By now, people are used to unusual goings-on in cryptocurrency markets. But little could have prepared Wall Street for the spectacle of Sept. 8, when it awoke to find the head of a $50 billion digital-assets exchange bashing a powerful regulator in a 21-tweet tirade. There was Brian Armstrong, chief executive officer of Coinbase Global Inc., accusing the U.S. Securities and Exchange Commission of “sketchy behavior” and “intimidation tactics” after it effectively blocked his company from rolling out a product that would let users earn 4% by lending their tokens. Finance Twitter spectators were agog—surely the leader of a public company knew better than to infuriate an agency with the ability to make or break his industry?
But in the us-against-them world of crypto finance, even securities cops aren’t immune to public expressions of outrage. Armstrong’s tweets were accompanied by a blog post, in which Coinbase disclosed that the SEC had served it with a Wells notice—meaning it may pursue enforcement action—and opened a formal investigation into its proposed lending product. That program, Coinbase Lend, promised above-market interest rates for clients who allowed the company to use their crypto-denominated funds to make loans.
This isn’t the first time regulators have cracked down on crypto: They all but shut down the initial coin offering boom in 2018. But it’s an unusually public skirmish with the SEC for a large, well-known crypto company—a dust-up that puts the brakes on a product it had hoped would be a hit with investors. It also marked the loudest statement yet from the SEC under Gary Gensler, who took over the agency in April, and has vowed to beef up crypto regulation. “If he wanted to, he could practically focus on crypto regulation his entire tenure,” says Stéphane Ouellette, CEO and co-founder of FRNT Financial Inc., a crypto-focused capital markets platform.
The SEC, born in the Great Depression, operates in a legal framework that many crypto devotees believe to be outdated. (Coinbase alludes to this in its S-1, a registration form companies file before going public, saying many regulatory regimes were created before the advent of the internet and don’t address crypto.) The agency considers any security to be its business.
There are aspects of Coinbase’s program that critics say could bring it under the SEC’s purview. To make such a determination, the agency relies on a 1940s U.S. Supreme Court legal test for whether a product involves “the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” Going by Armstrong’s account of discussions with the regulator, that was enough to put the crypto exchange in its crosshairs. It’s safe to say he disagrees with the outcome.
“They responded by telling us this lend feature is a security. Ok—seems strange, how can lending be a security? So we ask the SEC to help us understand and share their view,” Armstrong told his 825,000-plus followers. “They refuse to tell us.” On Twitter, where a lot of crypto discourse plays out, critics mocked his tirade. Coinbase is a high-profile, publicly listed company with a chief legal officer, Paul Grewal, who previously worked as a Facebook Inc. lawyer and clerked for a U.S. appeals court early in his career. “Them saying, ‘Why don’t we know?’ sounds like they’re looking for the court of public opinion to help them out in the courtroom,” says Tim Swanson, head of market intelligence at Clearmatics, a London-based blockchain company.
The SEC’s threat to sue Coinbase came after a lengthy back-and-forth between lawyers for the company and the regulator, according to two people familiar with the matter, who asked not to be identified discussing private deliberations. It’s common for financial companies to run plans by their regulators privately before going ahead, and those conversations often lead to a product getting tweaked to be approved. In this case, the SEC never signaled it was comfortable with Coinbase’s plan, said the people. Representatives for the SEC and Coinbase declined to comment.
As Lend was being discussed behind the scenes, Gensler was publicly promising a tougher approach to crypto. In an interview with Bloomberg Businessweek in July, Gensler said platforms that pool assets could get swept up in the agency’s rules, as could those offering services to borrow or lend coins. He also raised concerns about companies advertising an interest-rate return on a crypto asset. “It’s not just a matter of law, it’s a matter of ‘How do we protect investors?’ ” Gensler said.
On Sept. 14, in front of the Senate Banking Committee, Gensler drilled down on one of his concerns about exchanges like Coinbase, without discussing Lend specifically. “Stablecoins may well be securities,” Gensler told the committee, without mentioning any specific one. Stablecoins are tokens whose value is pegged to a dollar or other traditional currency. Of Coinbase, he said the exchange could have “dozens of tokens that may be securities.”
Cornell Law School professor Robert Hockett says regulators are cognizant of past instances of shadow banking, or banklike activities that grow largely unabated until officials can no longer ignore them. It happened with money-market mutual funds in the 1980s and ’90s. “There’s a cat-and-mouse game going on constantly,” says Hockett, a former Federal Reserve Bank of New York lawyer. “What regulators are saying is, ‘Look, let’s not wait for another crash before the cat springs. Let’s, this time, have the cat catch the mouse the moment it comes out of the hole rather than waiting for it to eat half the pantry.’ ”
Little is known about Lend beyond what’s on its website (which mainly focuses on the 4% annual return), but analysts have an idea of how it might work: Customers deposit stablecoins to Coinbase, which it then re-lends to market participants—hedge funds or other exchanges, for instance—which might use those coins to short an asset, hedge a position, or be part of a complex trade. In return, market participants pay Coinbase a higher rate than it offers its customers, and Coinbase pockets the difference.
The appeal to clients with stablecoins sitting in their Coinbase wallets is obvious: Good luck finding a traditional savings account that yields more than 0.60% annually. Interest rates on conventional bank deposits are often below 0.50%, whereas a 10-year government bond yields about 1.30%. Crypto investors can find higher rates with other platforms (the market rate on peer-to-peer lending platforms such as Bitfinex is about 8%), but BTIG LLC analyst Mark Palmer says the payout matches the perceived risk of the particular coin as well as its liquidity. Coinbase has 68 million verified users and offers USD Coin, which is pegged to the U.S. dollar.
Concerns from critics and regulators often focus on risks involved, including volatility in crypto markets and a lack of insurance against losses. (Coinbase says the crypto that clients lend to it—their principal—is guaranteed by the company.) It’s not a totally new invention: BlockFi Inc. and other crypto companies have been offering loan products for years. As the crypto army sees it, the rules simply don’t fit the latest innovations.
“There are lots of people questioning whether laws from 1933 and legal precedent from 1946 should govern new technology,” says Max Schatzow, a partner at law firm Stark & Stark, which represents financial institutions. “But that’s the reality. The law is the law. The precedent is the precedent.”
Crypto backers, including Coinbase, have said they’d welcome greater regulatory involvement. After all, if the head of the SEC is preoccupying himself with their business, he must see how prodigiously crypto has grown and changed finance. A framework and clearer rules also would allow the industry to evolve. That isn’t only crucial to crypto companies, but also to their potential counterparties that might get involved in a loan product.
“The first time anyone runs through a wall, blood is going to be spilled,” says BTIG’s Palmer. “What we have right now is a number of entrepreneurs in the cryptocurrency space who are running through a wall and trying to get through to the clarity they hope to see on the other side.”
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