Coinbase Fights the SEC (Nobody Wins)

Exploring the transformation of value in the digital age

By Michael J. Casey, Chief Content Officer

Sept. 10, 2021

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Another week, another clash between regulators and the cryptocurrency community, this time with the most high profile company in the space: Coinbase. This week's newsletter dissects the news that the U.S. Securities and Exchange Commission had threatened to sue the company over its proposed crypto lending program, Lend, and in doing so had demanded information on clients that had inquired about it. This is not how regulation should be done.

Keeping with the theme, our podcast was lucky to have another Washington insider as its guest for the second of a two-episode dive into the regulatory climate in Washington. Sheila Warren and I get the lowdown from Rep. Tom Emmer (R-Minn.), who among other roles is the co-chair of the Congressional Blockchain Caucus.

Have a listen after reading the newsletter.

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Coinbase v SEC: Why Crypto Regulation Needs Fixing

Melody Wang/CoinDesk

After Coinbase complained Wednesday about the Securities and Exchange Commission's threat to sue the crypto exchange company over its proposed stablecoin lending program, known as Lend, the Crypto Twitter lawyer community rose up, almost in unison, with a predictable refrain.

In essence: "This is clearly an unregistered security. You don't understand the law. Be quiet."

I'm starting to believe that, with the exception of a few crypto lawyers – see the newsletter's "Conversation" section for examples – the legal profession, with its revolving door relationship with regulators, is the problem here. Because while a letter-of-the-law reading of the Howey Test says enabling USDC holders to generate interest constitutes a security offering, it misses the point. And by point, I mean that enforcing outdated laws is counter to the public interest.

The Coinbase-SEC spat is a good example of why our financial regulatory system needs fixing.

It's hard not to conclude that the existing suite of financial laws – laws that a divided, dysfunctional Congress seems unable to update for 21st century technological realities – serve only to protect the interests of Wall Street and wealthy investors, at the cost of the general public.

Worse, this stasis leads to a default position on macro and monetary policy that perpetuates the low-interest rate environment and deepens that divide.

Frustration is justified

Could Coinbase CEO Brian Armstrong, who accused the SEC of "sketchy behavior" been a little more diplomatic? Perhaps. It's not how most public companies address their regulator.

But there's justification in the crypto community's frequent frustration over a lack of clear guidance from the agency – along with that of SEC Commissioner Hester Peirce, who shared similar sentiments with me on CoinDesk TV's "All About Bitcoin" show last week. There are real innovative opportunities within crypto to provide valuable, safe, useful products to savers, if only policymakers would devise an appropriate regulatory framework.

This is not to say there shouldn't be rigorous regulation of centralized custodial entities such as Coinbase, which have fiduciary duties to their customers in ways that fully decentralized crypto projects do not. But using the blunt instrument of securities laws is counterproductive, especially when the crypto industry has tools for storing and trading assets that offer greater security and transparency than the heavily intermediated financial system for which those laws are mostly designed.

What we need is a visionary legislative overhaul. And for that we need Congress to recognize that crypto technology is inherently transformative and that, with the power of permissionless, open-source innovation, has the potential not only to spur economic growth and support U.S. technological leadership but – if, and only if, it is implemented and regulated properly – can foster financial inclusion and address economic imbalances.

Continue reading this column here.

–Michael J. Casey

Off the Charts

Futures Driving Spot

When the bitcoin price plunged 10% on Tuesday, it coincided with the launch of El Salvador's bitcoin project, prompting a variety of conspiracy theories. Some commentators said the price action looked manipulated. We'll probably never know whether that was the case but thanks to some fine analysis by Will Clemente of Blockware Intelligence, we have a good picture of what type of investor drove the sell-off. It was all about the leveraged futures positions.

The chart above, which Clemente shared in the Blockware Solutions Market Intelligence newsletter, shows a giant liquidation of long positions in bitcoin held by investors in the futures market. When accompanied by other charts that Clemente provided, including various measures of leverage in the market, it appears that investors were heavy on margins and needed to liquidate to cover their positions once the price began to fall.

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The Conversation

Not Helpful

Illustration: Rachel Sun/CoinDesk

Continuing with the lawyer theme that began this newsletter, let's start with this section with a tweet from Georgetown law professor Adam Levitin about the Coinbase blog post and its author, Paul Grewal, the company's chief legal officer, whose pre-Coinbase career includes a stint as a federal magistrate.

The point Levitin was making, laid out in the rest of his thread and other tweets, was essentially that Grewel's argument that Coinbase's offering wasn't a security was specious, that Lend had all characteristics that met the test and that saying otherwise was unhelpful. But like so much Twitter, it quickly got personal, as Jake Chervinsky, general counsel for decentralized finance service Compound, took issue, "with all due respect" with Levitin's attack on Grewel.

The pair volleyed a few more tweets at each other and then Levitin took a choice of words to describe Chervinsky that hit deep.

For any serious, liberal-minded person in this industry, to be labeled a "crypto bro" is harsh, almost the ultimate ad hominem attack. By now it was personal.

The fight went on and on, with Levitin later laying down a separate 13-tweet mansplainer thread on why Coinbase's Lend is a security. As I said, he's probably right but also misses the point.

So, to end this section, let's do as promised in the column and find a lawyer who can deal with both sides of the issue. Here, Andersen Kill's Preston Byrne, someone I don't always agree with, nails it: Yes, it's the law, but the law is crap.

Relevant Reads

El Salvador's Big Bitcoin Day

El Salvador made history on Tuesday when a law making bitcoin legal tender went into effect, the first of its kind in the world. It wasn't the perfect start as the price of bitcoin happened to plunge that day – after, not before, President Nayib Bukele had tweeted out news that his government had purchased 400 BTC. But as Bradley Keoun reported, Bukele was undeterred as he treated the sell-off as an opportunity to buy more.

While there were certainly hiccups with the launch, including problems with the government-sponsored bitcoin app, crypto companies are finding the opportunity that El Salvador poses hard to resist. Ian Allison reported that crypto payments provider Flexa is now building a Lightning-based service in the country.

For many, El Salvador is a less-than-perfect poster child for bitcoin, as there are allegations of autocracy against Bukele's government, with protests and public opinion suggesting the legal tender move was made without widespread popular support. When a prominent critic of the law was arrested, it didn't help that image. As Andres Engler reported, Mario Gomez was later released. But it wasn't a good look.

Still, as OpEd contributor Edan Yago noted, the government doesn't have much of a reputational risk because it is already something of a pariah in international circles, making its bold bitcoin experiment an asymmetric bet. If it works, and the country achieves the kind of monetary self-determination that so many emerging market nations crave, he argued, the payoff could be an inspiration for others.