securities

Former LDO holder files class-action lawsuit against Lido DAO for crypto losses

The investor claimed that 64% of LDO tokens are controlled by just a few venture capital firms, preventing ordinary investors from having any control over decisions.

An LDO holder initiated a class-action lawsuit against the governing body for liquid staking protocol Lido, according to a complaint filed in a San Francisco United States District Court on Dec. 17. The lawsuit alleges that Lido’s LDO token is an unregistered security and that the Lido decentralized autonomous organization (Lido DAO) is liable for plaintiffs’ losses from the token’s price decline.

Lido is a liquid staking protocol that allows users to delegate their Ether (ETH) to a network of validators and earn staking rewards while also holding a derivative token called stETH that can be used in other applications. It is governed by holders of LDO, which collectively form Lido DAO.

The lawsuit was filed by Andrew Samuels, who resides in Solano County, California, the document states. The defendants are Lido DAO, as well as venture capital firms Paradigm, AH Capital Management, Dragonfly Digital Management and investment management company Robert Ventures. The document alleges that 64% of LDO tokens “are dedicated to the founders and early investors like [these defendants],” and therefore, “ordinary investors like Plaintiffs are unable to exert any meaningful influence on governance issues.”

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SEC’s ‘brute force’ crypto regulation attempt is ‘bad policy’ — Paradigm

The venture capital firm pointed out the fundamental differences between crypto assets and securities.

Criticisms of the United States Securities and Exchange Commission are mounting as the agency remains unrelenting in its war on crypto.

On April 21, Web3 venture capital firm Paradigm published a policy piece on the problems with SEC registration.

It claimed that SEC Chair Gary Gensler’s “attempt to brute force crypto assets that may not even constitute ‘securities’ into an ill-fitting disclosure framework is bad policy.”

The firm, which invests hundreds of millions into crypto and Web3 startups, said thythe SEC fails to provide crypto asset users and investors with the information they need.

It also denied the SEC’s claims it offers crypto entrepreneurs a viable path to compliance.

Paradigm points out the current disclosure policy was developed in the 1930s, long before the internet. It claims current policies are “tailor-made for centralized companies issuing securities” and that crypto markets are fundamentally different.

The firm noted that securities provide the holder legal rights against a centralized entity, however, there are no “legal rights” with most cryptocurrencies but “technological abilities in a protocol.”

Additionally, crypto assets can be completely independent of their issuer and maintain full functionality without their input.

Crypto assets can also be traded peer-to-peer and on a fundamentally different technology stack, unlike traditional securities and stocks, which trade on an “archaic system full of intermediaries.”

The venture firm concluded that the financial regulator needs to modify its current disclosure regime to incorporate new technologies and asset classes.

“Unsurprisingly, without major changes to the SEC’s current disclosure regime, the SEC is unable to effectively regulate crypto asset markets.”

Paradigm is not the only crypto industry representative that has been critical of the SEC and its policies.

Related: Gary Gensler’s SEC is playing a game, but not the one you think

Congressman Warren Davidson has also been vocal about the agency and its chief “cop on the beat.”

On April 16, the pro-crypto politician introduced legislation “to correct a long series of abuses” aiming at replacing Gensler with an executive director that reports to the board.

In an April 18 hearing on oversight of the SEC, Gensler was grilled by the chair of the House Financial Services Committee, Patrick McHenry. “Clearly, an asset cannot be both a commodity and a security,” said McHenry as Gensler refused to say what he considers the classification of Ether (ETH).

Magazine: Crypto regulation: Does SEC Chair Gary Gensler have the final say?

SEC targets DeFi in vote to revisit proposal concerning the definition of ‘exchange’

“It seems perverse to me that we would be encouraging centralization,” said SEC Commissioner Hester Peirce prior to a vote on the proposal.

The United States Securities and Exchange Commission has announced it will be revisiting the proposed redefinition of an “exchange” under the agency’s rules — a move that could include crypto market participants in decentralized finance, or DeFi.

