Just before the start of 2023, I predicted that “the SEC and CFTC will use clever enforcement actions to test the limits of their current powers.”
I hate to be “that guy” that publicly brags about his prediction coming true, so – to be clear – this is me saying, “even a blind squirrel can find a nut once in a while.”
I never could’ve predicted how widespread and sophisticated this “testing the limits of their current powers” would be. The Biden administration is trying to strangle crypto out of existence through a coordinated attack across various government agencies.
If you think that sounds crazy, remember that everyone’s talking about UFOs and alien invasions.
No need to bust out your tinfoil hats for this one, folks, because we’re approaching this like any good accountant would – by laying out the facts.
P.S. Welcome to our 264 new subscribers! You only need to remember three rules:
Never play cards with someone with the same first name as a city.
Never hike in bear country with somebody that can run faster than you.
Never (or, maybe, always) ask ChatGPT the circumference of a moose.
Operation Chokepoint 2.0
Starting in 2013, the Obama DoJ implemented a little-known program to isolate particular politically disfavored industries, like firearms manufacturers and payday lenders, that were otherwise operating within the law’s confines. “Operation Choke Point,” as it came to be known, sought to ringfence these industries by applying pressure through the banking industry rather than legislation.
At that time, the DoJ coordinated with the FDIC and OCC to urge banks to avoid doing business with these legal but disesteemed sectors. If federal officials were ideologically opposed to a business, they would pressure banks to terminate its accounts.
Where Chokepoint 1.0 primarily took place behind closed doors in off-the-record conversations, Chokepoint 2.0 is unfolding right in front of us. This time, the administration is going after crypto firms by way of blog post, written guidance, and enforcement action.
As to the administration’s motives, we can only speculate. Perhaps these agencies feel politically emboldened after the crypto catastrophes of 2022. Maybe Gensler is now overcompensating for failing to protect investors from Terra Luna, Three Arrows Capital, Celsius, and FTX. Or, perhaps something more sinister is brewing, and the US government is laying the groundwork for its own CBDC.
Whatever their reasons, regulators are waging an all-out war on crypto by attacking three distinct vectors:
Traditional finance liquidity (banks, VCs, PEs, and hedge funds)
Staking providers (and the security of blockchain networks)
Stablecoins (both algorithmic and fiat-backed)
TradFi Runs Dry
If you’re in the cryptocurrency business, you know that finding a friendly banker is about as easy as teaching a cat to fetch. Even today, it’s still an uphill battle for startups in this field to get a bank to say yes. That’s why stablecoins like Tether were the cool kids on the block, helping folks settle their fiat transactions when traditional banking routes were a dead end.
But hold onto your hats because things are heating up in the push to wall off the crypto world from old-fashioned banks. The Biden administration is taking a coordinated, all-hands-on-deck approach to encourage banks to steer clear of crypto firms, whether they’re traditional banks trying to serve crypto clients or upstart crypto companies looking to land bank charters.
Everybody’s in on this one, from the top brass in Congress to the Fed, FDIC, OCC, and DoJ. A whole host of banks that serve crypto clients, such as Signature and Silvergate, are facing major pressure from federal agencies, with everything from scolding letters to federal investigations.
The Federal Reserve, FDIC, and OCC are all issuing joint statements and final rules that discourage banks from dealing with crypto or holding crypto assets, citing “safety and soundness” concerns. Crypto-friendly banks are shrinking their deposits or shutting down their crypto-related verticals altogether, while Binance suspends bank transfers for retail clients. Even established crypto banks, like Custodia, are facing rejection in their attempts to become members of the Federal Reserve system.
As if the banking blow wasn’t enough, Gensler pulled another move on par with the baseness of Johnny Lawrence “sweeping the leg” of Daniel LaRusso in Karate Kid. Last week, the SEC introduced a new policy that could compel registered investment advisors (RIA) to use custodians outside the cryptocurrency industry to store digital assets.
For context, current regulations state that investment advisers must keep customers’ money and securities with a “qualified custodian.” This new rule would heighten the requirements for becoming a qualified custodian. While the rule wasn’t specific to crypto, Gary Gensler clarified his stance.
“Make no mistake: Based upon how crypto platforms generally operate, investment advisers cannot rely on them as qualified custodians. Though some crypto trading and lending platforms may claim to custody investors’ crypto, that does not mean they are qualified custodians.”
