It’s been quite a turbulent couple of days for crypto, as U.S. regulators sued the two biggest exchanges in the world, Binance and Coinbase.

The charges brought against both companies by the Securities and Exchange Commission explicitly show the regulator is getting very serious about bringing crypto under its jurisdiction and that of federal securities laws.

While those regulatory actions affected two of the largest players in crypto and caused an unsteadying of cryptocurrency prices, they could also likely affect the crypto startup and venture capital world as the industry tries to find its footing in a murky financial space.

“Most crypto firms and venture funds welcome thoughtful regulation in this space,” said Yash Patel, general partner at Telstra Ventures, who invests in crypto startups. “However, the SEC’s focus on enforcement by regulation versus more transparent, clear legislative action will compel most crypto firms — not just startups — to leave the U.S. and would not be ideal for America’s competitive position as key talent leaves elsewhere.”

Tough times for crypto

The cases against Binance and Coinbase are very different in scope.

The SEC’s suit alleges Coinbase’s prime brokerage, exchange and staking programs violate securities laws and that 13 assets listed on its platform are considered crypto asset securities, per its complaint.

On the other hand, the suit against Binance charges that exchange for operating a “web of deception,” alleging Binance and its co-founder Changpeng Zhao controlled customers’ assets on the platform and commingled or diverted billions of dollars of those assets as they desired, including to Sigma Chain, a European business Zhao owned and controlled.

It also alleges the Binance.US exchange — which was said to be its own independent exchange — was actually controlled by Zhao and Binance.

Those cases come of course against the backdrop of the complete collapse of FTX — one of the largest startup failures ever that likely only brought more regulatory scrutiny to the space (the SEC is suing disgraced FTX founder Sam Bankman-Fried).

It also is happening after cryptocurrency prices took a huge tumble last year — although some like ether and bitcoin have made a nice rebound so far this year.

All of that seems to have significantly cooled the venture market for crypto — which saw a significant pullback.

Per Crunchbase data, venture capital investment in crypto globally dropped from $6.2 billion in 444 deals in the first quarter of 2022 to only $1.1 billion in only 200 deals in the first quarter of this year.

The numbers are even more ominous when just focusing on VC-backed, U.S.-based crypto startups. In Q1 2022, such startups saw $3.8 billion in 189 deals. The first quarter of this year saw those numbers drop to only $278 million in 73 deals, per Crunchbase.

A chilling effect?

Whether the recent SEC actions will affect funding and deal numbers obviously remains to be seen, but those in the industry are wary.

VCs for years have asked for more clarity, especially around the issue of certain cryptocurrencies being securities as opposed to commodities (which we talked about last year here).

The distinction between the two affects which agency regulates it.

“The SEC is effectively classifying all crypto tokens as securities in this lawsuit against Coinbase, which isn’t necessarily the stance the (Commodity Futures Trading Commission) has historically had,” Patel said. “There’s still a lot of confusion about where the two agencies sit.”

Christian Lopez, head of blockchain and digital assets at Cohen & Co. Capital Markets, added regulation is necessary and welcome in crypto, but the concern is lack of regulatory clarity.

“The industry would welcome sensible guidelines within which to operate, so long as it doesn’t stifle innovation,” Lopez said.

However, Lopez said he believes the U.S. is falling behind other jurisdictions like Hong Kong and Europe which have taken a more welcoming approach to their crypto communities.

“As an investor, I would certainly be concerned about the SEC’s crackdown in the U.S.,” Lopez said. “However, we believe that actions taken by other jurisdictions will force the U.S. to step up to the plate.

“Otherwise we risk losing innovative companies and entrepreneurs and forcing them to move offshore,” he added.

While the SEC’s actions seem clear as to what it wants, Patel adds more thoughtful guidance and clearer rules are needed from all players in the regulatory space.

“There has always been bipartisan support for innovators in (crypto), and this lawsuit will be just as much a political issue as it is a legal fight,” he said.

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