Kraken Is the Latest Crypto Exchange to Face SEC Charges. Are Any U.S. Platforms Safe?

The Securities and Exchange Commission (SEC) continues to crack down on crypto. This week, it brought charges against Kraken, accusing the popular crypto exchange of acting as an unregistered securities exchange, broker, dealer, and clearing agency. It also claims Kraken commingled customer funds with its own cash, creating significant risks for its customers. Kraken denies any wrongdoing and says it will defend itself in court.

Here's what crypto investors need to know about the charges, as well as what steps they might take to protect their investments.

The SEC's accusations against Kraken

Putting aside the commingling of funds, the main thrust of the SEC's charges against Kraken is very similar to those levied against Coinbase in June. It centers on the question of whether certain cryptocurrencies are actually securities.

Currently, most cryptocurrencies are considered to be commodities and come under the remit of the Commodity Futures Trading Commission (CFTC). If cryptocurrencies are in fact securities, they need to be registered with the SEC, which has strict rules on how they report information and how they can be traded.

In its charges against Kraken, the SEC lists the following 11 cryptocurrencies as unregistered securities:

1. Cardano (ADA)
2. Algorand (ALGO)
3. Cosmos (ATOM)
4. Filecoin (FIL)
5. Flow (FLOW)
6. Internet Computer (ICP)
7. Decentraland (MANA)
8. Polygon (MATIC)
9. NEAR Protocol (NEAR)
10. OMG Network (OMG)
11. Solana (SOL)

Why the SEC says many cryptos should be treated as securities

The SEC claims that many cryptocurrencies qualify as investment contracts under something called the Howey test. This test comes from a 1946 ruling that says an investment contract exists "when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others."

Many crypto advocates argue that the decentralized nature of these projects mean the "common enterprise" box is not checked. Even so, if the SEC can win that argument in court, it would mean Kraken, Coinbase, and many other cryptocurrency exchanges have been operating illegally by letting people buy and sell those assets.

Why Kraken says the SEC is wrong

Kraken hit back at the charges and says it intends to vigorously defend its position in court. It says the SEC's complaint is based on a technical argument about what constitutes an investment contract. "This is incorrect as a matter of law, false as a matter of fact, and disastrous as a matter of policy," the exchange wrote in a blog post.

It points out that the charges don't reflect any failure on its part to safeguard customer funds. "The complaint against Kraken alleges no fraud, no market manipulation, no customer losses due to hacking or compromised security, and no breaches of fiduciary duty," says the exchange. "This so-called 'commingling' is no more than Kraken spending fees it has already earned."

Finally, Kraken accuses the SEC of "regulation via enforcement" -- a common complaint about the SEC's crypto cases. Crypto insiders want to see clear regulation rather than case-by-case charges that attempt to use existing laws to set precedent. Kraken argues that the various bills on the table in Congress are a better way to create a comprehensive framework for crypto.

Are any U.S. crypto exchanges safe? Take these steps to protect your crypto

It's going to take a while for the SEC's charges against platforms like Kraken and Coinbase to play out in court. Even so, there are a couple of steps investors might take in the wake of the SEC's continued crypto crusade.

Use a secure crypto exchange

Unfortunately, the SEC's actions don't help us much in terms of identifying which platforms are safe to use. By the SEC logic, almost every crypto platform in the U.S. has broken the rules: There are very few crypto exchanges that haven't listed popular cryptocurrencies like Cardano, Cosmos, Polygon, or Solana. Allowing people to trade those cryptos doesn't speak to a platform's safety (or lack of it).

A better way? Do your own due diligence. That means looking at how an exchange will store your assets, whether it has third-party audits, and how transparent it is about its activities. I'm a big fan of New York's BitLicense. Exchanges have to submit detailed information about their finances and compliance procedures to qualify. It's controversial, but in the absence of a wider framework, it's a good way for investors to find solid ground.

Re-evaluate your crypto portfolio

Now may be a good time to decide if you want to hold the cryptos the SEC has labeled as unregistered securities. There are two considerations here. Firstly, if the courts decide a specific coin or token is actually a security, it will almost certainly impact its price in the short term. It could also impact its long-term potential, as it could affect its operations in the U.S.

Secondly, you may have trouble selling your holdings. When the SEC brought charges against Ripple (XRP) for trading unregistered securities, many top U.S. crypto exchanges delisted the token. Several platforms (such as Robinhood) have already removed the coins and tokens on the SEC's hit list. Others may follow suit. There's a risk you find yourself holding crypto assets that you can't easily sell.

Bottom line

Crypto regulation and enforcement is complicated and messy. The collapse of platforms like FTX and cryptocurrencies like Terra's LUNA highlight a need for increased regulation and investor protection. But there's very little consensus on what shape that protection should take. Crypto investors would be wise to brace for more volatility in this shifting regulatory environment.