Lionel Laurent

Coinbase’s ‘End of Story’ Is Just the Beginning for Crypto Regulation

A few days ago, Coinbase Global Inc.’s top lawyer issued an unequivocal rejection of the US Securities and Exchange Commission’s allegations that digital tokens it offers its customers were, in fact, unregistered securities. “Coinbase does not list securities,” Paul Grewal wrote in a blog post. “End of story.”

The end? Given the SEC has opened an investigation into Coinbase’s activities, according to Bloomberg News, this looks more like just the beginning of hard questions about crypto platforms’ business models and their future profit prospects amid a brutal market crash. Crypto’s utopian babble is about to be scrutinized in ways that are likely to fundamentally change the market for digital currencies.

With consumers nursing losses and politicians fearing a backlash, there’s more pressure on regulators to get a grip and ensure — however belatedly — that market rules are followed. Watchdogs such as SEC boss Gary Gensler have plenty of targets that are feathered and quacking but claim not to be ducks: bank-like lending products that aren’t subject to bank-like oversight, digital dollar substitutes that aren’t backed by dollars, trading venues that aren’t registered exchanges, and investment tokens that say they aren’t securities.

Coinbase may find it hard to escape more oversight as a consequence. Even without prejudging the outcome of this specific case, Coinbase’s IPO filing already makes it clear that the potential for crypto assets to be classified as securities carries a “high degree of uncertainty,” and that its own best efforts to assess the risk of a particular token being deemed a security doesn’t mean regulators will agree. When the SEC filed a lawsuit alleging Ripple was a security in 2020, Coinbase appeared to get ahead of the issue by suspending the token from its platform.

We know the SEC’s views on a handful of other tokens that it reckons fit the definition of a security — including XYO, Power Ledger, and Flexa’s AMP — because the watchdog aired them following the arrest of a former Coinbase employee who allegedly traded them using insider information. Embarrassingly, the unusual trades were first spotted and publicized by a Twitter user. What Coinbase defends as a “rigorous diligence process” that keeps consumers safe and securities off the platform is being portrayed by the SEC as doing neither.

This isn’t usually existential or fatal for crypto platforms. When the SEC went after rival Poloniex last year for operating an unregistered exchange, the settlement was just $10.4 million; Coinbase, with 2021 revenue of $7.4 billion, could pay that kind of fine without missing a beat.

But if scrutiny leads to a more humbled or regulated Coinbase — the fact that it’s not a registered exchange or broker-dealer has publicly irked Gensler — that will threaten its business model of extracting fat profits from millions of punters looking to get crypto-rich. Transaction fees starting at 0.5% and a relative lack of red tape helped Coinbase list at a frothy $87 billion valuation last year, based on profit hopes rather than just utopian talk of an “Internet of value.” Its growth promises involved listing more tokens, hiring more people and rolling out new products. Those are all under threat — so much so that funds controlled by techno-optimist Cathie Wood have just dumped Coinbase stock for the first time this year.

Coinbase would obviously rather be having a different kind of discussion — one where it somehow partners with regulators to approve new rules, rather than struggling to prove it’s following existing edicts. A July 21 memo by its top lobbyist Faryar Shirzad, for example, offered a plan to overhaul century-old laws that allegedly fail to accommodate today’s “decentralized, cryptographically-based, automated” market.

But this looks disconnected from the reality of today’s crypto market scars. Former Commodity Futures Trading Commission Chair Timothy Massad once warned that Coinbase’s IPO might benefit from the “illusion of regulation.” The irony is that the company’s success has made it a lightning rod for enforcement, as seen last year when Coinbase shelved a lending product after SEC pressure. Like Big Tech before it, crypto has become big enough and important enough to face its first regulatory close-up.