This rule would effectively prevent most VCs, PEs, hedge funds, and crypto exchanges from holding digital assets on behalf of investors. Instead, investors would need to park their crypto with a chartered bank or trust company, a broker-dealer registered with the SEC, or a futures commission merchant registered with the Commodity Futures Trading Commission (CFTC).
So, let me get this straight, only banks can hold investors’ digital assets, but banks are also strongly discouraged from holding these assets due to “safety and soundness” concerns?
Burned at the Stake
If you thought we were about to make an abrupt U-turn to talk about witches, you will be sorely disappointed. No, we’re talking about digital asset staking, but we felt that all the steak puns were overdone (well done?). Staking is the process of holding and locking up funds to support the security and operations of a blockchain network and, in return, earning rewards or interest on those funds.
On Feb. 9th, crypto exchange Kraken shut down its US crypto-staking service and paid a $30M fine in settlement to the SEC. They claimed Kraken failed to register its staking service as a securities product offering.
At this point, this enforcement action doesn’t come as a surprise because SEC Chairman Gary Gensler believes everything under the sun is a security. Ryan Sean Adams of Bankless said it best.
What does come as a surprise, however, is that there was no, “hey, you messed up the first time, but let’s figure out how to get your securities registered.” Kraken’s staking platform straight up got shut down – no questions asked. SEC Commissioner Hester Peirce slammed the actions of her colleagues in her statement in response to the Kraken settlement.
“Most concerning, though, is that our solution to a registration violation is to shut down entirely a program that has served people well. The program will no longer be available in the United States, and Kraken is enjoined from ever offering a staking service in the United States, registered or not. A paternalistic and lazy regulator settles on a solution like the one in this settlement: do not initiate a public process to develop a workable registration process that provides valuable information to investors, just shut it down.”
A “paternalistic and lazy regulator.” Wow. I wonder how she and Gensler get along.
Coinbase responded to the Kraken case by posting an article defending its position that Coinbase’s staking services are not securities. The SEC uses the Howey Test from a 1946 Supreme Court case (time for an updated test?) to determine whether an investment contract is a security. The four test elements are:
An investment of money
In a common enterprise
With the expectation of profit
To be derived from the efforts of others
Coinbase argues that staking services don’t constitute an investment of money because staking customers retain full ownership of their investments at all times. Second, staking services do not meet the “common enterprise” prong of Howey because assets are staked on decentralized networks. Third, staking rewards are simply payments for validation services provided to the blockchain, not a return on investment. Lastly, staking services don’t pay rewards based on the “efforts of others” because they are IT services, not investment services.
So, what about Kraken’s staking service made it a security in the eyes of the SEC? We aren’t entirely sure, but to use a legal term, “facts and circumstances matter.” Word on the street has it that Kraken may have met some of the Howey test elements because it took custody of funds (investment of money), marketed a specific return (expectation of profit), and, at times, actively managed funds to produce said return (efforts of others).
Stablecoins Deemed Unstable
Last, but not least, crypto is under attack on the stablecoin front. Since stablecoins are typically pegged to the value of fiat currency, they serve as crucial on-ramps to the crypto ecosystem.
On February 12, news broke that the SEC intends to sue stablecoin issuer Paxos over the issuance of Binance’s stablecoin BUSD. The firm said it “categorically disagrees with the SEC staff because BUSD is not a security under the federal securities laws.” It also claimed that Paxos is “always backed 1:1 with U.S. dollar-denominated reserves, fully segregated and held in bankruptcy remote accounts,” and said the firm is “prepared to vigorously litigate if necessary.”
Remember last year when the TerraUSD stablecoin collapsed and took down several crypto companies with it? Gary Gensler and the SEC finally got around to suing Terraform Labs, the company responsible for the catastrophe, and its co-founder Do Kwon.
I won’t even try to argue that this wasn’t a total fraud, because it was. The timing of the lawsuit does seem a bit fishy, though. One week, the SEC goes after a fiat-backed stablecoin. The next, they go after an algorithmic stablecoin that wasn’t backed by anything – one that blew up so badly that anyone could get on board with the enforcement action. Is the SEC setting the stage to come out and say, “Fiat-backed stablecoins didn’t work, and algorithmic stablecoins definitely didn’t work, so try out our fancy new CBDC!”?
Spotlight – Three-for-One
We’ve got a hefty Spotlight section in this entry!
First, don’t miss the Triple Entry Lunch Break livestream later today. The TE LB is a “podcast style” breakdown of this newsletter’s top stories, and one of my favorite ways to catch up with thought leaders in crypto accounting and finance. Past guests include Michael Nadeau of The DeFi Report and Libby Schultz of CipherCounts.