In an April 14 open meeting with SEC commissioners and staff, SEC Chair Gary Gensler said the proposed rule amendments could benefit investors and markets by bringing certain brokers under additional regulatory scrutiny as well as “modernizing” rules that define an exchange. Under the proposal, an “exchange” would be more closely defined as a system that “bring[s] together buyers and sellers of securities through structured methods to negotiate a trade” and explicitly include DeFi.

“This would account for the evolving nature and electronification of trading platforms in the last 25 years,” said Gensler.

SEC Chair Gary Gensler addressing commissioners in an April 14 open meeting. Source: SEC

The commission proposed similar amendments in January 2022, keeping the comment period for the public open until June. Some crypto advocacy groups criticized the SEC’s actions at the time, suggesting it was an overreach of the commission’s authority that could jeopardize participation in the space.

Gensler added:

“Given how crypto trading platforms operate today, many of them currently are exchanges regardless of this reopening release we’re considering today. These platforms match orders of multiple buyers and sellers of crypto securities using established non-discretionary methods. That’s the definition of exchange, and today, most crypto trading platforms meet it.”

SEC Commissioner Hester Peirce, also known as “Crypto Mom” by many of her pro-crypto policy positions, raised concerns about the rules regarding trading platforms that do not handle tokens qualifying as securities, or how to address operators that move from securities to non-securities trading. She added there was “so much ambiguity” regarding the SEC’s current treatment of securities.

“It’s possible that operating a system that uses these technologies to perform exchange activities under the proposed rules in a manner that complies with applicable regulations could significantly reduce the extent to which the system is decentralized,” said Peirce. “Have we thought about how forcing centralization would benefit the American public? […] It seems perverse to me that we would be encouraging centralization.”

Related: US SEC seeks to expand its Crypto Assets and Cyber Unit

Following the meeting, the SEC reiterated that DeFi projects fall under the commission’s current rules. The U.S. Treasury Department also targeted DeFi services in an April 6 warning regarding money laundering and terrorist financing. 

The public comment period for the proposed amendment will be open for 30 following publication in the Federal Register.

Magazine: Crypto Wendy on trashing the SEC, sexism, and how underdogs can win

Coinbase CEO on its Wells notice: SEC is like soccer referees in a game of pickleball

Brian Armstrong made the interesting analogy when asked to explain the firm’s recent “Wells notice” in “NFL terms.“

Brian Armstrong, the co-founder and CEO of crypto exchange Coinbase, has compared the United States Securities and Exchange Commission (SEC) to “soccer refs” in a game of pickleball, criticizing U.S. regulators for not being able to “agree on the rules” of “this new game.”

The comments came after Armstrong revealed that his firm had been issued a Wells notice on March 22, which he said: “typically precedes an enforcement action.“

The Coinbase CEO has been critical of U.S. regulators’ seeming lack of clarity around crypto regulation. There has also been an ongoing debate on who should be the primary body regulating crypto.

Asked to explain the most recent development “in NFL terms,” Armstrong quipped:

“Imagine you’ve got both football and soccer refs on the field, but we’re actually playing pickleball (fastest growing new sport in America). The refs can’t really agree on the rules of this new game, and one of them decides to change a call they made back in April 2021.”

The reference to a “call they made back in April 2021” refers to the SEC’s approval of Coinbase’s application to go public. Armstrong argued that its filings “clearly explained” its asset listing process and “included 57 references to staking.”

In a separate tweet, Coinbase chief legal officer Paul Grewal claimed the SEC provided “no clear rule book” on crypto regulations and that “efforts to engage with the SEC are met with silence or enforcement actions.“

Both executives appear to welcome the chance to use the “legal process” to provide the crypto industry with regulatory clarity.

“We are proud to stand up for our customers and the industry in these moments,” said Armstrong.

“Going forward, the legal process will provide an open and public forum before an unbiased body where we will be able to make clear for all to see that the SEC simply has not been fair, reasonable, or even demonstrated a seriousness of purpose when it comes to its engagement on digital assets.”

While other firms like Kraken reached a settlement with the SEC that required it to stop offering staking services to U.S. customers, Armstrong has repeatedly asserted that Coinbase’s staking services are not securities and that the firm would be happy to defend this position in court if required.

