Today, the U.S. Securities and Exchange Commission ( SEC ) filed a lawsuit against cryptocurrency exchange Coinbase in New York federal court. The US SEC claimed in the lawsuit against Coinbase that over time, Coinbase has earned billions of dollars in revenue but lacked the disclosures and protections required for registration. Coinbase has never been registered as a broker, national securities exchange, or clearinghouse, and has not been granted any applicable exemptions. Coinbase has been operating since at least 2019 as an unregistered broker, including soliciting potential investors, handling client funds and assets, and charging transaction-based fees; and as an unregistered exchange, including offering a marketplace that aggregates multiple buys and sells Both parties' crypto assets and match and execute these orders. The SEC said that over the years, Coinbase violated the regulatory structure and failed to meet the disclosure requirements that Congress and the SEC built to protect the national securities market and investors.
Written by: Michael Nadeau
Compilation: Luffy, Foresight News (this article was published before the US SEC formally filed a lawsuit against Coinbase)
Whether you are an entrepreneur, developer, or investor, as long as you are in the cryptocurrency industry, understanding the upcoming regulations and policies is a must for you. With the topic of regulation heating up in the US and MiCA becoming law in Europe, now is the time to dig a little deeper.
Regulation is a broad topic, and for readability and comprehension, we have divided the content into two parts. In Part 1, we'll discuss the following:
The role played by the Securities and Exchange Commission (SEC)
Coinbase's feud with the SEC
The divide between the executive branch and the legislative branch
Crypto Users and the 2024 Election
Image credit: Times Higher Education
The role of the SEC
protect investors;
Maintain a fair, orderly and efficient market;
Improve capital efficiency.
The SEC promotes full public disclosure of companies, protects investors from fraudulent and manipulative market practices, and oversees corporate takeovers.
The SEC is responsible for maintaining the orderly operation of the world's largest capital markets. They also have the power to make new rules, so long as they fit within the framework established by Congress in 1933/1934. The SEC's implementation of this framework is intended to create an environment that holds bad actors accountable and provides opportunities for good actors to innovate.
Without thoughtful regulation, the crypto industry cannot mature and reach its true potential. But the current regulatory framework was created in 1933/1934, and we don’t yet have a new set of laws or regulations to apply to new types of crypto assets.
Encrypted assets are fundamentally different from traditional securities in many ways, such as:
There are no investment contracts (secondary transactions).
Cryptoassets do not represent legal ownership.
Cryptoassets do not entitle holders to receive interest or dividends.
Many cryptoassets have commodity-like characteristics, where the asset is used for payment or consumption of services.
Cryptoassets are digital bearers that are self-custodial.
Encrypted assets can be traded in a peer-to-peer manner.
Cryptoassets are traded globally with almost instant settlement around the clock.
Due to the nature of the public chain, services such as custody, bookkeeping/transfer agency, trading, and auditing can be bundled.
Smart contracts enable new peer-to-peer business models and the automation of markets such as asset trading.
The transparency and automated audit/verification capabilities of public blockchains create new tools for regulators to comply with investor disclosures in new ways.
As crypto networks mature, they become more decentralized. The lack of centralization makes it difficult to comply with current disclosure requirements for traditional securities.
The SEC's desire to place cryptocurrencies in the same regulatory framework as traditional securities is not going to work. But we should also not abandon the goal of protecting investors while improving capital efficiency. We just need to adjust the rules, or create new ones. That job will fall to Congress, not the SEC.
Of course, cryptocurrencies are not free from political complications.
Law enforcement supervision
Unfortunately, rather than fostering innovation, protecting investors, and holding bad actors accountable, the SEC's current approach—regulation through enforcement—has penalized many companies that seek to comply, while keeping investors pushed to high-risk, opaque offshore entities.
The results of this strategy appear to be at odds with the SEC's mission.
I'm not here to explain why this is the case, and cryptocurrency is not the first industry to encounter similar challenges. Our job is to try to see the field with clear eyes. At the end of the day, we're just trying to predict where things are going. As an industry operator and investor, understanding regulation and policymaking is all about assessing risk.
To do this, let's first look at the case of Coinbase.
Coinbase's feud with the SEC
As a public company, Coinbase is one of the most trusted names in the crypto space.
The auditor behind Coinbase is Deloitte, and has long sought compliance by voluntarily working with regulators. Here's a brief overview of Coinbase's history with the SEC:
Prior to 2020: Coinbase received all relevant state remittance licenses (2014), New York State BitLicense (2017), SEC-approved Alternative Trading System Company ATS (2018), and SEC-registered proprietary broker license (2019). ATS and trading broker licenses are currently pending regulatory approval.
October 2020: Coinbase files initial listing draft S-1 with SEC.
December 2020: Coinbase submitted a legal analysis of its staking service.
February 2021: SEC publishes second comment letter, Coinbase responds to legal analysis of whether tokens listed on its spot exchange are securities.
April 2021: SEC declares Coinbase's S-1 effective; Coinbase officially goes public.
