Terraform logo close-up on website page.

SEC investigation of Do Kwon and Terraform Labs to proceed as court affirms subpoenas

Do Kwon and his company, Terraform Labs, must comply with subpoenas served by the U.S. Securities and Exchange Commission (SEC) in their investigation into whether Kwon and Terraform violated federal securities laws, the U.S. Court of Appeals have ordered.

The SEC began investigating Do Kwon and Terraform in November, over digital assets issued by them which are based on the Terraform Labs Mirror Protocol. The protocol is designed to ‘mirror’ the price of U.S. securities and was the basis for the TerraUSD stablecoin.

An earlier court had rejected an attempt to block the SEC’s investigative subpoenas, and the two recipients had appealed on the basis that the court lacked jurisdiction over them because of their insufficient contacts in the United States. Terraform is incorporated in Singapore, while Kwon is a resident of South Korea.

The Court of Appeals was unimpressed by the appellant’s arguments. It agreed with the finding of the district court that the appellants brought themselves comfortably within the jurisdiction of the U.S. courts by promoting their digital assets to U.S. investors and employing U.S. residents, among other things. For example, Terraform indicated to the court that 15% of Mirror Protocol users are based within the United States.

The court was particularly unimpressed by an argument advanced by the appellants that service of the subpoenas directly to Kwon was not valid because they weren’t served to his attorney—while simultaneously arguing that their counsel was not authorized to accept service. Kwon had been served the subpoenas—both in his capacity as an individual and as representative of Terraform Labs—in November before going on stage at an industry conference.

“Appellant’s reading of the Rules is contrary to the text and would produce absurd results by allowing a party to insist on service through counsel, but allow the party to block said service by not authorizing their counsel to receive any filings.”

With the SEC’s investigation going ahead and the subpoenas confirmed, the curtain is set to be pulled back on Terraform Labs, Do Kwon and their disastrous stablecoin collapse. This is vital not just because of the traders directly impacted by the event (reports of lost family savings and even suicides were widespread; Luna, the stablecoin’s twin token, was worth $40 billion before its value was wiped in the crash) but because of the impact stablecoin projects have on the wider financial system.

Indeed, Terra turned out to be something of a canary in the ‘crypto’ coal mine, with its spectacular collapse highlighted how poorly built the foundations of some of the industry’s biggest projects really are. Notorious stablecoin Tether (USDT) had $10 billion knocked off its $83 billion market cap following the Terra collapse and for a time lost its own peg to the dollar. The peg recovered, but exposure to the Tether scheme is much greater than it ever had been with Terra, and a UST-like collapse could have disastrous and unforeseeable consequences stretching far beyond the digital asset industry.

In that light, it’s no wonder the SEC had Terra in their sights well before last month’s crash. It’s why the question of whether a digital asset amounts to a security or not is so important: securities are subject to the rigorous legal requirements of the US securities legislation which, among other things, are designed to protect the investors who are sold them.

The law has already come knocking for Tether, and a recently introduced bipartisan bill would greatly increase the rules governing stablecoins intended for one-to-one redemptions including requiring them to be 100% backed. This obviously impacts Tether, but would also have the effect of severely limiting the viability of algorithmic stablecoins like Terra—if not destroy it entirely.

In the meantime, the SEC’s probe into Do Kwon and Terraform Labs will presumably proceed full steam ahead.

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