I spent a lot of years living in Southern California where, near the coastline, the weather is darn near perfect, averaging in the 70s for much of the year. That’s not to say it didn’t get hot or cold, but with not-so-extreme coastline extremes that tend to be between 42 and 98 degrees (for brief periods), it was almost never too hot or too cold. Even so, there was often a surprise for summer vacationers arriving in June as they often found overcast beaches, a weather pattern impacted by the marine layer resulting in what was colloquially known as “June Gloom”. June Gloom was the opposite of beach weather – colder temps and a lack of that famed California sun. Fortunately, even with June Gloom, the sun would work its way free in the afternoon, opening the doors for a half day frenzy at the beaches.
In the crypto markets I think it’s safe to say we had our own June Gloom, what with the SEC quite ceremoniously filing suits against Binance and Coinbase, albeit with very different charges. It seems also that, Just as the California sun penetrates that gloomy marine layer, so too have the markets have rallied through this bit of gloom. What’s the takeaway?
Simply put, I (and I think the markets) are excited and – dare I say it – I’m glad that Coinbase is getting sued. Let me explain.
Sniper Fire
The SEC for years has been like a hit man, purchased on a rooftop looking for crypto ventures to go after. Embroiled in a case against Ripple, which seemed a sure victory and now which looks like a coin flip, they have picked various targets and gone after them. Now, to be fair, there certainly have been legitimate targets – projects and exchanges and companies – that have flouted securities laws. I’m not arguing against enforcement; it should be taken to protect the American consumer. I think that appropriate regulation is, well, appropriate.
The Coinbase case does not fall into that bucket. Coinbase is being sued for operating an unregulated securities exchange and selling unregistered securities. The SEC has named a number of tokens that Coinbase has offered stating they are securities. Let’s pause for a moment here and note that the SEC has made the same claims against Binance, however its case is very different as it includes additional charges of commingling customer funds, inadequate money laundering controls and a host of others which basically amount to charges of fraud. It also doesn’t help that the Binance’s Chief Commercial Officer texted another in the company with the comment: “We are operating as a fking unlicensed securities exchange in the USA bro.” Not good Binance. Not good.
Coinbase is a different animal entirely. From the very beginning Coinbase has been doing it’s very best to be a good actor, to be compliant with US laws and to ultimately provide a solid and safe choice for customers. Their position is that they are not selling securities, so they are not an unregulated exchange.
Wells, Wells, Wells
The suit isn’t a surprise. Coinbase received a Wells notice in March. Simply put, Wells notice is from the SEC saying “you’re doing bad stuff so you better pay a fine and get in line or we’re going to sue you.” Most companies just pay the notices when they get them because, look, who wants to fight the SEC. Not many. But let’s dive a little deeper into the backstory.
Coinbase went public on April 14, 2021, which required an intense amount of scrutiny including scrutiny from… the SEC. 2021 was the fervor of the last Bull run and Coinbase’s business hasn’t ostensibly changed. Wouldn’t this have been an issue that materialized then? I’ll let that rhetorical just sit there.
Then, after an investigation last summer, Coinbase and the SEC were in dialog about registering a part of the business if it was required to do so. I quote Paul Grewal, Coinbase’s legal counsel, from his March 22 statement:
“…the SEC asked us if we would be interested in discussing a potential resolution that would include registering some portion of our business with the SEC. We said absolutely yes. Specifically, the SEC asked us to provide our views on what a registration path for Coinbase could look like – because there is no existing way for a crypto exchange to register. We developed and proposed two different registration models. We spent millions of dollars on legal support to build these proposals and repeatedly asked for the SEC’s feedback. We got none. We also reiterated that we stand by our listings process – we don’t list securities today – and repeatedly invited the SEC to raise any questions about any asset at all on our platform. They raised none.
Coinbase went on to meet with the SEC over 30 times in a nine-month period, requesting feedback on possibilities of how to register, and the SEC agreed to provide feedback in January 2023 – yet the day before the meeting the SEC cancelled the meeting and said “Nah, we’re going to just go back to enforcement.”
So let’s unpack this. We have a company that has been attempting to work with the SEC, taking meetings, asking for guidance and clarity, proposing solutions and the SEC just said “Nope”, then took it’s toys, went home and filed an action. This doesn’t seem cricket.
Insecurities
So what about the accusation of securities? Well, let’s begin with the supposition that many crypto assets probably are securities. The Howey test is designed to determine if something is an investment contract. Paraphrased, it says if you sell something for money (an offering, like a stock) and that something is sold with the expectation it will increase in value via group efforts (like growing a company), then that something is a security. We agree that there are a lot of nonsense projects out there that are simply trying to raise money via sale of a token where that token has no other purpose. That’s a security. We agree.
