The blockchain and digital asset universe experienced a series of unprecedented events from mid-2022 through early 2023 that will continue to shape the digital asset landscape, including:

  • a new "crypto winter" caused by the cascading collapse of multiple digital asset-related entities;
  • resultant aggressive enforcement by the Department of Justice (DOJ), the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC);
  • new executive and agency attention to digital assets; and
  • increased focus on digital asset-related legislative solutions

These events are likely to continue to reverberate in 2023 and beyond, including through:

  • a new effort by bank regulators to "shadow ban" crypto companies from obtaining banking services, often referred to as Operation Choke Point 2.0;
  • continued interagency turf battles;
  • continued aggressive enforcement by DOJ, the SEC and the CFTC; and
  • a reinvigoration of digital asset legislation in the 118th Congress.

2022–2023 Blockchain Year in Review

Cascading collapses

2022 saw the onset of a new crypto winter, during which cryptocurrencies including Bitcoin, Ethereum and others dropped in value by more than 50%, alongside a similarly significant drop in the value of many non-fungible tokens (NFTs). Perhaps the biggest driver of this loss of market confidence was a cascading series of collapses and investor losses beginning in May 2022, which then continued through the remainder of the year.

LUNA

If there was a ground zero for the cataclysmic events of 2022, it was the collapse of the algorithmic stablecoin TerraUSD (UST) and its sister token LUNA in May 2022, resulting in the loss of approximately USD40 billion in investor funds, and a more than 99% reduction in the value of the LUNA token. The crash of UST and LUNA sent shockwaves throughout the industry, triggering crises at entities that were significantly exposed to UST/LUNA and at counterparties of such entities.

Three Arrows Capital

The first domino to fall after the LUNA crash was Three Arrows Capital (3AC). 3AC had significant exposure to LUNA, and the collapse of LUNA and the subsequent reduction in the value of 3AC's investments resulted in a margin call 3AC was unable to satisfy. As a result, in June 2022, 3AC was ordered to liquidate by a court in the British Virgin Islands. 3AC subsequently filed for bankruptcy in the Southern District of New York (SDNY), at which time the fund owed approximately USD3.5 billion to over 25 creditors, according to court documents.

Voyager Digital

The next month, crypto brokerage firm Voyager Digital collapsed, due in part to exposure to 3AC. Voyager allowed users to deposit cryptocurrency in exchange for yields as high as 12%. In turn, Voyager lent user funds to traders and institutions, including 3AC. 3AC was Voyager's largest counterparty, and was the recipient of a USD650 million unsecured loan. Following 3AC's collapse and the broader market downturn, Voyager filed for bankruptcy in the SDNY on 6 July 2022.

Celsius Network

Also in July 2022, virtual currency lender Celsius Network collapsed. Celsius similarly allowed users to deposit cryptocurrency, which Celsius in turn lent to others, in return for a significant annual percentage yield of up to 17%. Following the LUNA crash and the collapse of 3AC, Celsius Network depositors began withdrawing funds en masse at a rate Celsius was ultimately unable to satisfy, resulting in Celsius freezing customer transactions and filing for bankruptcy.

FTX and Alameda

Four months later, on 11 November 2022, FTX Trading Ltd. filed for Chapter 11 bankruptcy protection. FTX had formerly operated one of the largest and most popular cryptocurrency exchanges, and operated alongside quantitative cryptocurrency trading firm Alameda Research. The sudden collapse of FTX further destabilised the crypto industry, and its effects continue to be felt well into 2023. According to charges later filed by DOJ, FTX founder Sam BankmanFried misappropriated FTX customer funds to cover losses incurred by Alameda, among other offences.

The collapse of FTX and the crimes allegedly committed by Bankman-Fried were particularly jarring in Washington, where Bankman-Fried had cultivated an image as a paragon of compliance and had been well regarded by many on Capitol Hill. Many government officials who had embraced Bankman-Fried felt burned, and the result was increased demagoguing among some in Congress against the entire cryptocurrency industry.

DOJ, SEC and CFTC enforcement

The past year has been marked by remarkably aggressive enforcement activity. DOJ, the SEC and the CFTC have individually and collectively accelerated enforcement activity in the digital asset space.

The most prominent case brought by DOJ was FTX, where DOJ charged Bankman-Fried with 13 offences relating to his operation of the exchange and secured guilty pleas from three former FTX or Alameda executives (Gary Wang, Caroline Ellison and Nishad Singh). The SEC and CFTC brought parallel enforcement actions against FTX and Bankman-Fried, among others.

The same was true in the case against Do Kwon. On 16 February 2023, the SEC charged Terrform Labs PTE Ltd. and Do Kwon with the offer and sale of unregistered securities. The SEC complaint also alleged that Terraform and Do Kwon "engaged in a fraudulent scheme to mislead investors about the Terraform blockchain" and on-chain assets, including through repeated claims that certain tokens would increase in value. The complaint further alleged that they failed to provide full disclosure regarding certain assets, such as Terra protocol tokens LUNA and TerraUSD, which the SEC alleged are securities. On 23 March 2023, Do Kwon was arrested in Montenegro and subsequently charged by DOJ with eight criminal counts of fraud and conspiracy.

But perhaps the most important US enforcement development has been the dramatic escalation of the SEC's campaign to regulate the digital asset industry by enforcement.

Wahi

In parallel proceedings on 21 July 2022, DOJ and the SEC initiated actions based on an alleged insider trading scheme against Ishan Wahi, a former product manager for Coinbase Global, Inc. (Coinbase), Ishan's brother Nikhil Wahi, and a friend. The SEC complaint alleged that the defendants used confidential information regarding digital assets that Coinbase planned to list, as well as the timing of listing announcements, to make trading profits of at least USD1.5 million. The SEC complaint was notable because the SEC specifically alleged that several of the relevant digital assets were securities, and thus subject to federal securities laws, but without engaging with, or bringing any actions against, the issuers of those tokens or otherwise giving them an opportunity to defend themselves. In short, with Wahi the SEC moved from "regulation by enforcement" to "regulation by enforcement against someone else".

DOJ's indictment charged the defendants with wire fraud and conspiracy to commit wire fraud, in what prosecutors called the first insider trading case involving cryptocurrency. Notably, however, the indictment did not refer to the assets as securities. DOJ eventually secured wire fraud guilty pleas from the two Wahi brothers.

Despite pleading guilty to the criminal charges, the defendants challenged the SEC's parallel civil charges, arguing that securities laws do not apply to the crypto-assets in question. In a motion to dismiss filed on 6 February 2023, the defendants accused the SEC of "trying to seize broad regulatory jurisdiction over a massive new industry via an enforcement action", and argued that the SEC should engage in rulemaking if it believes that digital assets are securities.

In light of the significant implications of the SEC's expanding view that secondary trades in crypto tokens should be considered SEC regulated transactions involving investment contracts, it is unsurprising that there were a number of amicus briefs filed in the case. For example, the Blockchain Association filed a brief challenging the SEC's approach of seeking to apply the securities laws to tokens without any formal SEC action or court ruling. The Blockchain Association brief also argued that "the SEC is engaging in regulation by enforcement against absent third parties", in reference to the SEC's labelling of various crypto tokens as securities, which could impair their value and impact secondary market trading. The Investor Choice Advocates Network filed an amicus brief arguing that the SEC exceeded its statutory authority in attempting to regulate digital assets. Likewise, the Chamber of Digital Commerce filed an amicus brief urging dismissal of the case, which the Chamber called a "dramatic overreach by the SEC".

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Previously Published by CHAMBERS GLOBAL PRACTICE GUIDES

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