June 7, 2023

Exploring the tech behind crypto

one block at a time

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Hi, Bradley Keoun here, editor of The Protocol.

In today’s issue of The Protocol, we’re covering the implications for big blockchain projects including Cosmos, Solana and Cardano of their native tokens being labeled as securities by the U.S. Securities and Exchange Commission – found deep within regulatory suits filed this week against crypto exchanges Binance and Coinbase. We also have the news on Optimism's "Bedrock" upgrade, a pump in prices for metaverse-related tokens following the announcement of Apple's new VR headset and the Sui blockchain's Formula 1 sponsorship with Red Bull Racing. 

SEC's Campaign Against Binance, Coinbase Ensnares Tokens at Core of Blockchains From Cardano to Solana

The U.S. Securities and Exchange Commission’s crackdown this week on major crypto exchanges also may have landed an existential blow against some of the biggest blockchain projects – with enforcers arguing in a pair of landmark enforcement cases that popular tokens issued by protocols including Cosmos, Filecoin, Algorand, Cardano, Solana might be securities – a designation that would trigger extensive additional regulatory hurdles. 

The collateral damage could be crucial, since the tokens sit at the core of key technological designs and “tokenomic” systems for some of the most successful and promising decentralized networks.  

Binance and Coinbase were accused of a range of federal securities violations, in a one-two punch that follows months of SEC Chair Gary Gensler warning that he thought many tokens besides bitcoin (BTC) probably qualified as securities. The cases could end up in court, with Binance calling the allegations “baseless” and Coinbase claiming that the SEC relied on “an enforcement-only approach in the absence of clear rules for the digital-asset industry.” 

Coinbase CEO Brian Armstrong tweeted, “There is no path to ‘come in and register.’ We tried, repeatedly.” U.S. Senator Cynthia Lummis, who has advocated for the crypto industry, tweeted that the agency had “failed to provide adequate guidance on what differentiates a security from a commodity.” 

(CNBC)

So far, the blockchain-development teams behind the tokens named in the sweep have not themselves been formally accused of any wrongdoing, but the SEC went into exhaustive detail on the history of initial coin offerings (ICO) or other token sales and then painstakingly mapped out how prices of the digital assets would depend on the efforts of the team. That language comports with the Howey test, a precedent used by securities regulators to determine whether a token might qualify as an investment security; the key question under the test is whether profits depend on the efforts of others. 

In the complaint against Coinbase, for example, the SEC homed in on the exchange’s listing of Cardano’s ADA token, mentioning the project 33 times and devoting an entire section that ran for nearly three pages to document the token’s issuance (starting with a $62 million of sales from 2015 to 2017) and subsequent existence. “Investor funds were used to enact the Cardano roadmap,” the complaint reads, noting that the teams behind the project had “described the efforts they have made and will continue to make to develop the Cardano protocol and blockchain and attract users to the technology.”

Charles Hoskinson, Cardano’s founder, provided a glimpse of how blockchain teams might respond when he tweeted, “It’s always the same fight between freedom and authoritarianism just with different players, technology, and words. This event seems to be a political philosophical disagreement with the very existence of cryptocurrencies and what they represent.” (CoinDesk contacted all of the projects named in the suits; few of them responded, and those that did mostly declined to comment.)

Industry executives can hardly claim to be surprised by this week's regulatory developments. Ever since the ICO craze of 2017, many tokens have been cast by critics, skeptics, Bitcoiners and even many altcoiners as akin to “crypto-equity” – a phrase that might signal just how favorably the project-fundraising and personal-enrichment benefits of selling tokens compared with their crucial function as technological elements of the various blockchain ecosystems. But many teams have argued, citing regulatory precedents including a 2018 speech by former SEC Division of Corporation Finance Director Bill Hinman, that decentralization could represent a formidable defense against the Howey test. (Hinman’s speech has attracted attention recently, since it’s come up in Ripple Labs’ courtroom defense against the SEC’s 2020 lawsuit alleging that the company’s $1.3 billion sales of XRP – the cryptocurrency used in its payment network – amounted to an unregistered securities offering.) 

What happens next? Blockchain Association CEO Kristin Smith said that “We’re confident the courts will prove Chair Gensler wrong in due time.” ETC Group’s Bradley Duke said in an email that the SEC is sending the message that, “You are not welcome in the U.S.” Token prices tumbled on Monday when the Binance suit was unveiled, though digital-asset markets appeared to stabilize on Tuesday. Some European officials told CoinDesk’s Jack Schickler they see an opportunity to tempt U.S. crypto firms to relocate abroad. 

There’s certainly a feeling among crypto-industry executives that they’re being targeted unfairly for their efforts to innovate in the areas of financial services and payments – disrupting Wall Street. Gensler probably did little to dispel that narrative when he said Tuesday that, “We don’t need more digital currency… We already have digital currency, it’s called the U.S. dollar.” (One clever Twitter user posted, “I question the actual value of Gary Gensler.”)   

One of the few encouraging takeaways from the regulatory dump came from the recognition that ether (ETH), the native cryptocurrency of the Ethereum blockchain, was not among those the SEC named as likely securities. As recently as April, Gensler had refused to say whether ether was a security – raising concerns among analysts at the time. On Tuesday, the digital-asset analysis firm K33 noted that “ETH was not implicated as a security, despite similar characteristics to its current staking model and its ICO to several of the highlighted coins. This silver lining might explain ETH’s outperformance vs. BTC amidst yesterday’s sell-off.”

How it will all play out remains a giant source of uncertainty for blockchain protocols that depend on the tokens as a core element of their technology. What’s safe to say, as the newsletter Bankless put it, is that this week’s development provide “another display of the contentious relationship between the crypto ecosystem and American regulators.”

Network News

Burak Keceli, creator of Ark. (Burak Keceli)

Burak Keceli, the 24-year-old self-taught Bitcoin developer and researcher who disrupted a large chunk of Bitcoin’s Lightning Network last year, is now proposing a new layer 2 protocol dubbed Ark that he says will solve Lightning’s “inbound liquidity" problem. 

The rocky rollout last month of Ethereum clone PulseChain, led by the twerking crypto entrepreneur Richard Heart, might reveal risks of trusting “bizarro” projects “beneath serious attention.” 

Bitcoin Ordinals community debunks claim that single entity owns majority of Bitcoin Ordinals, after researcher notes that a single public key produced majority of inscriptions; turns out there’s an explanation for this; they were produced by Unisat.io on behalf of users. (Protos) 

Also:

Protocol Village

OP Labs CEO Karl Floersch. (Optimism)

Money Center

Data Corner

Calendar

Consensus @ Consensus 

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