SEC Issues Warning Against Investing in Crypto Asset Securities

The United States Securities and Exchange Commission has often talked about the purported “dangers” of crypto-assets while highlighting the need to strongly regulate the industry. It wasn’t until the FTX blow-up that the regulator stepped up its aggression.

In yet another instance stigmatizing the asset class, the securities watchdog has released a bulletin urging investors to exercise caution when dealing with cryptocurrencies.

SEC’s “Investor Alert”

The SEC’s Office of Investor Education and Advocacy cautioned investors against considering an investment involving crypto asset securities citing its “exceptionally volatile and speculative” nature. The post also pointed out that the crypto exchanges “may lack important protections for investors.”

The SEC explained that the law requires parties, including securities broker-dealers, investment advisers, alternative trading systems (ATS), and exchanges, to register with the regulatory agency, a state regulator, and/or a self-regulatory organization (SRO), such as FINRA. It added that platforms offering lending or staking services in crypto assets may be subject to federal securities laws.

It stated that unregistered platforms offering crypto asset securities may not provide relevant details required by investors to make informed decisions. The SEC also attempted to touch on the concept of proof-of-reserves – an auditing procedure allowing users to verify that a crypto exchange has sufficient reserves backing all user balances.

Proof-of-reserve reports have gained significant traction after the FTX collapse to address the transparency concerns surrounding centralized crypto exchanges.

But the SEC maintained these types of services may not provide any meaningful assurance and verify that these entities hold adequate assets to back their users’ balances.

“Crypto asset entities might use these in lieu of audited financial statements in order to obscure and confuse customers about the safety of their assets. In addition, a proof of reserves is not as rigorous, or as comprehensive, as a financial statement audit and may not provide any level of assurance.”

The SEC further stated that so far, no crypto asset entity is registered with it as a national securities exchange, nor any existing national securities exchange currently trades crypto asset securities. In doing so, it indicated that investors engaging with crypto asset securities may not benefit from rules that protect against fraud, manipulation, front-running, wash sales, and other misconduct.

The actions of the SEC represent a key inflection point for crypto, and the heart of this battle is the debate over whether crypto-assets should be considered securities or commodities.

Eyes on Coinbase

The SEC is currently at loggerheads with one of the most prominent crypto exchanges – Coinbase. The San Francisco-based platform was issued Wells Notice this week, setting the ball rolling on a potential lawsuit, following a slew of investigations by the Gary Gensler-led regulatory agency.

In response, Coinbase co-founder and CEO Brian Armstrong said the SEC reviewed its business in detail and approved the platform to go public two years ago while maintaining that they were “right on the law” and “confident in the facts.”