Today I’ll be joined by Pat White, CEO and co-founder of Bitwave. Pat joined our Proof-of-Reserve “war room” discussion last year and brings a wealth of knowledge to this space. I can’t wait to get his take on Chokepoint 2.0!
Tap the image to go to the event on LinkedIn Live at noon MST!
Next, this Thursday – 2.23 – we’re hosting our latest free CPE webinar with our friends over at Gilded. Come hear CPAs Alyssa Rambeau and Nik Fahrer (aka “Crypto Nik”) talk about mastering cost basis for crypto. Anybody in crypto accounting will want to check this out, but especially if you’re in enterprise digital asset accounting! Tap the image to register.
Finally, ICYMI, we soft-launched our crypto CPE course platform two weeks ago, learn.multisig. We’re still giving away free access to our introductory course, WTF is Web3 (and Why Does It Matter?). If you’re still wondering what exactly all this web3 stuff is about and why it matters to the future of accounting and finance, then this course is for you. Eligible for 1 CPE credit in Specialized Knowledge.
The Water Cooler
Things worth talking about at the office water cooler…if you 1) talk to people, 2) still work in an office, and 3) have a water cooler.
Featured Funding Finds: Lukka beefs up on-chain capabilities
Last week, Lukka gave the belated Valentine’s Day gift of a forever home to web3 blockchain analytics firm Venato. Lukka has carved out a space as a leading institutional crypto asset data and data management provider. And like when you adopt a puppy and also need to accept the inseparable littermate as part of the deal, Venato’s R&D and engineering teams are coming with – and they’re bringing deep blockchain, web3, and DeFi development expertise with them.
Why we noticed:
Lukka has cited “expanded DeFi data management capabilities and on-chain data coverage” as the hope for the acquisition, but if we were betting people over here we would a) have put money on the Chiefs to win the Super Bowl last Sunday and b) say the boost in on-chain capabilities is the more important reason to make this deal. Lukka has been a solid data provider and connector to APIs but didn’t have the on-chain abilities before. They’re recognizing and responding to increased institutional demand for both on-chain and off-chain data reporting. Overall, it seems like a smart move as they continue to occupy an important space in what we call the “build-a-better-back-office” pantheon of web3 software and service providers.
Tom’s Transaction (aka ChatT.O.M.)
Accountants beleaguered by busy season: have no fear, ChatTOM is here!
If you’re new here and don’t know what’s going on: this is Tom’s Transaction (aka ChatTOM – Transaction Observation Model). This section of Triple Entry features a scenario based on a real-life transaction Tom (real accountant) encountered on Etherscan. Your mission, should you choose to accept it, is to test your crypto accounting knowledge by solving Tom’s Transaction.
So. Here you go.
What is this transaction and how would you account for it? You can write in with your response, or (even better) jump on the Triple Entry Lunch Break Livestream this afternoon and drop it in the comments! We’ll reveal the answer in our next entry.
Want to know why? Here’s ChatTOM giving the rundown!
Balance Sheet: Debit to the digital asset account
Credit to the token liability account
P&L: No changes during a staking event
Upon staking, the tokens leave the wallet, but remain the property of the borrower. The digital assets are a non-cash collateral, and they should remain unchanged on the borrower’s balance sheet. Any adjustments to the lending vault are considered non-taxable events; therefore, collateralized assets will not have any change in value and follow a similar treatment to digital wallet transfers.
Upon borrowing, there will be a debit in the digital asset account for the fair value of the received tokens, and a corresponding credit to the token liability account. This is similar to a cash loan, in which there is a debit to the bank account and an offsetting credit to a loan liability account. Just remember that the changes to the fair value of the borrowed tokens affects both the digital asset and token liability accounts.
Disclaimer: The transactions being used are publicly available information on the blockchain that were randomly selected to show certain types of crypto activity. The owners of the wallets involved, as well as the true nature of the transactions, are unknown. These are interpretations of transactions as they might relate to US GAAP. None of the tokens, wallets, or protocols are endorsed, and links (when available) are provided for educational purposes only.
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Big news! Multisig is joining forces with Bitwave, the leading crypto accounting software! The acquisition was announced live on stage at Enterprise Digital Asset Summit (EDAS) 2023. We’re excited to reinforce our shared commitment to empower, inform, and educate accounting and finance professionals everywhere!