Related: Cathie Wood’s ARK sells Coinbase stock for the first time in 2023

The crypto community has widely condemned the recent notice, with many agreeing that the SEC has reversed its earlier position regarding Coinbase.

Many have also thrown their support behind Coinbase, seeming to agree that Coinbase would be fighting on behalf of the entire U.S. crypto industry as an unclear regulatory environment drives activity offshore.

Magazine: Best and worst countries for crypto taxes — Plus crypto tax tips

Primary vs. secondary markets: Key differences

Primary and secondary markets differ in securities, pricing, risk, volume, liquidity, timeframe and more.

Stock and crypto markets are essential components of the global financial system. These markets provide a platform for investors to buy and sell financial assets, which helps companies raise capital for investment and growth. Moreover, the stock and crypto markets play a crucial role in determining the value of an asset. The market price of a stock or cryptocurrency reflects the collective sentiment of investors about its prospects, which can impact its future growth potential. 

Lastly, the stock and crypto markets can be used as indicators of broader economic trends and sentiments. For instance, swings in the stock market can indicate changes in investor perceptions of the health of the economy, whereas moves in the cryptocurrency market can be caused by changes in the law, developments in technology or changes in consumer tastes. Investors can learn more about the state of the economy, potential hazards and investment possibilities by keeping an eye on these markets.

Types of markets

The primary market and the secondary market are the two main categories of markets.

Companies first offer new securities to the public on the primary market, including stocks, bonds and other financial instruments. The primary market’s goal is to help the issuer, whether it be a business, a governmental body or another group, raise money. These securities can be bought directly from the issuer by investors, with the money going to the issuer.

On the other hand, previously issued securities are traded between investors on the secondary market. Instead of purchasing securities directly from the issuer, investors buy and sell securities that have already been issued in this market. The secondary market provides liquidity to investors, allowing them to buy and sell securities quickly and easily. This market is also important for price discovery, as the price of a security is determined by supply and demand factors.

In the cryptocurrency world, the primary market is where new tokens or coins are first offered to the public through initial coin offerings (ICOs) or initial exchange offerings (IEOs). The secondary market, on the other hand, is where previously issued cryptocurrencies are traded among investors. An example of the secondary market in crypto is the cryptocurrency exchange Binance, where investors can buy and sell various cryptocurrencies, such as Bitcoin (BTC), Ether (ETH) and others.

Related: Fundraising 101: A beginners guide on raising funds using cryptocurrencies

Primary vs. secondary markets

There are several key differences between primary and secondary markets.

Purpose

The primary market is where new securities are issued for the first time, while the secondary market is where previously issued securities are traded between investors.

Issuer

In the primary market, securities are issued directly by the issuer, whether it’s a company, government entity or other organization. In the secondary market, investors trade securities among themselves without involvement from the issuer.

Pricing

On the primary market, the price of a security is typically set by the issuer, based on factors such as market demand, supply and the company’s financials. On the secondary market, the price of a security is determined by supply and demand factors, with investors buying and selling based on their own perceptions of the value of the security.

Risk

The primary market carries a higher risk for investors, as the securities being issued are new and have not yet been tested in the market. In contrast, the secondary market carries a lower risk, as investors can evaluate the performance and stability of the security before deciding to buy or sell.

Related: The NFT marketplace: How to buy and sell nonfungible tokens

Volume

The primary market typically has a lower trading volume compared to the secondary market, as securities are issued on a limited basis. The secondary market, on the other hand, has a high trading volume, as investors buy and sell securities on a daily basis.

Liquidity

The primary market has limited liquidity, as investors cannot easily sell newly issued securities until they are listed on the secondary market. In contrast, the secondary market is highly liquid, as investors can buy and sell securities on an ongoing basis.

Timeframe

The primary market is generally open for a limited period of time, as securities are issued on a specific date or over a limited period. The secondary market, on the other hand, is open continuously, allowing investors to buy and sell securities at any time.

Tel Aviv Stock Exchange moves toward offering crypto trading

Israel’s sole public stock exchange wants to allow its clients to trade crypto but faces regulatory resistance.

A draft for the approval of an expansion of crypto trading activities to non-banking members has been published by the Tel Aviv Stock Exchange (TASE) for public comments.

