The U.S. Securities and Exchange Commission has launched a sweeping inquiry into whether crypto exchanges have proper safeguards to prevent insider trading on their platforms, FOX Business has learned.
According to a person with direct knowledge of the inquiry, the SEC has sent a letter to one major crypto exchange requesting information about how the platform protects users from insider trading facilitated through its network, but, this person believes the inquiry covers other exchanges as well.
The letter was sent following last month’s collapse of Terra’s UST stablecoin and governance token LUNA, when around $40 billion of investor wealth was wiped out. It’s unclear if other letters have been issued, but the person with direct knowledge said based on conversation with industry insiders the investigation is wide-ranging.
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The SEC declined to comment. Press officials from the two biggest crypto exchanges, Binance and Coinbase declined comment. Press officials from FTX and Crypto.com did not respond to numerous requests for comment.
It could not be determined if the inquiry is being led by the SEC's enforcement division or Office of Compliance Inspections and Examinations, which often conducts preliminary examinations of areas of regulatory interest. An inquiry by the enforcement division would signal the SEC is worried about potentially serious regulatory violations.
The move comes amid yet another massive upheaval in crypto and greater scrutiny by regulators over the nascent market. In recent weeks, the crypto market has been in meltdown mode; the price of Bitcoin — the most popular digital coin — lost nearly a third of its value in the past week and is down 70% from its November all-time high.
The overall value of the crypto market has plunged below $1 Trillion. Amid the turmoil, the SEC has ramped up its oversight of whether crypto insiders have sold coins and tokens before the tumult and used their positions and the information advantage they might have to trade through the declines and profit.
Immediately following the implosion of stablecoin UST and its sister token LUNA in May, SEC Chairman Gary Gensler took aim at crypto exchanges, accusing them of trading against their clients. In an interview with Bloomberg, Gensler said he’s concerned that crypto exchanges aren’t putting up proper walls between different parts of their businesses (i.e. market-making and trading services) like traditional exchanges are required to.
It’s unclear if insider trading statutes — designed to prevent insiders from profitably trading on material non-public information — can extend to a market where digital coins may not be legally designated securities.
But the SEC under Gensler may not be waiting for court precedent to start applying insider trading rules to crypto. Several recent media accounts have detailed anonymous crypto insiders buying and selling their digital coins before market moving announcements.
"A request for more information from the SEC to crypto exchanges would make sense given the SEC's recent emphasis on regulating the exchanges, ostensibly in the name of consumer protection, said Jeremy Hogan, partner at Hogan & Hogan law firm. "In the past there have been allegations of insiders buying large amounts of tokens that were going to be listed on an exchange (thereby increasing the price) but which listing was not yet public knowledge, and it's that sort of trading that the SEC might be forewarning the exchange they need to get control of."
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The SEC may also want to show it's aggressively regulating a market that is poised for a massive correction.
Celsius Network, one of the largest crypto lenders that manages around $11B in assets, informed users on Sunday night that it would pause all withdrawals, swaps and account transfers due to "extreme market conditions." The announcement incited a panic as concerns about Celsius’ liquidity set in, which incited a major selloff across the crypto board.
Adding to the selling pressure, Coinbase, BlockFi and Crypto.com have all announced significant staff layoffs over the past 24 hours in an effort to keep costs down as they prepare for what was coined a "crypto winter" by the Winklevoss Twins, who run Gemini Trust Co.
In addition to the inquiry letters, Gensler has also been urging crypto exchanges to voluntarily register with the commission to avoid being penalized for selling unregistered security tokens. The problem is, current laws make it difficult to determine which tokens constitute securities and, therefore, hard to know which exchanges are operating outside of compliance.