Top Stories of the Week

001 Judge Makes Key Ruling in SEC v. Binance

Judge Jackson casts doubt on the SEC’s authority to regulate secondary crypto transactions. On June 28, Judge Amy Berman Jackson of the U.S. District Court for the District of Columbia struck a blow to the Security & Exchange Commission’s (SEC) campaign against crypto exchanges. In partially granting Binance’s motion to dismiss (MTD), Judge Jackson ruled that crypto assets themselves are not inherently securities, rejected the idea that tokens “embody” investment contract securities, and dismissed the SEC’s claims relating to secondary sales of tokens on secondary markets. The court also rejected the argument that Binance’s stablecoin BUSD was offered and sold as an investment contract and rejected that offering interest-rewards on BUSD deposits offers of BUSD into an investment contract.

On the other hand, Judge Jackson denied Binance’s MTD claims relating to its initial and ongoing sales of the BNB token, matters related to Binance.us ’s staking program, and the alleged failure to register Binance.com and Binance.us as securities exchanges, broker-dealers, and clearing agencies, among other claims. This lets most of the SEC’s case against Binance proceed. Read Judge Jackson’s full order here .

Our Take

The allegation that crypto asset tokens are inherently securities and/or embody investment contracts, and that those designations carry forth into secondary sales on spot crypto exchanges (“embodiment theory”), is at the core of the SEC’s ongoing litigation against the cryptocurrency industry. While Judge Jackson drew a distinction between tokens themselves and offers to sell them, and argued that a facts-and-circumstances based approach is necessary to determine whether or not a crypto asset is a security, Judge Jackson expressed concern with the SEC’s argument that if a crypto token was originally sold as part of an investment contract, then any secondary sale of that token would constitute a securities transaction, saying that “the agency’s decision to oversee this billion dollar industry through litigation – case by case, coin by coin, court after court – is probably not an efficient way to proceed, and it risks inconsistent results that may leave the relevant parties and their potential customers without clear guidance.”

Judge Jackson’s ruling contradicts the ruling of New York Southern District Judge Katherine Polk Falia’s in SEC v. Coinbase in which Judge Falia did not reject the SEC’s “embodiment theory.” Judge Polk applied the Howey Test to allow the SEC’s claim that at least some Coinbase customers had bought tokens on the exchange as investment contracts due to the alleged presence of a common enterprise (each token’s supposed “ecosystem”) with a reasonable expectation of profits from the managerial efforts of the token issuer, regardless of whether the issuer sold tokens directly to the Coinbase user or if the Coinbase user bought the tokens on the exchange. Judge Jackson expressly rejected this theory and, in doing so, struck a blow to the core of the SEC’s alleged authority to oversee secondary spot market transactions on crypto exchanges. Judge Jackson in this case and Judge Torres in SEC v. Ripple Labs take detailed and similar approaches that call into question the SEC’s authority.

It is true that most of the SEC’s case against Binance can proceed, but this “embodiment theory” issue is perhaps the most salient to the rest of the crypto industry, and Judge Jackson’s dismissal of that claim provides tailwinds to other industry stakeholders and calls into question the scope of the SEC’s alleged authority. Both Ripple and Coinbase have now cited Judge Jackson’s ruling in their own cases and, assuming these issues are appealed and reach the Circuit Court of Appeals level, we would face a split that could eventually reach a Supreme Court that has shown itself to be hostile to novel interpretations of regulatory authority from federal agencies. (Thanks to our friends on the CahillNXT team at Cahill Gordon & Reindel LLP for providing additional analysis). - Alex Thorn

002 World's First DVT Middleware Client, Goes Live

On Monday, July 1, Obol announced the release of Charon 1.0.0, the first version of Obol’s middleware solution for distributed validators (DVs) that the team will ensure remains compatible with future releases. The team wrote , “Charon 1.0 is the first long-term support (LTS) version of Charon, which will remain compatible with future releases and serve as a foundation for large-scale use cases and deployments of DVs.” Then, on Wednesday, July 3, Obol Labs officially rebranded to DV Labs and launched the Obol Collective. The Obol Collective is a consortium of Ethereum stakeholders supporting the development of DV technology. It is led by DV Labs. Early participants in the Obol Collective include but are not limited to EigenLayer, Lido, Figment, Bitcoin Suisse, and Nethermind.

With the release of Charon 1.0.0, the Obol Collective will focus on expanding the number of Ethereum validators using DV technology. In April, Lido announced 0.5% of total ETH staked through Lido would be managed by DVs. Lido token holders are currently weighing a proposal to increase this threshold to 4% of total ETH staked. About the release of Charon 1.0.0, Ben Edgington, former Ethereum protocol developer and angel investor in Obol, said , “As protocol devs we aim to build profoundly fault-tolerant systems. Charon takes this to another level with squad staking: decentralising the decentralisation.”