In a TASE first, a Feb. 27 announcement stated the proposed structure will enable customers to deposit fiat money designated for investments in digital assets.

Non-banking members will act as licensed providers for crypto trading and custodial services should the proposal be approved. Customer funds will be placed in an “omnibus account” as the intermediary for crypto trading activities.

It will also allow clients to withdraw funds originating from the sale of crypto but the process is somewhat convoluted. This has been done to mitigate risks and enhance consumer protection, according to the announcement.

“This is another step in the advancement and development of the Israeli capital market that aims to encourage innovation and competition while mitigating the risks and protecting the customers.”

Once comments have been submitted, the proposal will be sent for approval by the TASE Board of Directors, however, no timeframe was provided.

The lobby of the TASE building, located in central Tel Aviv, is Israel’s only public stock exchange. Source: Yaniv Morozovsky

Things may not go so smoothly for the Tel Aviv Stock Exchange and its crypto trading ambitions, however.

The regulatory outlook in Israel is becoming harsh for the sector as a proposed law plans to classify crypto assets as securities. In January, the Israeli Securities Authority (ISA) proposed a framework for regulating digital assets, placing them under the umbrella of securities.

In February, the CEO of Israeli crypto trading and custody firm Altshuler Shaham Horizon, Ilan Sterk, told Cointelegraph that the reclassification is “changing everything here,” and added, “it will kill the industry.”

Related: Proposed Israeli law to classify crypto as securities will hurt the industry, says crypto exec

The TASE announcement stated the current regulatory approach in Israel is to “impose regulation on financial activities or services in digital assets similarly to that currently applied to non-digital assets.”

However, the TASE remained confident, concluding:

“TASE believes that the alignment of local regulation with international regulation will attract more foreign investments and foreign investors into the Israeli market.”

In September, Israeli crypto exchange Bits of Gold became the first in the country to receive a license from the Capital Markets Authority.

Crypto lawyers flame Gensler over claims that all crypto are securities

Crypto lawyers weighed in on Gary Gensler’s crypto regulation claims, saying that the the Securities and Exchange Commission has no legal standing to police the space.

Cryptocurrency lawyers have rebuffed comments made by the head of the United States securities regulator, who claimed in a recent interview that every cryptocurrency except Bitcoin (BTC) is a security that falls under its jurisdiction.

In a wide-ranging Feb. 23 New York Magazine interview discussing crypto, Securities and Exchange Commission Chair Gary Gensler claimed “everything other than Bitcoin” falls under the agency’s remit.

He added other crypto projects “are securities because there’s a group in the middle and the public is anticipating profits based on that group,” which he said is not the case with Bitcoin.

Jake Chervinsky, a lawyer and policy lead at the crypto advocacy group the Blockchain Association, argued however in a Feb. 26 tweet that Gensler’s “opinion is not the law” despite his claimed command over the crypto sector.

He added “until and unless” the SEC “proves its case in court” for its jurisdiction over each individual token “one at a time” then it “lacks authority to regulate any of them.”

Lawyer Logan Bolinger also chimed in, tweeting on Feb. 26 “that Gensler’s opinions on what is or isn’t a security are not legally dispositive” — meaning it’s not the final legal determination.

“Judges — not SEC chairs — ultimately determine what the law means and how it applies,” Bolinger added.

The policy lead at advocacy body Bitcoin Policy Institute, Jason Brett, said Gensler’s comments “shouldn’t be celebrated, but feared” and stated, “there are ways to win other than via a regulatory moat.”

SEC needs 12,305 lawsuits: Delphi Labs counsel

Meanwhile, Gabriel Shapiro, the general counsel at investment firm Delphi Labs, outlined in a series of tweets the seemingly impossible enforcement that the SEC would have to carry out on the industry to cement its rule.

Shapiro said that over 12,300 tokens worth around $663 billion are — according to Gensler — unregistered securities that are illegal in the U.S. and, as mentioned by Chervinsky, the agency would have to file a lawsuit against each token creator.

