How U.S. Judges Might Save Crypto From the SEC

If this year’s bruising battle between U.S. regulators and the crypto industry were a prize fight, we might judge the latest round as one in which the latter finally landed some meaningful blows even as the former maintained the upper hand.

By the week’s end, fallout from the liquidation of Silvergate Bank ensnared institutions such as Signature Bank and Silicon Valley Bank following government warnings about banks’ exposure to crypto. But it would be wrong to downplay the points crypto scored between Thursday last week and this past Tuesday, when the Securities and Exchange Commission suffered important setbacks in two separate court cases.

Given that it’s impossible for either fighter to fully knock the other out, the question is whether this round holds any signals as to who will ultimately be judged the winner when we reach the 15th round many months – or more likely years – hence.

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Here I’ll go out on that all-too-familiar limb and say that if the U.S. continues to be a rule-of-law nation – some might say that’s a big assumption – then this week’s developments suggest that, when all is said and done, crypto will inevitably win.

Kool-Aid Casey, the critics will call me – the same people who think “crypto” is defined solely by the get-rich-quick, scam-filled culture embodied by Celsius Network, Terra, FTX and other high-profile failures of 2022 and not by the underlying technology with which they happened to be associated.

My confidence comes from two separate courtrooms in which judges, guided by an impartial legal framework, eschewed that popularist mode of judgment and instead considered the SEC’s claims against the facts and counter-arguments presented to them. That’s an environment in which crypto won’t be anthropomorphized by politicians and social media commentators but treated as the amoral, apolitical technology that it is, a tool that has both good and bad applications, neither a villain nor a hero.

‘Might have an issue’

In the first case, Judge Michael Wiles of the Southern District Bankruptcy Court in New York said he was “absolutely shocked” by SEC lawyer William Uptegrove’s bid to block Binance’s acquisition of failed exchange Voyager on the vague grounds that the agency “might have an issue” with Voyager’s VGX token possibly being an unregistered security. Four days later, Wiles approved Binance’s deal.

Read more: U.S. Justice Dept. Appeals New York Judge’s Decision to Approve Voyager’s Sale to Binance.US

In the second case, one dealing with asset manager Grayscale’s challenge of the SEC’s rejection of its bitcoin exchange-traded fund application, an appeals court panel grilled the SEC’s lawyer over the Commission’s argument that spot market-based prices for a bitcoin ETF cannot be trusted whereas those underpinning SEC-approved futures-based bitcoin ETFs can be.

Many have long seen this as an inconsistent double-standard because futures prices are directly derivative of what’s happening in spot markets. So, when SEC senior counsel Emily Parise struggled to assuage the judges’ concerns, investors started buying the Grayscale Bitcoin Trust, a close-ended trust whose wide discount to the underlying price of bitcoin would likely close if it’s allowed to convert to an ETF. (Grayscale is a subsidiary of Digital Currency Group, which also owns CoinDesk.)

Separation-of-powers

Thank God one of the three branches of government seems to be upholding the separation-of-powers principle.

In the U.S, a dysfunctional, divided legislative branch repeatedly fails to reach the consensus needed to enact laws, especially in the divisive, little-understood area of crypto, which desperately needs new rules befitting its decentralized governance structure. That abdication of responsibility by Congress has created a vacuum in which executive-branch agencies such as the SEC are excessively empowered to practice regulation by enforcement.

The SEC has thus cultivated a Damocles Sword-like version of raw, discretionary power: it fosters the general expectation among crypto providers that it might one day choose to define their product as a security, but offers no clear guidelines on if and when the blade might drop. It’s the threat that’s empowering, not the action per se.

This capricious, arbitrary practice of regulation by a tripled-headed lawmaker-judge-and-executioner is effective with private-sector companies that cannot fight back – such as crypto exchange Kraken, which was forced to withdraw its staking-as-a-service product after the SEC deemed it an unregistered security. But it won’t fly in the courtrooms of judges like Michael Wiles. There, the judiciary branch continues to act as a check on unfettered executive power.

The long game

Of course, these are just two cases of a curtailed SEC, whereas the latest destruction of wealth, in which we’ve shifted from the initial FTX leverage-and-contagion story to one that exhibits the fingerprints of politics, offers evidence that the agency continues to wield great power.

There’s a direct line from the SEC’s campaigns against crypto protocols and entities, to the Federal Reserve’s generalized, unspecific warnings about banks’ exposure to “crypto,” to this week’s collapse of Silvergate and the panicked sell-off in the shares of Signature and Silicon Valley banks. Bank runs are always, to some degree, phenomena of mass psychology. Regulators practicing arbitrary enforcement are uniquely empowered to set them off.

Read more: Silicon Valley Bank Shuttered by State Regulators

But, as I said, I’m focused on the 15th round.

And there, in the long run, is where the United States’ decentralized system of government across state and federal jurisdictions is cause for hope. While the political stacking of the U.S. Supreme Court gives reasons to worry about judicial independence at the very highest level, the day-to-day practice of justice across this vast land is, by design, mostly free of capture by the executive branch.

That balance of power has existed for more than two centuries. It will last for a long while yet, notwithstanding the dystopian visions that permeate popular culture these days. And, over time, as it puts the law above politics and popular opinion, the judiciary will directly and indirectly force the other branches of government to reckon with unfinished business.

Crypto is, and will for some time, be a quintessential case of unfinished business. Protocols that are sufficiently decentralized won’t be shut down because they literally cannot be. So, in one shape or another, the industry will stick around. And eventually, battered, bruised and bloodied, it will gain the legislative clarity and legitimacy it needs.