Sometimes you make a bad business decision, and you keep paying for it. And for Circle — the company behind the USDC stablecoin — that bad decision was Poloniex, the crypto exchange it bought in February 2018 for $400 million.
The Securities and Exchange Commission announced in a press release on Monday that Poloniex agreed to pay $10 million to settle charges that it operated an unregistered securities exchange. Poloniex neither admits or denies the claims by agreeing to the settlement.
Circle, which plans to go public via a special-purpose acquisition company merger, will cover the cost of the settlement, adding to the $156.8 million it already lost when it sold Poloniex in October 2019 — only 18 months after buying the troubled exchange.
According to the SEC, Poloniex allowed users to trade digital assets that were unregistered securities from July 2017 through November 2019, though it didn’t specify exactly which tokens were securities.
Exchanges that sell securities have to register with the SEC or apply for an exemption, according to Section 5 of the Security and Exchange Act of 1934.
Although Circle had plans to turn Poloniex into a regulated exchange, those plans never materialized. Instead, Circle ended up paying for Poloniex’s mistakes.
History of Polo
Poloniex launched in January 2014. In its early days, it operated out of Somerville, Massachusetts, not far from Circle headquarters in Boston.
The exchange started off allowing users to trade bitcoin for a number of “promising” altcoins — such as Namecoin, Memorycoin, Klondikecoin, Earthcoin, and the like — as you can see from this 2014 web archive.
In March 2014, Poloniex lost 12.3% of its bitcoin supply (97 BTC), worth around $48,000 at the time, when it was hacked, leaving the company insolvent.
“I take full responsibility; I will be donating some of my own money, and I will not be taking profit before the debt is paid,” Poloniex then-owner Tristan D’Agosta said on BitcoinTalk, writing under the username Busoni.
By July 2014, D’Agosta said he had paid back the debt, thanks to the popularity of Monero, a privacy coin known for its use in money laundering, darknet markets, ransomware, and cryptojacking.
Since Poloniex was never able to get proper banking, it remained a crypto-to-crypto exchange. If you wanted to exit into fiat, you had to move your BTC or ETH to a banked crypto exchange, such as Kraken or Coinbase.
All through the initial coin offering craze and bitcoin bull market of 2017, Poloniex cashed in, listing a slew of ICO tokens in the same manner that it had previously listed all those altcoins.
Circle knew the SEC was breathing down Polo’s neck when it opted to purchase the exchange.
According to Circle’s consolidated December 31, 2020, and 2019, financial statements, which were part of its SPAC filing, the SEC had filed a complaint against Poloniex in December 2017 related to “the trading of cryptocurrencies that may be characterized as securities.” Circle set aside $10.4 million to pay for the settlement.
In July 2017, the SEC released its infamous DAO Report, effectively saying that most ICOs were investment contracts. The report also warned crypto exchanges that they needed to register with the SEC as a national exchange or apply for an exemption — if they were going to list these tokens.
At that time, Poloniex should have delisted every single one of its ICO tokens. Instead, the exchange put profits ahead of common sense.
“Poloniex chose increased profits over compliance with the federal securities laws by including digital asset securities on its unregistered exchange,” Kristina Littman, chief of the SEC enforcement cyber unit, said in a statement.
Circle purchased Polo with pie-in-the-sky plans. A few months after the purchase, Circle would get $110 million in funding led by Bitmain, a Chinese crypto mining company, to launch USDC. Eventually, the stablecoin business would become more attractive.
Jeremy Allaire and Sean Neville, Circle’s co-founders, described turning Poloniex into a marketplace for “tokens which represent everything of value,” including physical goods, real estate and even creative productions.
The timing of the purchase was terrible. In February 2018, Bitcoin had lost half of its value since reaching nearly $20,000 in December 2017. Retailers were selling their bitcoin and getting out of the crypto markets. And Poloniex was left with a backlog of 140,000 open customer tickets to deal with.
Circle figured that if it could transform Poloniex into a respectable alternative trading system — a type of exchange that would qualify for an exemption — the SEC would not push charges.
According to a leaked slide from a Circle presentation, the SEC told Circle that it would “not pursue any enforcement action for prior activity” at Poloniex as long as Circle turns it into a regulated exchange.
Only the ATS never happened. Instead, Circle moved most of Poloniex’s international operations offshore to Bermuda in July 2019, so that it could sidestep US regulations.
Around the same time, Poloniex announced a partnership with payment processor Simplex in mid-2019 that allowed users in 80 countries to fund their accounts with cash and have their money automatically “tokenized” into USDC.
Meanwhile, throughout 2019, Poloniex’s problems kept adding up.
Circle received subpoenas from the US Treasury Department’s Office of Foreign Assets Control (OFAC) and an Iranian government agency looking into Poloniex registered accounts and transactions that may have violated sanctions. According to its SPAC filings, Circle estimated the penalty would be between $1.1 million to $2.8 million.
Several Poloniex investors lost money in May 2019 when CLAM token suffered a flash crash, causing substantial numbers of margin loans to default. The exchange had to socialize $14 million in losses, opening itself up to class-action lawsuits.
Circle estimated it would have to pay $1.3 million for two settlements, according to its filings. The company says “the remaining prospective claims are not probable of being successful at the current time and will continue to monitor developments around these claims and other claims made by affected lenders.”
Enough is enough
In October 2019, Circle decided to spin off Poloniex to a new entity — Seychelles-based Polo Digital Assets Ltd — backed by an Asian investment group. Tron CEO Justin Sun led the consortium with plans to invest $100 million into the exchange.
Why did Circle sell Polo? It is likely the crypto downturn of 2018 made operating the exchange too costly. And I’m guessing it was a lot more work to turn Polo into a regulated exchange than Circle anticipated, given all Polo’s previous mishaps.
Neville stepped down from Circle after the sale. He didn’t give an explicit reason why, but he told Coindesk that the company’s recent sale of Polo was one of several factors that made “the time appropriate for me to transition.”
After that, Circle decided to put all of its energy into its USDC stablecoin, of which there are now 26.7 billion in circulation.