Kraken digital asset exchange continues its fight with U.S. securities regulators as it blocks German users from accessing the Lightning Network for reasons that remain unclear.
On September 12, Kraken’s attorneys filed their latest response to a civil lawsuit filed last year by the Securities and Exchange Commission (SEC) against its parent company, Payward Inc. and Payward Ventures Inc. The lawsuit accuses Kraken of operating as an unregistered securities exchange, broker, dealer, and clearinghouse, putting customer assets at risk through poor “business practices, inadequate internal controls, and poor record-keeping practices.”
Kraken previously paid a $30 million fine to the SEC in connection with its asset betting service, but asked to dismiss the case on the grounds that none of the tokens it offered to the public were considered securities and therefore ineligible for SEC oversight.
That bid was rejected late last month by U.S. District Judge William Orrick of the Northern District of California, who ruled that the SEC “has reasoned that at least some of the cryptocurrency transactions Kraken facilitates on its network constitute investment contracts, i.e., securities, and are therefore subject to securities laws.”
Some of the other “cryptocurrency” companies targeted by the SEC in this manner have made similar arguments to Kraken, but these arguments have been dismissed by other federal judges in other jurisdictions. While there has been criticism of the SEC’s historical use of the phrase “cryptocurrency asset securities,” the judges have largely supported the regulator’s belief that some transactions represent “investment contracts,” thus triggering a plank of the Howey test.
Kraken’s recently filed 76-page response largely sticks to its original argument, continuing to assert that the SEC has no jurisdiction over digital assets and that only Congress can resolve this dilemma by creating tailored rules for “cryptocurrencies.”
This is a popular and selfish evasion strategy by the ‘crypto’ companies who know all too well that Congress can’t come to an agreement on how to boil water. The obvious hope is that the current environment will last long enough for everyone in the ‘crypto’ C-suite to retire to their nuclear bunkers on their private islands where no one cares if they’re lying.
Don’t mention Lightning Network
Across the pond, Kraken has offered conflicting explanations for why it suddenly blocked German customers’ access to the Lightning Network, a “scaling solution” to the many shortcomings of the BTC blockchain, including its glacial capacity of 7 transactions per second (TPS) and the high transaction fees that come with that limited throughput.
Coincidentally, the developers who run the most popular iteration of Lightning were among those who created the artificially limited BTC network by imposing limits on Bitcoin. It’s pretty cool when supply and demand are under the same roof, right?
Kraken recently announced in a notice on their support page that changes will apply to customers in Germany starting September 10. Verified customers will “face BaFin (German Federal Financial Supervisory Authority) regulated entities (DLT Securities GmbH and DLT Custody GmbH) for cryptocurrency services.”
This announcement comes along with a private revision to Kraken’s list of “supported cryptocurrency withdrawal address formats for German customers.” German customers who previously enjoyed fee-free BTC withdrawals to Kraken’s Lightning Network noted that this option has now disappeared.
According to Kraken support, customers were initially told it was a site maintenance issue, but a team member later admitted, “We do not currently support BTC Lightning trading. This change took effect on September 10th due to new regulatory requirements.”
When asked for more details, the team member would only say, “Lightning addresses are no longer supported,” and that “(c)etails are currently down due to regulatory issues, but will be available once the service is available again.”
As the change became more widely known, Kraken changed its tune, claiming that support staff had “misquoted regulatory changes” in their conversation with the German customer. Instead, the absence of Lightning was “a result of technical changes,” the nature of which was never explained. “Technical changes that only apply within certain country boundaries.. right?” one Reddit user said.
Significantly, no date was given for the resumption of Lightning withdrawals. A Kraken spokesperson said only that the exchange “unfortunately sometimes has to make difficult decisions in order to provide a stable and secure platform for as many German customers as possible.”
Working as intended (when it doesn’t work at all)
Lightning was intended in part as a way to use BTC without having to wait a week for a transaction to be approved, or without having to pay more in fees than the product or service you were trying to buy. (That is, when the notoriously vulnerable Lightning actually works.)
However, Lightning transactions are not processed on the main BTC network, and as the reality of blockchain traceability became apparent to the ‘crypto’ public, some individuals saw Lightning as a way to avoid scrutiny of their transactions.
While some of these individuals may have done so for principled reasons, many others may have known that the product or service they were seeking was not the kind of information they wanted to share with the authorities. Or they simply wanted to hide their digital escape route after a fraud, rug-pulling, or other crime, and needed to launder the same proceeds.
If you’re looking for a potential reason why Germany’s BaFin might have asked Kraken to reinstate Lightning, consider that a few months ago the European Union Internal Security Innovation Hub (a group that includes the EU law enforcement agency Europol) declared that Layer 2s like Lightning were “an obstacle to criminal investigations, particularly with regard to the admissibility of evidence.”
In the United States, the question of whether individuals who run Lightning nodes are actually acting as unauthorized money transmitters remains largely untested. However, since Lightning nodes generate fees on the transactions they process, it wouldn’t be hard to find a U.S. judge who agrees that where there’s profit, there must be permission.
Some blockchains should mention: ~not to do Artificially limiting bandwidth does not require a Layer 2 scaling solution. BSV, the only protocol that respects Satoshi Nakamoto’s original Bitcoin design, can handle 3 million transactions per second, all on a robust and secure base layer with fees measured in cents.
BSV further differentiates itself from the pack by requiring nodes to adhere to strict network access rules, including enabling digital asset recovery. The latter does not treat victims of fraud, theft, or misdirected transfers as tech-illiterate people who deserve to die, but instead gives them the opportunity to pursue legal remedies to help recover their digital assets.
It’s solid, capable, fast, compliant, and consumer-friendly. It’s enough to make you believe that Satoshi Nakamoto knows what he’s doing.
But maybe these people aren’t like that
Kraken was founded by far-right libertarians who historically have not made a big fuss about who their platform is used for and for what purposes. Kraken co-founder and former CEO Jesse Powell has criticized the US authorities for shutting down controversial coin mixers like Tornado Cash, which was popular when North Korean hackers were trying to launder stolen tokens.
Despite Powell’s laissez-faire views, he has not shied away from taking some anti-competitive tactics when it comes to technologies that offer alternatives to the dominant ‘crypto casino’ trading model. Kraken was one of four exchanges that participated in the delisting of BSV tokens in April 2019. The others were Binance, Bittylicious, and Shapeshift.
This led to a £9.9 billion class action against four exchanges in the UK. The legal action, which seeks to compensate holders of BSV tokens for the loss in the fiat value of their digital assets following the delisting, is currently in court after the Competition Appeal Tribunal (CAT) ruled that the criteria for the claim were met.
Powell’s personal life has proven at times as controversial as his company. He previously hinted that he may have committed bank fraud to keep Kraken’s cash flowing in its early days, and his home was raided by the FBI last year amid allegations that he hacked and cyberstalked a California arts organization in an attempt to oust him from its board of directors.
Just thinking about it, maybe the latter incident explains why Kraken’s lightning-quick excuse to a customer feels so hollow?
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