November 2021: Coinbase meets with SEC Chairman Gensler to discuss registering a securities trading platform.
July 2022: Coinbase files a formal rulemaking petition , which includes 140 specific questions to the SEC.
Q4 2022: Coinbase met 12 times with SEC staff (including law enforcement) to discuss registration paths and related matters, for a total of 30 meetings in 9 months.
January 2023: SEC enforcement staff notifies Coinbase that they will continue to take enforcement action.
March 2023: Coinbase receives a Wells Notice from the SEC.
April 2023: Coinbase sues the SEC to respond to a July 2022 rulemaking petition.
May 15, 2023: SEC responds to Coinbase's petition.
We currently don't know exactly what the SEC's enforcement action against Coinbase is, we just know it happened.
Disclosure: We are not lawyers. We believe the most important factor in all of this has to do with the fact that the SEC reviewed Coinbase's operations and approved the company's S1 listing in April 2021. Now, these do not exonerate Coinbase from enforcement action.
The reasons are as follows:
The SEC hasn't issued any new regulations since Coinbase's S1 was approved. Congress has not passed any new laws related to crypto assets. Additionally, Coinbase's core business has not changed.
Coinbase disclosed its asset listing process and Staking business to the SEC when it went public. Additionally, the SEC already knew how Coinbase kept user assets.
All of this suggests to the investing public that the SEC believes the business is legitimate and compliant. Therefore, investors in the Coinbase IPO have all the information they need to assess the risk.
Now, by issuing the Wells Notice, the SEC is implying that Coinbase's core business is illegal or non-compliant and that enforcement action is imminent.
Coinbase's core business has not changed, nor have any new regulations or laws been introduced since Coinbase went public.
So it's hard to pinpoint what's wrong with the SEC -- that's a problem in itself. We believe regulation will only be counterproductive if the public, investors, entrepreneurs, and Coinbase itself don't know what they're doing wrong.
Howey test
Coinbase claims that they do not trade securities. They shared their listing process with the SEC when they went public, claiming that they reject over 90% of crypto assets seeking listing.
At the same time, Gary Gensler, the current chairman of the US Securities and Exchange Commission, has repeatedly stated publicly that "except for Bitcoin, all encrypted assets are securities." Remember, this is not an official policy, it's just a public statement made by Gary Gensler.
He also made completely contradictory public statements. In fact, in 2018 he stated that more than 75% of ICO tokens were not securities.
He even made a statement about how crypto networks have become “sufficiently decentralized” over time, changing the way they are treated as securities.
Ultimately, to meet securities law thresholds, the SEC must certify that a particular crypto asset traded on Coinbase is part of an ongoing investment contract. Coinbase doesn't think they are for two reasons:
There is no investment contract between Coinbase users who buy and sell crypto assets and the issuers of those assets. Token issuers cannot raise funds from users trading on Coinbase.
Previous cases applying the Howey test to crypto assets have targeted issuers raising capital through the sale of unregistered securities. This is different from the secondary market that Coinbase trades on. Coinbase believes that secondary market transactions do not meet all 4 conditions of the Howey test:
Investment of funds: In the secondary market, the investment does not go to the issuer or promoter.
Co-Investment Enterprises: This does not exist for users buying crypto assets on Coinbase. Again, this condition applies to the primary market, not the secondary market.
Profit Expectation: For encrypted assets with consumer/commodity characteristics, there is no profit expectation. For example, users of Ethereum need to purchase tokens to pay Gas fees to access services on the network.
Profiting from the efforts of others: Again, this applies to the primary market rather than the secondary market.
what happened next
For now, it remains to be seen what kind of enforcement action the SEC will take against Coinbase. Is it related to the listing of assets? Pledge? hosting? we do not know. All we know is that the SEC is planning to take action against Coinbase.
With some of the best lawyers and policy experts working for it, and with $5 billion in cash on hand, Coinbase is probably better suited to challenge the SEC than any other crypto company.
The market appears to be pricing in the worst. But we think Coinbase has a good chance of winning or settling.
Notably, the SEC recently ended insider trading charges against former Coinbase employees, who also charged that the underlying assets were securities. However, the settlement statement did not state that the crypto assets involved were securities, and it appears that the charges were dropped.
In terms of time, it may be many years before we figure this out.
Finally, we believe that expanding existing federal securities laws to include cryptoassets under their regulatory purview is unnecessary and wrong. Policy issues of crypto asset regulation should be left to Congress.
We think the bipartisan bill introduced by Senators Gillibrand and Lummis is a great start. We hear an updated version of the bill is being finalized. Additionally, a new market structure bill passed Friday: It was authored by House Financial Services Committee Chairman Patrick McHenry and House Agriculture Committee Chairman Glenn Thompson (R-PA) Glenn Thompson. In describing the roles of the SEC and CFTC , the bill defines key terms such as decentralization, blockchain (public blockchain only), digital asset, digital asset issuer, Stablecoin, etc. related new laws.