Related: Emojis count as financial advice and have legal consequences, judge rules

The SEC has handled crypto in two main ways, according to Shapiro: Either fining token creators and requiring the issuer to register, or fining them and ordering the created tokens to be destroyed and delisted from exchanges.

“SEC registration is not only too expensive for most token creators — there is also no clear path for registration of tokens,” Shapiro said, adding:

“What is the plan here? Since registration is not feasible, it can only be [that] everyone pays huge fines, stops working on the protocols, destroys all dev premines, and delists [tokens] from trading. That would mean 12,305 lawsuits.”

“What is the plan? We are all wondering, and billions of American [dollars] are at risk.”

Crypto exchange Kraken faces probe over possible securities violations: Report

The probe is reportedly looking at certain offerings that Kraken has made to its United States customers that could be in breach of securities laws.

Cryptocurrency exchange Kraken is reportedly being probed by the United States Securities and Exchange Commission over whether it breached rules around the offering of securities. 

According to a Feb. 8 Bloomberg report, the probe relates to certain offerings that Kraken has made to U.S. clients. A person with knowledge of the matter said the probe is at an advanced stage and could reach a settlement in the coming days.

However, at this stage, it is not clear which offerings are being scrutinized by the securities regulator.

When asked about the alleged probe, an SEC spokesperson told Cointelegraph, “The SEC does not comment on the existence or nonexistence of a possible investigation.”

Kraken did not immediately respond to a request for comment.

The SEC’s Washington headquarters. Source: Wikipedia

Gensler said in December that his main goal for regulating crypto throughout 2023 was to make crypto exchanges and lending platforms come into compliance, which he said could occur through firms registering with the SEC or through enforcement actions.

Related: Judge dismisses proposed class-action suit alleging Coinbase securities sales

Kraken CEO Dave Ripley argued in September that he didn’t see a need to register Kraken as an exchange with the SEC because it does not offer securities, adding “There are not any tokens out there that are securities that we’re interested in listing.”

SEC Chairman Gary Gensler has repeatedly said, however, that he considers most cryptocurrencies other than Bitcoin (BTC) to be securities.

The SEC however recently conceded during a Jan. 30 appeal hearing in the LBRY v SEC case that the sale of LBRY Credits (LBC) in the secondary market doesn’t constitute a security, after the judge was persuaded by an argument from attorney John Deaton highlighting that the courts had never deemed the underlying asset to be a security in similar cases.

The regulator often refers to the “Howey test” to determine what constitutes a security. The name comes from the SEC v Howey case from 1946, which set a precedent in the U.S. for what transactions are considered securities.

It held that a transaction qualifies as an investment contract — and therefore is considered a security — where there is an investment in a common enterprise with profits earned exclusively through the work of others.

SEC to up scrutiny of firms offering or giving advice about crypto

After a recent warning from the SEC, registered crypto brokers and advisers may need to be on edge when giving advice this year.

Crypto brokers and investment advisers offering or giving advice about cryptocurrencies will be put under the scope of the United States securities watchdog this year.

A Feb. 7 statement from the Securities and Exchange Commission’s (SEC) Division of Examinations outlined its priorities for 2023, suggesting brokers and advisers dealing in crypto will need to be extra careful when offering, selling or making recommendations regarding digital assets.

It stated that SEC-registered brokers and advisers will be closely watched to see if they followed their “respective standards of care” when making recommendations, referrals and providing investment advice.

The SEC will also examine whether these entities “routinely” review and update their procedures to ensure they meet “compliance, disclosure and risk management practices.”

This announcement was similar to the SEC’s priorities released in 2022, however, it seems this year the regulator is putting more emphasis on standards of care and practices by brokers rather than their consideration of unique risks presented by “emerging financial technologies” highlighted in 2022.

The most recent statement comes nearly two weeks after a report claimed the SEC has been investigating registered investment advisers that may be offering digital asset custody to its clients without proper qualifications.

Related: SEC leaked crypto miners’ personal information during investigation: Report

The SEC’s investigation has reportedly been going on for several months but is now top of the priority list after the collapse of the crypto exchange FTX, according to a report from Reuters.

