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SEC has 'no real chance' in Grayscale appeal, spot BTC ETFs 'inevitable' - Banxa CLO Richard Mico

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(Kitco News) - 2023 has seen a barrage of lawsuits and enforcement actions against cryptocurrency companies after the events of 2022, which included the collapse of FTX and Terra/Luna, highlighted the dire need to establish a regulatory framework for the rapidly growing asset class.

One decision that is likely to reverberate throughout the ecosystem for years to come was the dismissal of a class action lawsuit against Uniswap, the leading decentralized exchange (DEX) in the industry. The plaintiffs in the lawsuit accused the platform of alleged securities violations after they lost money due to “scam tokens” listed on the DEX between December 2020 and March 2022.

To get more insight into this case and what it means for crypto and the decentralized finance (DeFi) ecosystem, Kitco Crypto spoke with Richard Mico, the U.S. CEO and Chief Legal Officer of Banxa, a payment-and-compliance infrastructure provider for the global crypto industry.

“The full dismissal of the class-action suit against Uniswap Labs is yet another notable win for the broader crypto and DeFi ecosystem,” Mico said. “The class action lawsuit alleges harm after purchasing ‘scam tokens’ on the Uniswap platform. But notably, Judge Katherine Polk Failla in her decision noted that ‘Due to the Protocol’s decentralized nature… [there is] no identifiable defendant.’”

He noted that while this decision is “not officially precedent-setting as a district court decision, decisions of the Southern District of New York often yield greater respect, meaning the underlying rationale could well be referenced and applied in future similar cases which could shape future DeFi cases or ones involving securities issues.”

One of the biggest challenges faced in regulating the crypto industry has been a lack of knowledge about blockchain technology, its capabilities, and how it operates in a decentralized manner, which is vastly different from the way traditional financial platforms have operated.

The decision in the Uniswap case is one of the first where the judge showed a deeper understanding of the technology and how decentralized networks operate.

“As one of the first test cases for DeFi, the decision appears to demonstrate a greater understanding of the complexities of decentralized networks, given the distinctions drawn between the token issuers and the Uniswap platform itself,” Mico said. “As Judge Failla wrote in her decision, ‘[I]t defies logic that a drafter of computer code underlying a particular software platform could be liable under Section 29(b) [of the Exchange Act] for a third-party’s misuse of that platform. As discussed, smart contracts are self-executing, self-enforcing code that contain the terms of the agreement between the buyer and seller.’”

“Moreover, Judge Failla did point to the current state of crypto regulation and noted that relevant laws currently don’t exist, stating, ‘The Court declines to stretch the federal securities laws to cover the conduct alleged, and concludes that Plaintiffs’ concerns are better addressed to Congress than to this Court.’” he said.

While the case is important in establishing a positive ruling for DeFi platforms, Mico said it is unlikely to alter how the SEC is approaching its enforcement actions toward the industry.

“I don’t anticipate the SEC altering its current tact of regulation-by-enforcement any time soon,” he said. “Despite having suffered multiple courtroom setbacks in recent months, the SEC has unfortunately continued on its aggressive path with SEC Chair Gary Gensler even recently warning that DeFi projects were ‘under increased scrutiny.’ In the absence of comprehensive new regulation for the industry, this trend of piecemeal and conflicting decisions will be par for the course.”

“However, it is expected that moving forward crypto defendants will raise this ruling in challenging the SEC’s jurisdiction over token issuers and platforms,” he said. “Time will tell whether this argument will be successful.”

Grayscale ruling

When asked what options the SEC has after an appellate court ruled that the regulator must review Grayscale’s application to convert its Grayscale Bitcoin Trust (GBTC) into an ETF, Mico said the ruling “makes it clear that the SEC’s denial of the spot BTC ETF was ‘arbitrary and capricious’ because it was inconsistent with the SEC’s treatment of similar products, namely the futures BTC ETF.”