This does not mean all tokens are securities. Some provide voting rights. Some provide access to technology. Some are designed for digital exchange. And many sound projects have not sold them as an offering, they have created them as a part of the project. Simply stated, just because a liquid asset exists and can be exchanged does not mean that they were sold in an offering with the expectation of price appreciation. Coinbase has a very rigorous process of evaluating assets to determine if they would be considered a security, rejecting over 90% of them. This process was disclosed to the SEC when Coinbase went public.
The challenge here is we have a new kind of asset, so we need new kinds of rules. Regulators can’t really agree on whether or not crypto assets are in general commodities, securities or maybe something else entirely. The truth is sometimes they are a commodity, sometimes a security, sometimes both and sometimes neither. I would expect that clarity on this would be paramount before any enforcement action is made. (For those that want more color on this Jake and I discuss this in detail in our award winning book, Crypto Decrypted)
Anyway, back to the plot. In an effort to be a good actor, Coinbase in 2022 petitioned the SEC for clarity so they could follow the law. The SEC refused to respond, and in April this year Coinbase asked the courts to step in and get the regulator to reply, basically because the existing rules are not properly suited for digital assets.
What we see here is, Coinbase has been in dialog, has been trying to do the right thing, worked with the SEC and has asked for clarity every step of the way. They have been basically stonewalled, met with silence and are now getting sued. This case is very defensible, and I find the SEC unwillingness to work with Coinbase reprehensible.
On another note, of the coins that the SEC claims are securities, such as Solana and Polygon, they have not taken any action against the actual projects. It seems to me that, if these were securities then the action is to file against the projects directly as they did against Ripple and so many others. They haven’t. Apparently, they just want Coinbase.
Why is this Good?
I’m happy about this whole thing because now we have a stand-up fight. For years, the SEC has taken some actions, enforced, weighed (Ethereum is not a security), changed its mind on (Oops. Just kidding. We’re not sure about Ethereum but I’m not saying either way) and have basically tried to bully enterprises into compliance amidst an obfuscated set of standards and no actual clarity. Now, we have clarity. Lines are drawn and regardless of the outcome, it’s going to be great for the industry. Up until this suit we’ve had claims and vagueness and veiled threats. The SEC wants to control the world of crypto and they state (just about) every crypto asset is a security, and they are willing to fight for it. I think this shows a blatant lack of understanding of what blockchain and crypto assets really are.
As it turns out, the fate of innovation in America may be the very thing that is at stake. If Coinbase wins this case, and CEO Brian Armstrong feels very certain that their position as outlined above is defensible, then it will blaze the trail for blockchain innovation and crypto adoption to occur in America.
If not, then the likely outcome is that this innovation will simply go overseas. In fact, Coinbase has already opened up a business in Bermuda, preparing for this in the (I believe unlikely) event that they lose. Likewise Gemini, one of Coinbase’s competitors, has applied for a License in Dubai. Even large funds are preparing for the worst, as seem by Marc Andresen’s a16z is opening a London office. The fight here is for the fate of crypto in the US.
What is often overlooked by so many is that there are regulatory friendly environments around the world, including Hong Kong, Dubai, Singapore, Japan and even Europe. Unlike the rise of the Internet, which was US founded and a US led expansion, the United States is currently a player in the blockchain space – not the defacto leader. Whether we remain a player, a leader or a bystander may very well be determined by this case.
No matter which side loses, however, the crypto & blockchain community worldwide will win. If the SEC triumphs and innovation moves overseas then we have a great, big, beautiful world where this technology can thrive. It will just be at the cost of America’s position. If, however, Coinbase wins, then I see the US, already a leader in hash rate (bitcoin mining), cementing its position as a regulatory friendly environment and taking a strong leadership position. I would think this would be in the best interest of the USA. Whichever happens, the clarity will create the path for the next step, certainly.
In Closing
I want to be abundantly clear. I am a US Citizen. I love my country. I want us to take a leadership role in this new frontier. I want us to embrace this technology. I want us to thrive.
Unfortunately, the actions of the SEC have not forwarded that agenda, and now it is down to the outcome of a long, drawn-out SEC v. Coinbase suit that will yield clarity. It’s really too bad, because the SEC, with a little bit of guidance, prudence and wisdom, could have put this to bed long ago. They could have l had their cake and eaten it by adopting clear guidelines and fostering innovation while at the same time going after true bad actors and securities in the space.
Anyway, as I said, I’m glad we’re here. The reason we have a judicial branch is to resolve conflict such as this, and I do have confidence that in this case, justice will serve us quite well.
That’s it for now! Until next time be well, stay safe, and I’ll keep Decrypting Crypto for you!
James
Disclaimer: Not investment advice. This information should not be construed as a recommendation, investment or tax advice, or an offer or solicitation to buy or sell any security.