By law, investment advisory firms must be qualified to offer custody services to clients and comply with custodial safeguards set out in the Investment Advisers Act of 1940.

Did dYdX violate the law by changing its tokenomics?

The dYdX Foundation made an abrupt change to its project’s tokenomics, but it may have done so in consultation with its attorneys.

On Jan. 24, the dYdX Foundation, the entity responsible for the dYdX decentralized crypto exchange, announced “changes” to its tokenomics — the way it distributes tokens to early investors, employees and contractors, and, of course, the public.

So, what’s uncommon about the situation? The project’s foundation, in agreement with dYdX Trading Inc. and its early investors, decided to amend the project’s tokenomics and extend the period for which such investors’ initial batch of tokens would be locked, changing the date from Feb. 1 to Dec. 1, 2023. Whether this was a good or a bad thing depended on which side of the trade one was on. On the one hand, investors agreeing to hold their tokens for a longer period suggests a vote of confidence on their part in the project’s long-term success. On the other hand, anyone taking a short position in dYdX in anticipation of the increased supply might have been disappointed, as the token’s price rocketed following news of the amendment.

Related: My story of telling the SEC ‘I told you so’ on FTX

But why the delay? Although dYdX is not officially available in the United States, recent victories in enforcement actions on the part of the Securities and Exchange Commission may have prompted a heart-to-heart chat between the foundation and its attorneys. Now, whether the DYDX governance token might ultimately be viewed as a “security” under U.S. law could fill volumes and is outside the scope of this article. What matters is: Why would the signatories to the amendment to the lockup documents consent to a longer lockup? Why not let the tokens unlock and simply hodl them?

In the United States, all offers and sales of “securities” are either registered, exempt or illegal. Specific rules apply not only to the initial offer and sale of securities but also to resales — that is, sales by existing tokenholders to others. As a general matter, one may not serve as a conduit (legally speaking, an “underwriter”) between the issuer of the securities and the general public without following certain rules. Securities received in exempt offerings are referred to as “restricted securities,” and resales of the securities are an illegal “distribution” unless a safe harbor applies.

dYdX’s 10-year token vesting schedule. Source: dYdX

One such safe harbor is Securities Act Rule 144. One must follow the restrictions of Rule 144 in order to qualify for relief and sell without fear of being deemed an “underwriter.” There are classes of restrictions that apply to different types of holders — specifically, “affiliates” (those who control or are controlled by the issuer) and “non-affiliates.” All sales, affiliate or non-affiliate, are subject to a one-year holding period. This holding period establishes, in theory, that the securities were purchased with “investment intent,” not for immediate dumping on the unsuspecting public.

Sales by affiliates are subject to other restrictions, including that there is “current public information” available about the issuer, limitations on how many securities can be sold in a given period of time, manner of sale restrictions and filing requirements.

Related: Crypto users push back against dYdX promotion requiring face scan

While it is highly unlikely that dYdX insiders long to be subject to the full gamut of United States securities law, perhaps they were inspired by its basic principles, especially if they have short holding periods in the tokens. A common vehicle used by crypto projects to attract early-stage capital, for example, is a “simple agreement for future tokens,” or SAFT. This type of agreement does not convey the tokens immediately but promises to do so in exchange for an up-front investment. As noted above, if you are subject to a holding period on your restricted securities, you must own them in the first place to start the clock running. It is unclear whether the foundation used SAFTs for its investors, but if it did, some of the investors might be new to ownership indeed.

Maybe the dYdX investors who participated in the decision to change its tokenomics wanted to signal their confidence to the market by delaying their access to the tokens. It’s possible they anticipated the pump that followed news of the amendment. Or, perhaps they were inspired by U.S. laws and are looking to inch toward eventual compliance with those laws. It will be interesting to see what other measures, if any, dYdX takes with respect to token emissions going forward.

Ari Good is an attorney whose clients include payments companies, cryptocurrency exchanges and token issuers. His practice areas focus on tax, securities and financial services compliance matters. He received his JD from the DePaul University College of Law in 1997, his LL.M. in taxation from the University of Florida in 2005, and is presently a candidate for the Executive LL.M. in securities and financial regulation from the Georgetown University Law Center.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.