Could SEC's crypto exchange crackdown usher in a purge?

UHNW advisor and CEO speaks out on risks from 'fraudcoins' and tokenized venture capital – and how Bitcoin could come out ahead

Could SEC's crypto exchange crackdown usher in a purge?

The past few weeks have brought whirlwind developments in the crypto space, with the Securities and Exchange Commission in the U.S. launching legal actions against cryptocurrency exchanges Binance and Coinbase.

The SEC has accused Coinbase of evading securities laws by operating as a broker, exchange, and clearing agency without proper registration.

It’s levelling more serious accusations against Binance, which SEC Chair Gary Gensler alleges has been acting fraudulently by deceiving investors about risk controls, tampering with trade volumes, and hiding other crucial operational data, among other charges.

To Arthur Salzer, founder, CEO and CIO of family office Northland Wealth Management, the regulator’s actions have been a long time coming.

“First and foremost, we're surprised that the SEC hasn't acted sooner,” Salzer told Wealth Professional.

‘Really just tokenized venture capital’

Between 2017 and 2019, Salzer says he and his team at Northland did around 2,000 hours of due diligence on cryptocurrencies before cementing their convictions on Bitcoin as an alternative asset class; the first few hundred hours, he recalls, were spent looking at reasons not to invest.

“Except Bitcoin, pretty much every other token is really just tokenized venture capital,” Salzer says. “When you look at these tokens and measure them against the Howey Test, these are securities that should be subject to U.S. securities laws.

“That’s one of the risks you had to underwrite and understand that it’s likely to happen at some point,” he says. “The SEC is finally getting to it, which is very good to see.”

The business models behind the vast majority of crypto tokens, Salzer argues, are “fraudcoins” built solely on the ability to pump and dump them to the retail public. He says a common tactic is for people related to the founder of those tokens to get brokerage accounts, onshore or elsewhere, and trade amongst themselves at higher and higher prices to generate the perception of volume and a rising price trend.

That’s different from the model behind Bitcoin, Salzer explains. Though bitcoin prices are also extremely volatile, it’s a “cleaner” asset that isn’t propped up by Ponzi-like manipulations. Instead, it behaves more like a digital asset people can own either by mining it and spending a lot of energy, or buying it from someone else for a certain price.

“The challenge with tokenized VC is there are no shareholder rights, and there are no limited partnership agreements. They’re like Air Canada points,” Salzer says. “The ability to change what the token does, or what the underlying company does, is totally up to management, and investors who own the tokens have no say. With Bitcoin, you need a 95% acceptance rate among people running thousands of nodes across the network before any change can occur. … It’s much more democratic.”

Cleaning up the crypto Wild West

From what Salzer sees, most if not all crypto investors don’t appreciate the difference between investing in a digital commodity and in digital venture capital. As an investor, he says it’s important to put them in different buckets, and be able to underwrite their respective risks properly. For tokenized venture companies, it would be ideal to get as close to the management as possible and gain an understanding of what’s going on.

The ongoing SEC action against Coinbase and Binance ups the pressure for US policymakers to create a regulatory framework around the crypto space. Increased regulation, Salzer argues, will bring about a much-needed purge of illegitimate crypto schemes, which will ultimately bolster the investment case for Bitcoin.

“The investment case for bitcoin is unique. It’s the only digital asset which cannot be copied or duplicated,” Salzer said. “Just look what happened to music when the ability to stream occurred.”

While Salzer says the disclosure needed for a true crypto renaissance currently doesn’t exist in any way, shape or form, he believes that the market share of Bitcoin will over time eclipse everything else in the world of digital assets.

“Also, the Bitcoin network along with its secondary layer Lightning has the ability to disrupt the global payment networks,” he adds.

“Just look at what the entrepreneur Jack Mallers has created with Strike. Strike has the ability serve 3 billion people and rid them of the exorbitant costs of companies such as Western Union. This isn’t about the price of bitcoin, but the potential value of the Bitcoin network.”