“A very embarrassing outcome for the SEC,” he said. “Given this was a unanimous decision of the Court of Appeal, the SEC has no real chance of a successful appeal. Accordingly, the SEC only has two options, withdraw the approval for the futures BTC ETF or approve the spot BTC ETF.”

Mico said that while “Some consider the SEC’s historic petulant approach to crypto regulation means they will seek to further unreasonably stifle the crypto industry,” he is “far more optimistic.”

“The Grayscale ruling has materially increased the likelihood of the spot BTC ETC being approved to ~80% in my estimation,” he said. “I am confident that the SEC will, begrudgingly, approve the various spot BTC ETF applications between October 2023 and March 2024. This ruling and, in turn, the inevitable approval of the spot BTC ETC will open the floodgates for traditional investments in Bitcoin, enhancing the credibility and influence of this digital asset.”

Grayscale decision is arguably the most important decision so far for the crypto community - Felix Shipkevich

Ripple and XRP

On the topic of the ruling that XRP is not a security and the SEC’s subsequent appeal of that decision, Mico said, “On balance, I believe that the SEC’s motion to seek appellate review in the XRP case will be granted given the ‘industry-wide significance’ which is of ‘special consequence’ and because of the contradictory legal conclusions of the District court.”

“However, it is likely to take years before a decision is issued by the Second Circuit Court of Appeals,” he said. “It is true that there is a real question of law that requires clarity from a superior court or lawmakers. I am cautiously optimistic that lawmakers will step in before an appellate decision is handed down. If not, on balance, I suspect that Judge Torres’ decision will hold that subsequent sales on public exchanges are not offers of securities at law, because purchasers did not have a reasonable expectation of profit tied to Ripple's efforts.”

Non-fungible tokens

When asked about the recent victories for the SEC in their lawsuits against non-fungible token (NFT) issuers Impact Theory and Stoner Cats, Mico highlighted that “Both of these enforcements occurred without the SEC issuing any guidance to the market on the application of securities laws to NFTs, and against a backdrop of dissent from two SEC Commissioners.”

“Let the SEC’s crusade of regulation by way of enforcement continue!” he said. “It is expected that the SEC will opportunistically seek to leverage these two enforcement actions against other NFT issuers.”

“However, the SEC’s enforcement actions are not binding on the Courts, and do not automatically mean that they are legally or ethically correctly enforcing the law,” he noted. “On the contrary, some commentators compellingly argue that the SEC continues to incorrectly interpret and apply the law, and is negligent in failing to provide regulatory clarity. One needs to look no further than the civil unrest and dissension within the SEC to understand why market participants remain perplexed.”

Mico said these cases are significant because “they represent the first time the SEC has pursued issuers of NFTs for violating securities laws, and because unique issues arise with NFTs that do not arise with other types of crypto tokens or conventional securities. Typical crypto tokens are fungible tokens that are interchangeable and indistinguishable, whereas NFTs represent a unique item.”

“Since at least March 2022, the SEC has been investigating the manner in which NFTs are marketed, advertised, and sold,” he said. “More recently, the SEC has announced significant increases in staff to focus on digital assets including NFTs. It is therefore very likely that the SEC will maintain its activist approach and scrutiny of NFTs.”

Mico said that while he “somewhat sympathizes” with SEC Chair Gary Gensler’s position on the need to consider the “economic reality” of some tokens, he disagrees “that this automatically categorizes an asset as a security, and that there has been sufficient regulatory clarity and ‘fair notice’ provided to market participants by the SEC.”

As for a higher-level outlook on the state of crypto regulation in the U.S. moving forward, Mico said that he is hopeful that the SEC will begin to collaborate more closely with crypto companies amid the pushback from the industry and the public at large.

“The U.S. has fallen behind other leaders in innovation, and in order to catch up, will need to establish a clear regulatory framework that enables technological advancement without hurting investors,” he said.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.