The U.S. Securities and Exchange Commission (SEC) has opened a full-frontal assault on the cryptocurrency exchange industry with separate lawsuits against Binance and Coinbase, the largest such enterprises in the world and the U.S., respectively.

Led by Chair Gary Gensler, the securities watchdog yesterday levied 13 serious securities violation accusations against Binance, including that the exchange failed to meaningfully separate its global and U.S.-based operations, put customer funds at risk and engaged in a “calculated effort to evade the law.”

This is an excerpt from The Node newsletter, a daily roundup of the most pivotal crypto news on CoinDesk and beyond. You can subscribe to get the full newsletter here.

Perhaps most seriously, in an allegation that recalls the crooked dealings between Sam Bankman-Fried’s crypto exchange FTX and hedge fund Alameda Research, the SEC has accused Binance of commingling billions of dollars of customer assets through a third-party called Merit Peak Limited, which is owned by CEO Changpeng Zhao.

The charges against Coinbase – which has built a reputation as a crypto exchange willing until recently to work inside the bounds of the law – are almost as devastating.

But neither of these civil suits are all that surprising. In March, the Commodities and Futures Trading Commission (CFTC) filed a lengthy suit against Binance, including many complaints that are repeated in the SEC court documents. And, earlier this year, the SEC sent Coinbase a “Well’s notice,” which usually indicates the agency is building a case and intends to file charges.

The question now appears to be whether Binance or Coinbase will be subject to even more serious criminal charges brought by the U.S. Department of Justice. In Binance’s case, it’s long been rumored (and reported) that the DOJ is thinking through a case – though, according to Reuters, it appears to be split internally on the way forward.

Further, there appear to be several dissenters at the SEC, who argue the organization should have done more to provide a pathway for firms to “come into compliance” with the law. Most notably, Hester Peirce, one of five SEC commissioners, has said that, even if Gensler and the SEC’s actions are motivated by a real desire to protect investors, what they’ve done is spun uncertainty.

In a recent CoinDesk TV interview, Peirce said one way for her employer to “plant a flag” and establish dominance over the nascent crypto industry is to file enforcement actions. It’s become rote to suggest that U.S. authorities are “regulating by enforcement” and are also wrapped up in turf wars with other agencies, but the claims do have a ring of truth.

It’s not unheard of for the SEC and CFTC to go after the same target, but it does seem like a waste of resources for agencies that are perennially underfunded. And trying to establish which watchdog – securities or commodities – should take point has been a legislative nightmare, and frankly a national embarrassment.

Essentially the function of the SEC is to set standards for companies to follow. These include disclosure rules and protocols to prevent the criminal misuse of money (like laundering ill-gotten funds and financing terrorists). The agency is not necessarily tasked with rooting out bad actors, going against what many crypto activists mistakenly believe.

But, by filing suit, the SEC and CFTC do have a remarkable ability to signal what type of businesses or practices are less-than-desired in a functioning economy. And by going after the two biggest fish in crypto, it’s becoming clear that all exchanges are at risk. Scratch any financial firm and you’ll find it bleeds financial infractions, especially in an industry as rough-and-tumble as crypto.

What regulators want

But the idea that exchanges, as they currently operate, are not exactly welcome in the U.S. is not a new risk – even though the SEC’s recent cases are a reality check.

Gensler has been saying for years that existing financial rules apply to crypto services providers, that cryptocurrencies resemble securities unless issued under very specific conditions (in fact, labeling at least 61 specific tokens as securities in its various lawsuits) and that exchange operators have a responsibility to “come in and register” with the SEC.

There are many reports of crypto companies opening a dialogue with the SEC and having those meetings go belly up. (And a handful of counter-examples.) But the real fundamental change the SEC wants is for crypto companies to offer up more insight into who is using these platforms and how.

In other words, bog-standard surveillance and information disclosure rules seen across financial markets, and codified into law for crypto companies that want to do business in the European Union under the recently passed MiCA regulations.

"Coinbase's alleged failures deprive investors of critical protections, including rulebooks that prevent fraud and manipulation, proper disclosure, safeguards against conflicts of interest, and routine inspection," Gensler said in a tweet.

Why the rules may not work

To be sure, there are serious reasons why such reporting rules are anthema culturally in the crypto industry (which tends to value financial privacy and sovereignty quite highly), and why at a technological level either introduce risks for crypto users or are legitimately unneeded. Any disclosure on a blockchain is total disclosure, opening up a user’s entire history of transactions to view by nature of how blockchains work.

More importantly, there is also a fair argument that cryptocurrency networks have in-built systems for customer protection – or, at the very least, are optimizing for a different understanding of “safety” as financial regulators.

For crypto, what’s truly important is to offer equal access to all potential users while also ensuring that these new forms of money are non-confiscatable and their transactions irreversible. The open-ledger design also provides a complete view for authorities to track down bad actors when necessary, which is now standard practice.

That blockchains accomplish all this does not eliminate the need for regulations. And it’d clearly be better if founders and companies knew in advance how to operate within the bounds of the law. But crypto’s very real neutrality and technical achievements does put it in conflict with some regulatory aims, as argued in a recent “Consensus @ Consensus” report titled Should DeFi [decentralized finance] Defy Regulators?

This includes the “commodity-money” aspects of many tokens that have use in a decentralized system and utility beyond mere speculation. It also includes the programmatic circuit-breakers in DeFi lending markets, the pre-established rules that all necessarily follow when they engage with a smart contract.

When is it worth defying?

What’s true for pure decentralized systems does not necessarily apply to centralized companies like Coinbase and Binance, however. It’s difficult to predict the results of these recent lawsuits – and they are likely to play out for years – but the scope of the allegations does suggest the SEC is looking to totally, irrevocably reshape how crypto functions. Liquidity is already being drained out of Binance, which, even before the lawsuit, was seeing multi-year low transaction volumes.

Some predict such a hostile move will bottom out the domestic U.S. crypto industry. Others that it may usher in an age for truly decentralized finance and decentralized exchanges. It’s worth noting that allegations are not facts, and some degree of skepticism is warranted given Gensler’s clear bias. In the past, the SEC’s enforcement actions have led to slaps on the wrist.

What is certain is that exchanges – if they want to benefit from the efficiencies and protections of operating as “centralized” companies – will need to start acting a lot more like fintech firms and banks. That means more KYC [know-your-customer rules], more disclosures and more interactions with regulators. It’s why some think the real future of crypto exchanges isn't DeFi, but exchanges like FTX 2.0, a bankrupt company that would have every incentive to play by the rules.

It remains to be seen what the "v2" versons of Coinbase and Binance might be.