I'll start by pointing out that I couldn't find any disclosure as to whether de Gregorio is long or short cryptocurrencies or related companies. So it is safe to assume that he is one of the majority of "crypto experts" Talking Their Book. And that, with typical crypto-bro misogyny, he personifies the villain of the piece (my emphasis):
Letitia James.He correctly stresses the importance of decentralization:
That’s a name that probably won’t mean much to you, but it’s none other than one of the most powerful people in the United States, the New York’s Attorney General.
This woman, from this position of immense power, has filed a lawsuit against KuCoin for failing to register as a broker-dealer for securities and commodities.
As I’ve said many times, any indication that a Crypto project is centralized automatically makes it completely worthless, because the sole concept of blockchains is intrinsically related to the concept of decentralization.Note the implication that a "Crypto project" must be decentralized because otherwise it would be worthless, but you can see that its "market cap" is in the hundreds of millions or even billions of dollars, so it can't be.
Without decentralization, high security and integrity of data are no more, as the ledger relies on its distributed nature to guarantee the high-security thresholds it claims to have.
The reason de Gregorio is worried is that the NYAG's suit claims that the Merge has transformed Ethereum into a security because staking is an investment with a return. He explains the difference (my emphasis):
While PoW blockchains decide what node introduces the next block of transactions (receiving the reward for doing so) by a mathematical guessing competition, PoS decides the next node by random choice, in which the nodes stake their tokens to have a higher chance of being chosen.
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| Source |
But that isn't the case. The "nodes" in a PoW network are the mining pools. What are "mining pools"? Nakamoto's vision was of a large number of roughly equal nodes guessing — "one CPU one vote". Suppose there were 100 of them. The system is designed to generate a new block every 10 minutes. Thus on average a node will receive a block reward about once every 17 hours.
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| 2 pools control BTC 1/19/23 |
The idea of one node per ASIC makes no sense. To average a reward a day now requires about 175,000 ASICs, 99.7% of which will be trashed without ever earning anything. A mining pool is a way to aggregate huge numbers of ASICs into a single node and thereby gain rewards more frequently. ASIC owners pay the pool a fee that trades their chance for a big reward at infrequent random intervals (gambling) for a share in the pool's more frequent, more predictable flow of rewards (investment).
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| 3 pools control ETH |
de Gregorio introduces the Howey Test, the legal definition of a security:
The decades-old Howey Test consists of three criteria:But he gets it wrong by omitting the fourth prong. It is actually (my emphasis):
- Investment of Money: The first requirement is that the investment involves an exchange of money or something of value.
- Expectation of Profit: The second requirement is that the investment is made with the expectation of earning a profit.
- Common Enterprise: The third requirement is that the investment is made in a common enterprise.
It is completely obvious that staking services and exchange's staking products satisfy the Howey Test. They are common enterprises, to which you give something of value (ETH) in the expectation of profit derived from their running validators and using them to stake ETH including yours. The Kraken exchanges already paid $30M to settle an SEC lawsuit that alleged:
- An investment of money
- In a common enterprise
- With the expectation of profit
- To be derived from the efforts of others
This case concerns the illegal unregistered offer and sale of securities involving the staking of crypto assets. In particular, Defendants have offered and sold an investment contract to the general public, including United States investors, whereby investors transfer certain crypto assets to Kraken for “staking” in exchange for advertised annual investment returns of as much as 21% (the “Kraken Staking Program” or “Program”).A 21% annual return? Surely can't be a scam.
It has been established that Lido and the exchange staking programs are unregistered securities and thus illegal. It seems clear that the fourth prong means if you were to run your own validator staking your own ETH, that would not be a security. But unless you were a whale and could stake a lot of ETH, that would be a lot of hassle for an infreguent reward. Because the Gini coefficients of cryptocurrencies are so extreme (in 2019 Ethereum's was between 0.8 and 0.95), only a very few ETH HODL-ers would take that gamble.
It isn't as obvious that ETH itself satisfies the Howey Test. de Gregorio writes that the NYAG:
argues that the people in the Ethereum Foundation have considerable power over the network and a clear interest in heading the blockchain in a direction that favors them, as they allegedly own considerable amounts of ETH and thus have a clear interest in accruing the value of the token.The NYAG could be much stronger. Clearly, a network controlled by 2 or 3 pools can't actually be called "decentralized". The Lido service and the exchanges have more than "considerable power over the network", they control it. And, just as we saw with the big miners' veto over increasing Bitcoin's block size, the big validators will have a veto over proposals from the Ethereum Foundation.
