SEC Investigations into Coinbase and Binance Stress the Need for a Robust ‘Coin Due Diligence Policy’

July 11, 2023
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Regulatory scrutiny on cryptocurrencies as securities prompts policy changes and affects token futures. Learn how the recent SEC actions affect the future of your crypto business.


Amid the volatile waves within the cryptocurrency market, a tension brews between innovative crypto platforms and regulatory giants. The U.S. Securities and Exchange Commission (SEC) has brought forth its might, scrutinizing crypto exchange platforms, and in the process categorizing 61 cryptocurrencies as ‘securities’. The crosshairs significantly landed on Coinbase and Binance, with dozens of cryptocurrencies singled out. 

Defining Moments in the Decentralized Frontier

With these and other tokens in the crosshairs, and significant exchanges like Binance and Coinbase under scrutiny, the crypto industry stands on shifting grounds. Impacted negatively by the lawsuits, the future of numerous tokens are left hanging in the balance. The ultimate consequence remains clouded in uncertainty, but we witnessed a noticeable dip in the prices of well-known cryptocurrencies, seemingly as a direct result of the SEC’s introduction into the narrative. Accusations fly, with the SEC citing exchanges were involved in offering unregistered securities—a claim that’s not taken lightly.

The dynamic landscape of cryptocurrency is finding itself under the regulatory microscope, with discussions about the categorization of certain coins as ‘securities’ taking center stage. This has ushered a wave of introspection within the cryptocurrency industry, leading some service providers to reevaluate their future growth, or even participation, in the U.S. market. Amid the unfolding developments, certain tokens and foundations are stepping forward to clarify their stance, leading to healthy debates and discussions. Even as platforms like Robinhood actively manage the cryptos they support, the market is responsive, and prices are adjusting to the ordeals of these transformative times. Importantly, the sentiment among token creators and users remains flexible, mirroring the very nature of the evolving cryptocurrency space itself.

Innovators Need to Come Prepared with a Coin Due Diligence Policy

Amid the unfolding drama, one aspect stands unwavering—the palpable necessity of a comprehensive coin due diligence policy. In the face of stringent regulatory changes, the adoption of such a policy outlines a firm’s dedicated approach towards a proactive risk management strategy. 

Probing the Core: Is this Coin a Security?

Amidst the shifting and responsive crypto landscape, one reflective inquiry often emerges as the paramount concern: “Is this coin a security?” This seemingly simple question forms the cornerstone of any comprehensive Coin Due Diligence Policy. The answer isn’t just a label; it’s a determinant of how the coin will be regulated, its legal implications, and its broader acceptance in the market. Applying a framework like the Howey Test can help ascertain the potential security status of a coin, which we’ll dive into further below. But note, this deep inquiry bears significant weight in the broader spectrum of a firm’s risk management strategy and legal compliance.

Reputational Risk in Crypto Business Associations

Coin Due Diligence PolicyWithin the multifaceted cryptocurrency environment, the crucial role of a firm’s reputation often takes center stage. As this sector operates outside the realm of traditional finance, maintaining a strong reputation becomes the cornerstone for uniting the crypto community.

In the junction where the cryptocurrency sphere and regulatory institutions intersect, understanding reputational risk turns vital. This represents another key component of the Coin Due Diligence Policy. 

The character of a cryptocurrency, much like that of any business relationship, its reputation, significantly influences public perception, impacting potential investments and collaborations. But this relationship extends beyond direct interactions. It also encompasses the importance of carefully selecting which cryptos to offer support for. Association with third-party entities of dubious nature can also tarnish a firm’s reputation, attracting intensive regulatory security.

Generally, under a robust Coin Due Diligence Policy, any associated ‘undue reputational risk’ must be meticulously identified and assessed. This involves rigorous research, pinpointing possibly harmful media narratives associated with prospective cryptocurrencies.

Faced with potential reputational risk, firms must act decisively, often not offering support for risky cryptocurrencies, or “derisking” of those they may already be offering for exchange on their platform. Regardless of the decision, a memorandum detailing the rationale should thoroughly document the firm’s stance, showing its commitment to safeguarding reputation.

In today’s digital age, maintaining a clean reputation is not just an asset—it’s essential. By upholding a robust Coin Due Diligence Policy, crypto businesses not only strengthen their regulatory compliance but also fortify their market position. In essence, a safeguarded reputation fosters trust, stimulates growth within the crypto community, and validates a firm’s commitment to ethical conduct. Something we need now more than ever in the crypto space.

Navigating through numerous high-stake considerations requires a clear roadmap. 

A Clear Policy: Driving Trust and Confidence

Coin due diligence policies are both intricate and dynamic in nature. Your Coin Due Diligence Policy should crisply outline how you plan to document the evaluation process, itemizing the varied factors involved in the decision-making process. This involves utilizing resources from both within and outside the organization, contributing towards a well-rounded assessment.

This intricate procedure should delve into the manner in which your team will systematically document each step, examining the array of different elements in play, not just the Howey Test and reputational review. The resources leveraged in this process, both from internal departments and external entities, are key precursors in deriving an informed insight into these multifaceted factors.

What follows next is the ultimate progression of this policy – the formal introduction of the cryptocurrency. It necessitates a meticulously crafted blueprint that accentuates your supporting arguments and evidence, reinforcing the rationale behind the listing decision. 

A comprehensive and lucid policy is essential. It instills confidence among stakeholders by dramatizing an organization’s commitment to thorough research, risk assessment, and due diligence – right from the initial review phase to the listing and unfaltering support of the coin.

Pivotal Questions in Coin Due Diligence Policy

The preliminary course for these explorations often starts with time-tested methodologies such as the ‘Howey Test.’ The test poses key questions, focusing on investment money, expectation of profits, common enterprise, and profits driven by third-party efforts. On the heels of such facets, the understanding of market demand for the cryptocurrency in question arises. It explores the potential demand, community engagement, and user sentiment—all key players driving the cryptocurrency’s value.

While not comprehensive, here are three critical questions to be posed during the due diligence process that can help you start developing your Coin Due Diligence Policy:

1. Is the cryptocurrency considered a security?

Applying the Howey Test, it’s crucial to ascertain whether the coin involves an investment of money, promises expected profits, involves a common enterprise, and if the profits derive from the efforts of a promoter or third party.

2. What is the level of community demand for the cryptocurrency?

Undertaking various means of open-source research is essential to determine if there’s sufficient demand within the cryptocurrency community that supports the prospective coin.

3. Does the cryptocurrency pose any undue reputational risk?

Through comprehensive research involving potential adverse media and associated controversies, ensuring the prospective cryptocurrency doesn’t introduce an undue reputational risk to the business is vital.

Translating Insights Into Action

As we navigate through these momentous times, we invite you to learn more about the securities framework and the evolving landscape of cryptocurrency compliance. BitAML is dedicated to helping its clients navigate through regulatory changes in the cryptocurrency space with proactive approaches towards due diligence. Join us to stay ahead of the curve, help to ensure your compliance with regulatory obligations. Contact us to schedule your free consultation.

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