paragon of compliance
and had been well regarded by many on Capitol Hill. Many government
officials who had embraced Bankman-Fried felt burned, and the
result was increased demagoguing among some in Congress against the
entire cryptocurrency industry.
DOJ, SEC and CFTC enforcement
The past year has been marked by remarkably aggressive
enforcement activity. DOJ, the SEC and the CFTC have individually
and collectively accelerated enforcement activity in the digital
asset space.
The most prominent case brought by DOJ was FTX, where DOJ
charged Bankman-Fried with 13 offences relating to his operation of
the exchange and secured guilty pleas from three former FTX or
Alameda executives (Gary Wang, Caroline Ellison and Nishad Singh).
The SEC and CFTC brought parallel enforcement actions against FTX
and Bankman-Fried, among others.
The same was true in the case against Do Kwon. On 16 February
2023, the SEC charged Terrform Labs PTE Ltd. and Do Kwon with the
offer and sale of unregistered securities. The SEC complaint also
alleged that Terraform and Do Kwon “engaged in a fraudulent
scheme to mislead investors about the Terraform blockchain”
and on-chain assets, including through repeated claims that certain
tokens would increase in value. The complaint further alleged that
they failed to provide full disclosure regarding certain assets,
such as Terra protocol tokens LUNA and TerraUSD, which the SEC
alleged are securities. On 23 March 2023, Do Kwon was arrested in
Montenegro and subsequently charged by DOJ with eight criminal
counts of fraud and conspiracy.
But perhaps the most important US enforcement development has
been the dramatic escalation of the SEC’s campaign to regulate
the digital asset industry by enforcement.
Wahi
In parallel proceedings on 21 July 2022, DOJ and the SEC
initiated actions based on an alleged insider trading scheme
against Ishan Wahi, a former product manager for Coinbase Global,
Inc. (Coinbase), Ishan’s brother Nikhil Wahi, and a friend. The
SEC complaint alleged that the defendants used confidential
information regarding digital assets that Coinbase planned to list,
as well as the timing of listing announcements, to make trading
profits of at least USD1.5 million. The SEC complaint was notable
because the SEC specifically alleged that several of the relevant
digital assets were securities, and thus subject to federal
securities laws, but without engaging with, or bringing any actions
against, the issuers of those tokens or otherwise giving them an
opportunity to defend themselves. In short, with Wahi the SEC moved
from “regulation by enforcement” to “regulation by
enforcement against someone else”.
DOJ’s indictment charged the defendants with wire fraud and
conspiracy to commit wire fraud, in what prosecutors called the
first insider trading case involving cryptocurrency. Notably,
however, the indictment did not refer to the assets as securities.
DOJ eventually secured wire fraud guilty pleas from the two Wahi
brothers.
Despite pleading guilty to the criminal charges, the defendants
challenged the SEC’s parallel civil charges, arguing that
securities laws do not apply to the crypto-assets in question. In a
motion to dismiss filed on 6 February 2023, the defendants accused
the SEC of “trying to seize broad regulatory jurisdiction over
a massive new industry via an enforcement action”, and argued
that the SEC should engage in rulemaking if it believes that
digital assets are securities.
In light of the significant implications of the SEC’s
expanding view that secondary trades in crypto tokens should be
considered SEC regulated transactions involving investment
contracts, it is unsurprising that there were a number of amicus
briefs filed in the case. For example, the Blockchain Association
filed a brief challenging the SEC’s approach of seeking to
apply the securities laws to tokens without any formal SEC action
or court ruling. The Blockchain Association brief also argued that
“the SEC is engaging in regulation by enforcement against
absent third parties”, in reference to the SEC’s labelling
of various crypto tokens as securities, which could impair their
value and impact secondary market trading. The Investor Choice
Advocates Network filed an amicus brief arguing that the SEC
exceeded its statutory authority in attempting to regulate digital
assets. Likewise, the Chamber of Digital Commerce filed an amicus
brief urging dismissal of the case, which the Chamber called a
“dramatic overreach by the SEC”.
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