SEC chair Gary Gensler writes in Getting crypto firms to do their work within the bounds of the law:
The crypto market is no exception. It has many “trusted” — though non-compliant — intermediaries. Today, crypto is dominated by a handful of trading, lending, staking, and other financial intermediaries. The investing public is trusting these entities to be responsible with investors’ assets. According to some data, the three largest crypto trading platforms purportedly account for almost three quarters of all trading volume.So the lack of decentralization is well-known and it isn't just at the blockchain level, as shown by recent DARPA-sponsored research it is at every level of the stack. de Gregorio, the pontificator about cryptocurrencies who stresses the importance of decentralization, is either cynically gaslighting or has drunk the Kool-Aid by not pointing out that these systems are in practice centralized, and in theory must be.
It should not be surprising that the NYAG believes that ETH, backed by an ICO, with a foundation stuffed with whales, and controlled by large staking services, is a security. SEC chair Gensler writes:
We’ve been clear that most crypto tokens that are backed by entrepreneurs, among other features, are likely to be securities. We’ve been clear how lending and staking platforms come under the securities laws. We’ve been clear that platforms listing crypto securities must register with the SEC. Further, the securities laws are clear that these platforms are not to combine functions under a single umbrella that creates conflicts and risks for investors.de Gregorio and others base their case on the fact that back in 2018 the Director of the SEC’s Division of Corporation Finance William Hinman asserted that ETH was not a security because the Ethereum blockchain was "sufficiently decentralized". But Hinman's assertion was false then and is false now. And Hinman now works for A16Z, the "Softbank of crypto". It would be better to listen to the current SEC chair, who is in charge of enforcement, but doing so would "kill Crypto".
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Coinbase got a Wells notice from the SEC alleging that many of their products were unregistered securities.
Via Molly White, the SEC sued Justin Sun and three of his companies alleging that:
- TRX and BTT were unregistered securities.
- Sun fraudently manipulated the market for TRX through "extensive wash trading".
- Sun "orchestrat[ed] a scheme to pay celebrities to tout TRX and BTT without disclosing their compensation"
The SEC also sued the celebrities in question, "Lindsay Lohan, Jake Paul, Soulja Boy, Austin Mahone, Kendra Lust, Lil Yachty, Ne-Yo, and Akon". All but Soulja Boy and Austin Mahone have apparently settled with the SEC for a total of $400K.
It isn't just the "unregistered securities" issue that is a problem for cryptocurrency exchanges. In SDNY: EFTA Applies to Crypto Adam Levitin writes:
"I'd been puzzling about why no one has applied the Electronic Fund Transfers Act and Reg E thereunder to crypto: after all, if you have a crypto account with an exchange, it would seem to be an "account" at a "financial institution" that is primarily for personal, family, or household purposes and is used for electronic transfers of "funds." In fact, I had just emailed Bob Lawless for a sanity check on this, when I came across a very recent SDNY decision that held that the EFTA applies to crypto."
Judge Denise Cote wrote:
"Uphold moves to dismiss the claim for violation of the EFTA on the ground that the EFTA applies by its terms to transfers of “funds” and cryptocurrency does not constitute funds. The
defendants’ argument fails.
The EFTA “provide[s] a basic framework establishing the rights, liabilities, and responsibilities of participants in electronic fund transfer systems.” 15 U.S.C. § 1693(b). The EFTA conferred upon the Federal Reserve Board (the “Board”), and now the Consumer Financial Protection Bureau (the “CFPB”), the authority and responsibility to “prescribe regulations to carry out the purposes” of the Act. 15 U.S.C. § 1693b(a). The Board and the CFPB have promulgated administrative regulations, codified at 12 C.F.R. § 205 (“Regulation E”).
...
Uphold is a financial institution, as defined by the EFTA, because it “holds an account belonging to a consumer.” 15 U.S.C. § 1693a(9). As alleged in the FAC, Uphold directly maintains consumer accounts which enable its users “to transfer, purchase, trade, hold, and sell various cryptocurrencies on its platform.”
...
Defendants’ argument that cryptocurrency is not “funds” under the EFTA relies on a statement the CFPB released with a 2016 Rule. But, in that release, the CFPB expressly stated that it was taking no position with respect to the application of existing statutes, like the EFTA, to virtual currencies and services."
Levitin writes:
"Reg E has important consumer protections regarding unauthorized transactions, error resolution, and provision of receipts and periodic statements. It also creates huge compliance headaches for crypto exchanges, which are not set up for dealing with any of those problems."
Sidhartha Shukla reports that SEC Case Against Crypto Mogul Sun Stirs Questions Over Huobi:
"The TRX token at the center of fraud charges against digital-asset mogul Justin Sun makes up a significant slice of the reserves at the Huobi Global crypto exchange, where the China-born entrepreneur is an adviser.
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TRX — commonly referred to as Tron — comprises 18% of the reserves at Huobi, a major crypto platform, according to data from DeFiLlama.
