Home Coinbase Coinbase (COIN) Spat With SEC Ups the Ante in Washington’s Crypto Fight

Coinbase (COIN) Spat With SEC Ups the Ante in Washington’s Crypto Fight

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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.

relates to The Coinbase Spat With the SEC Ups the Ante in Washington’s Crypto Fight

Coinbase CEO Brian Armstrong in 2018.

Photographer: Christie Hemm Klok/Getty Images

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The SEC, born in the Great Depression, operates in a legal framework that many crypto devotees believe to be outdated.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.

relates to The Coinbase Spat With the SEC Ups the Ante in Washington’s Crypto Fight

The Nasdaq Market site in New York’s Times Square on April 14, during Coinbase’s initial public offering.

Photographer: Michael Nagle/Bloomberg

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.’ ”

As crypto companies get bigger and more mainstream, regulators are trying to clamp down on their innovations.

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