Our Take

As written about in prior newsletters , distributed validator technology (DVT) is a novel standard for staking that distributes the responsibilities and risks of running validators securely and efficiently across multiple operators. The release of Charon 1.0.0 is a major milestone for the maturity of DVT solutions and is a prominent example of technology that most Ethereum validators could benefit from that is not being developed in-protocol as part of the Ethereum roadmap. There are many examples of technology that Ethereum validators rely on that protocol developers did not create and do not maintain. The technology that enables validators to earn MEV is developed and maintained by Flashbots . The technology that enables validators to smooth rewards and accept funds delegated from users is primarily built by smart contract developers operating staking pools such as Lido and Rocketpool. Ethereum protocol developers have promoted the creation of these out-of-protocol technologies for the benefit of stakers in hopes to encourage innovation and improvements to the activity of staking that would otherwise take longer to develop in-protocol.

However, in doing so, developers have also encouraged dependencies between the Ethereum protocol and various out-of-protocol tools and applications. Not only can this lead to outsized influence and power over the Ethereum protocol by non-protocol developers, it can also lead to increased risk of bugs and software malfunction negatively impacting wider swaths of Ethereum’s validator set. As the tech stack supporting staking on Ethereum grows more complex and different parts of validators operations become maintained by different groups, there is a higher chance the interactions between each piece of technology may lead to unexpected outcomes and potential failures. Upgrades to any one piece of technology in this stack also become more difficult to execute and comprehensively test. Thus, while DVT is a major technological innovation that is quickly maturing for widespread use on Ethereum, its adoption may create new dependencies between Ethereum and DV Labs, as well as new risks for stakers. - Christine Kim

003 Polymarket, an On-Chain Prediction Market, Sees Record-Breaking Volume

In the wake of the first presidential debate between President Joe Biden and former President Donald Trump, monthly volume on Polymarket, a Polygon-based prediction market, reached a new high of $111.6m. Polymarket allows users to cast their opinions on the outcomes of a plethora of events ranging from sports to pop culture, though the top markets all pertain to politics such as the outcome of the U.S. Presidential election.

Each outcome of an event is represented by value-carrying tokens that users can purchase to signal their opinions. The value of each “outcome” fluctuates as the market casts their predictions. Outcomes that are increasingly more probable in the market’s opinion increase in value as the tokens are acquired, or as their relative share of the market increases. The opposite is true of outcomes with declining probability as tokens are sold off or diluted from buys of other outcomes.

Measuring the magnitude of Polymarket’s record breaking month, June’s volume cleared the previous monthly all-time high (May 2024 at $63.05m in volume) by 77%. The day of the U.S. Presidential debate, June 28, 2024, saw $10.7m in volume, making up 9.6% of the monthly total. If Polymarket were a DEX on Polygon, it would have notched a top three position in monthly volume, behind just Uniswap and QuickSwap.

Our Take?

Prediction markets have long been sought as a prime use case for blockchains. Their censor/ tamper resistant, transparent, and global nature makes them well suited for the task, as they allow for the unfiltered casting of opinion on any topic from anyone, anywhere. The qualities of transparency and inalterability become increasingly important as trust in centralized polls wanes and people search for real signals on public sentiment. One of crypto’s earliest and most anticipated projects was a prediction market called Augur, which was founded in 2014 but failed to ever receive significant usage.

Now, on-chain prediction markets are gaining some market penetration in terms of use on chain and mindshare off chain. The increased activity on Polymarket may be partly attributed to former President Donald Trump, who has consistently referenced market stats from the application over his social media app, Truth Social (July 2, 2024 , June 5, 2024 , June 6, 2024 to highlight a few mentions), to his millions of followers. Yahoo Finance has also shared articles on the prediction market from CoinDesk and PR Newswire .

On-chain prediction markets aren’t perfect, though. They solely reflect the opinions of individuals who are active on blockchains, which, today, is a small sect of people with possibly similar beliefs. With crypto becoming an increasingly partisan political issue, and Polymarket only able to be used with crypto, it’s possible that Polymarket’s political markets may be skewed by the pro-crypto biases of its participants. Additionally, the economic component of on-chain prediction markets can obfuscate real market opinion on an event. Users with large sums of capital can skew top line results in some markets as their opinion can carry more “weight” than people with less capital in aggregate (e.g. a market with two people, one with $10 and one with $2 will be skewed by the opinion of the person with $10). People may also vote for what the majority of the market believes in an attempt to make profit, not necessarily because they think a certain outcome will happen, blurring the actual opinions of people in the market. On the flipside, the incorporation of economic incentive allows for a more precise reflection of sentiment when measured on an individual-by-individual basis. For example, a single person can bet on both sides of a binary market (e.g. a market with “Yes” or “No” outcomes) in unequal proportions to signal that they are leaning predominantly one way but have some doubt that can still be baked into the market. – Zack Pokorny

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