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TRX, the native coin of Sun’s Tron ecosystem, slid almost 16% at one point on Wednesday after the US Securities & Exchange Commission accused him and his firms of market manipulation to make the token appear actively traded.
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Another big chunk of Huobi’s reserves are in the exchange’s own coin, HT. Taken together, TRX and HT account for about 41% of the platform’s reserves."
Matt Levine writes:
"The position of Coinbase — and of the crypto industry more broadly — is “look, SEC, if you want to have a flourishing system of legally compliant, safe, trustworthy crypto assets, you will need to work with us a little bit to write new rules,” and the position of the SEC is “no, we don’t want that, we want all of you to go away forever.” If Bernie Madoff came to the SEC and said “if you want a higher class of more trustworthy Ponzi schemes, you will need to write a few new rules adapting the disclosure regime to Ponzi schemes,” the SEC would have said “no we absolutely do not want that, we want much less Ponzi scheming, and we certainly do not want to give our approval to Ponzi schemes by writing rules for them.” One gets the sense the attitude to crypto is similar.
On the other hand Coinbase is an SEC-registered public company with an SEC-registered broker-dealer license! The approval is kind of already there! The SEC’s attitude to crypto is extremely negative, but it is only slowly getting around to doing anything about it — and in particular it is only slowly getting around to going after big respectable crypto firms like Coinbase. And in the interim, those firms have had time to get bigger and more respectable, with the SEC’s quiet acquiescence."
John Reed Stark, the ex-Chief of the SEC's Office of Internet Enforcement writes Why Coinbase Will Lose Its Battle With the SEC (Wells Notice Edition), a long an detailed explanation well worth your time:
"Rather than respond to the Wells Notice privately, as most companies would do, Coinbase, as per usual, instead immediately went into full offensive mode and laid out their defenses on Twitter and elsewhere in an attempt to rally the mob, and publicly shame the SEC into backing off. For whatever reason, Coinbase believes a Twitter rant against the SEC (who will never respond, unless it is with a lawsuit) is the best way to do battle against a Wells Notice.
Not only are Coinbase's arguments weak, misguided and more akin to public relations than legal positions, but Coinbase's arguments are also proven failures of crypto-mumbo-jumbo and ludicrous jaundiced rhetoric."
Decentralized In Name Only - Molly White's headline alone makes the point: BNB Chain team prepares to step in to prevent massive Venus Protocol liquidation.
From the "Decentralization!" department comes Molly White's Multichain finally confirms their CEO was arrested in China with this quote from the project:
"Since the inception of the project, all operational funds and investments from investors have been under Zhaojun's control. This also means that all the team's funds and access to the servers are with Zhaojun and the police"
Decentralization FTW! Vildana Hajric reports that Just Eight Exchanges Handle 90% of All Crypto Trading Volume:
"The top eight platforms account for nearly 92% of depth — a measure of all bids and asks within 10% of the mid price — and 90% of volume, according to Kaiko. Binance, the largest crypto exchange, has this year accounted for more than 30% of global market depth and more than 60% of worldwide trade volumes. Besides Binance, the list also includes Coinbase, OKX and Huobi, among others."
Kaiko’s Dessislava Aubert and Clara Medalie wrote:
"Highly concentrated crypto markets are both a good and bad thing. There is undoubtedly a shortage of liquidity, which when spread thin across many exchanges and trading pairs can exacerbate volatility and disrupt the price discovery process. ... Natural market forces have inevitably led to increasing concentration of this liquidity on a handful of platforms, which benefits the average trader. However, highly-concentrated crypto markets can create points of failure for the industry (ex: the FTX collapse)"
And these 8 exchanges are not exactly flourishing:
"In August, crypto trading volumes declined to the lowest level of the year, another sign of waning investor interest and a surprising one given the slew of positive news that the industry has seen come out, including exuberance over a potential Bitcoin ETF. The combined monthly volume of so-called spot and derivatives trading fell 11.5% to $2.09 trillion, and was the second-lowest monthly total since October 2020, according to data compiled by CCData."
Alexandra Scaggs reports on a speech by Rohit Chopra of the CFPB in CFPB looking at crypto platform hacks:
"Yes, the CFPB is thinking over how the Electronic Fund Transfer Act, or EFTA, might apply to crypto accounts.
The EFTA is meant to protect consumers from payments fraud. Institutions that facilitate electronic fund transfers are required to notify customers of whether, or when, they will be liable for unauthorised transfers (ie fraud). The liability disclosures are supposed to happen before an account’s first transfer takes place, according to CFPB rules."
This harks back to Adam Levitin's observation that EFTA and Reg E applies to cryptocurrencies.
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