Regulators are Coming for Crypto, Here’s How Firms are Reacting

If policymakers get their way, the Wild West days of the digital asset market may be coming to an end, and firms are starting to feel the pressure.

Cryptocurrency exchange and loans provider BlockFi is in hot water with regulators in three different US states. Binance CEO Changpeng “CZ” Zhao said he is willing to step down from his role leading the company if a candidate with a better understanding of the regulatory environment is found. Crypto exchange FTX moved to limit the amount of margin-trading debt traders can leverage from 101 times to 20 times.

While lawmakers on the federal level struggle to establish crypto legislation, states are taking the lead. New Jersey, Alabama and Texas each filed complaints last week alleging that New Jersey-based BlockFi is offering unregistered securities to clients through its high-yield interest account service. 

BlockFi issued a statement on Twitter, arguing that the product “is not a security” and therefore should not be under the New Jersey Bureau of Securities’ jurisdiction. Industry members are wondering about security classification as well. 

“There was no statutory analysis regarding the definition of a security in the order. It is not clear why the BlockFi deposit account wasn’t just a “deposit account”ㅡwhich should be regulated in its own right by a prudential regulatorㅡbut, not as a security,” said Georgia Quinn, general counsel at Anchorage Digital. “Overall, this continues to be an area where the industry needs further regulatory clarity and a deeper look at past precedents.”

New Jersey legislators have a different view of the situation. 

“Our rules are simple: if you sell securities in New Jersey, you need to comply with New Jersey’s securities laws,” Andrew Bruck, New Jersey’s acting attorney general, said last week. “No one gets a free pass simply because they’re operating in the fast-evolving cryptocurrency market.”

BlockFi declined Blockworks’ request for further comment.  

The crackdown comes as lawmakers across the world grapple with how to regulate this emerging asset class. China has issued several mining bans and the European Commission recently proposed a potential ban on anonymous crypto wallets. 

Crypto regulation talks have picked up steam across the US, too. The FBI recently issued a security warning regarding digital assets and congress has ramped up cryptocurrency-related hearings.

In June, the House subcommittee on oversight and investigations heard from crypto industry members during the “America on FIRE” hearing. On Tuesday, the Senate banking committee continued the discussion with the “Cryptocurrencies: what are they good for?” hearings. 

The recent regulatory action has some firms acting preemptively. Hong Kong-based FTX moved to cut down on high-risk trading Monday. 

“We’re going to be the ones to take the first step here,” Sam Bankman-Fried, FTX founder, announced via Twitter on Sunday. “Today, we’re removing high leverage from FTX. The greatest allowable will be 20x.”

Bankman-Fried explained that these types of high-risk trades are not serving the broader crypto industry. The exchange also raised $900 million in venture capital funding last week, and the step to limit leveraging may be beneficial in demonstrating compliance and legitimacy. 

Binance, less than a day later, took a similar stance. The exchange said that new customers will only be able to leverage up to 20 times. The rule will be extended to existing clients soon, who currently have been able to leverage up to 125 times. 

“For companies that enjoy higher levels of success in the form of market traction — translated to potential to harm users — the more complex or risky a product might seem, these are the most likely to create regulator ire,” said Alex Christian founder and CEO of Data Mynt. 

Binance’s Zhao also hinted at broader regulatory concerns the exchange is facing. He said that while no plans are currently in place, he is willing to step down and hand his role to someone better prepared to tackle regulatory challenges in the industry. 

“We’re going to pivot to be a fully regulated financial institution going forward,” Zhao told reporters during a virtual press conference Tuesday. He added that the company is “keeping our options open” when it comes to finding someone with the right regulatory experience. 

Going forward, it is unclear how regulators will approach the asset class, but firms are likely to continue taking steps to limit liabilities. 

“Some crypto and DeFi organizations will avoid the US markets playing regulatory arbitrage, some will remain anonymous, and the others will attempt to comply and make smart innovation around unclear regulatory guidance that was created for the concentrated ‘too big to fail’ legacy institutions,” said Christian. 

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