What Congress Thinks About Cryptocurrencies
At first glance, the U.S. appears to be largely opposed to cryptocurrency innovation.
The media tends to focus on negative headlines, which fuel fear, uncertainty and doubt.
Examples include Senator Elizabeth Warren's "Anti-Encryption Coalition" campaign, and the White House's recent enforcement actions.
But publicly available data provided by Coinbase paints a more nuanced picture.
In particular, the attitude of the legislative branch of Congress seems to be different from that of the executive branch. More Republican and Democratic policymakers support cryptocurrency innovation than oppose it.
The data below pertains to publicly available information related to legislative records, media statements, social media posts, caucus memberships, and public letters. Each member of Congress is then rated to determine whether they support or oppose crypto innovation. Members who were unable to collect or publicly verify information were not rated.
Source: Coinbase Public Policy Legislation Portal
We also hear that the divisions that do exist in Congress are more generational than ideological.
Interestingly, Coinbase’s data appears to be consistent with a recent statement made by Rep. Ritchie Torres in a discussion with Bankless:
My take is that divides in cryptocurrency are not partisan or ideological, but generational. You'll find that younger Democrats are more open to cryptocurrency innovation.
Congress, as you know, is a geriatric governing body. Currently, three leaders of our Democratic caucus are over 80 years old, and almost all committee chairmen are over 70 years old. Therefore, among congressional leaders, there is often a reluctance to new technologies such as cryptocurrencies.
On the Veteran Member of Congress Opposing Cryptocurrencies:
There seems to be an anti-cryptocurrency disorder syndrome clouding clear and rational thinking about cryptocurrencies. Much of this is rooted in ignorance. You will find that the pro-crypto MPs are much more educated than the opposition.
My role as a policymaker is not to assess the utility of cryptocurrencies. The role of government is not to destroy innovation, the role of government is to make sure that innovation is safe for consumers and investors. This is what we should do.
Cryptocurrency is not a partisan issue. Most studies show that slightly more Democrats than Republicans own and use cryptocurrencies in the United States.
2024 Election Cycle
Remember, Twitter started as a small platform where nerdy engineers shared what they had for breakfast. Facebook started as an on-campus social club at Harvard.
But within 10 years, both platforms have had a major impact on global election cycles.
We think Bitcoin and cryptocurrencies (and artificial intelligence) have a good chance of becoming a hot issue in the 2024 election cycle.
the democratic party
The Democratic National Committee has announced that it does not intend to hold primary debates, and it appears that Biden has secured the nomination.
Meanwhile, Biden, the White House, and the current regulators appointed by the president (SEC, FDIC, Fed) appear to be largely opposed to cryptocurrencies.
Having said that, we think their stance may change as we get closer to the next election cycle.
Keep in mind that many young members of Congress within the Democratic Party support cryptocurrencies, as do many of their constituents.
According to a recent study by Grayscale, 52% of Americans (including 59% of Democrats and 51% of Republicans) agree with the statement that “cryptocurrency is the future of finance”; Invest in crypto assets in the future.
As mentioned earlier, Democrats are more likely than Republicans to own crypto assets.
Meanwhile, various estimates suggest that approximately 20% of U.S. adults own crypto assets. According to the U.S. Federal Reserve itself, one in 10 U.S. adults will own or use cryptocurrencies by 2022, a bear market year. Coinbase has 110 million verified users (Deloitte audit). Finally, 67% of Americans agree that the financial system needs major change or overhaul.
When all of this is combined, we think the White House may have to adjust its policy on cryptocurrencies as the election cycle rolls around.
republican party
Republican presidential candidates are more likely to support crypto innovation. Republican leader Ron DeSantis has said he will "ban CBDCs" and support innovations related to Bitcoin and crypto. As governor, DeSantis made Florida one of the most crypto-friendly regions in the country.
It is unclear what Trump thinks about cryptocurrencies. He has spoken negatively about Bitcoin in the past, but also launched an NFT project last year. Notably, states such as Florida and Texas are largely supportive of the crypto industry.
Since cryptocurrency is seen as “anti-establishment,” we believe it fits Trump’s preferred campaign narrative. When we combine this with the fact that congressional Republicans tend to support crypto innovation, it is reasonable to predict that Trump will eventually align with the industry.
in conclusion
Cryptocurrency users are uniquely diverse and nonpartisan.
There aren't many political issues that cover both parties like this. As such, we think cryptocurrencies will present some interesting challenges and incentives for policymakers. As Charlie Munger likes to say: "Show me the incentives and I'll show you the results." Will politicians continue to be incentivized to scapegoat cryptocurrencies for some other agenda? It's hard to see that happening for at least a year. Rather, it is more likely to incentivize support for cryptocurrencies on both sides.
We see signs of it in public data, we see it in the drafting of new legislation.
As the Ripple and Coinbase case progresses, we'll have a chance to see how the court views the SEC's enforcement actions.
We'll have to wait and see, but the outlook may be brighter than the market expects.
