Nasdaq-listed cryptocurrency exchange Coinbase’s troubles have been growing for some time as its stock price followed earnings off a cliff in Q1, a massive round of layoffs hit, and the Securities and Exchange Commission (SEC) on Tuesday (July 26) leaked that it’s the target of a precedent-setting unregistered securities sale enforcement action.
If the agency wins, crypto payments could face long-term collateral damage.
See also: Why a Senate Bill’s $50 Tax Exemption Won’t Boost Crypto Spending
In the meantime, the revelation led one of Coinbase CEO Brian Armstrong’s biggest and most prominent Wall Street boosters, Ark Invest’s Cathie Wood, to bail out, dumping 1.41 million shares worth about $75 million on Tuesday, July 27 — just after COIN shares sank another 20% after news of the SEC investigation hit.
An investor of Cathie Wood’s prominence selling just as her holdings lost a fifth of their already-damaged value is bad enough. But the move came just three months after she doubled down on Coinbase, buying almost 550,000 shares worth about $29 million on May 11 — just a week after the one-two punch of a dismal first-quarter earnings report and the $48 billion Terra/LUNA stablecoin’s collapse knocked 50% off the exchange’s stock price.
It appears that Wood has finally come around to a position that much of Wall Street reached in the past eight months: Coinbase’s troubles aren’t ending anytime soon.
Coinbase Global Inc. is currently down about 85% since its November all-time high of $368.90 at the height of the crypto bull market. Call it a slight course correction — and not nearly as dramatic as the one facing the entire crypto industry as the iceberg that is SEC Chairman Gary Gensler’s reportedly forthcoming lawsuit against Coinbase looms ahead.
And if you’re looking at crypto payments using anything but bitcoin or stablecoins, that case — revealed by Bloomberg on Monday (July 25) — is something to keep a close eye on. That’s because if cryptocurrencies are securities, using them for day-to-day payments becomes so costly and complex as to be infeasible. Even buying a Coke with crypto would be subject to a capital gains tax of up to 20% — and all the headaches that figuring out capital gains involves.
Danger Ahead
The case the SEC reportedly plans to bring against Coinbase is effectively an attempt to set an industrywide precedent, something the commission has been trying to do long before Gensler took over as chairman.
The enforcement agency has stepped up that fight as the crypto market collapsed this year, and as Congress and the Biden administration move to create a broad regulatory framework for cryptocurrencies, edging toward defining them as commodities under the purview of the Commodity Futures Trading Commission (CFTC) rather than the SEC.
The industry has been lobbying hard for that, claiming SEC control will stifle innovation while touting crypto’s utility as a payments currency. Lately, that argument has been picking up support on Capitol Hill.
Read more: Bipartisan Bill to Give CFTC More Power Over Crypto at SEC’s Expense
While the SEC gotten a number of settlements — with very big fines — over the years when alleging that firms are illegally selling unlicensed securities, it hasn’t seen anything solidified into case law yet. It may be getting close to some sort of clarity with an ongoing lawsuit against cross-border payments firm Ripple.
See here: Ripple Lawyer Critical of SEC Push to Regulate Crypto
What the SEC has had is a great deal of criticism from the crypto industry, one of its own commissioners, Hester Peirce and, lately, Congress, who argue that the commission is trying to regulate by litigation rather than setting clear rules defining what determines if a cryptocurrency is or is not a security.
You may like: With Growing Support in Congress, SEC Commissioner Criticizes Expansion of Crypto Enforcement
Coinbase has been one of the SEC’s loudest critics in this regard, repeatedly demanding that it lay out clearly its definition of crypto as a security.
More like this: Coinbase’s SEC Petition Opens New Can of Crypto Regulation Worms
So, the SEC has a lot on the line with this case. If Coinbase either bends or loses, the argument that these tokens are securities becomes a lot stronger, and the SEC is in a much stronger position to force Coinbase — and then other cryptocurrency exchanges — to do something it has been pushing them to do for some time now: register as National Securities Exchanges under the SEC’s authority.
It’s worth noting that Gensler isn’t just on a power grab here. A former CFTC chairman, he taught crypto and blockchain at MIT for several years before taking over the SEC. He is intimately familiar with the ins and outs of the technology and both the reasons and ways it is traded — as well as the many ways the trading market can still be manipulated.
Also read: SEC Chair Emphasizes Investor Protection in Crypto Regulation
But why Coinbase? They’ve always been one of the best-run exchanges that worked hardest to get on regulators’ good side. Doing so arguably did get them a pass in the recent crypto lending offensive by the SEC — offering interest for crypto deposits to be lent out, which the agency said was also a type of security sale — when they were warned off before competing lender BlockFi was forced into a $100 million settlement fine.
One reasonable answer is they’re the highest profile exchange, thanks to that Nasdaq listing, and the SEC has a history for setting examples to get others into line.
More here: SEC’s Campaign Against Crypto Lending Grows Beyond Coinbase
The Foot in the Door
All this brings up the reason news of the Coinbase lawsuit broke this week.
On Thursday (July 21), the Department of Justice indicted a Coinbase manager and two associates for alleged insider trading that netted them more than $1.1 million based on knowledge of forthcoming announcements by Coinbase that it would list a new token — something that has for years led to a price spike, known as the “Coinbase Effect.”
While Coinbase isn’t getting any real blame for alleged criminal behavior of an employee, the charges — and especially the concurrent lawsuit the SEC has filed against the trio — require a finding that the tokens in question were, in fact, securities. And the Bloomberg report said the SEC had been preparing the case against Coinbase for some time.
“We are not concerned with labels, but rather the economic realities of an offering,” said Gurbir Grewal, the SEC’s Division of Enforcement’s new director, in an announcement of the suit. “In this case, those realities affirm that a number of the crypto assets at issue were securities, and, as alleged, the defendants engaged in typical insider trading ahead of their listing on Coinbase. Rest assured, we’ll continue to ensure a level playing field for investors, regardless of the label placed on the securities involved.”
To this, Coinbase Chief Legal Officer Paul Grewal said the company is confident that its “rigorous diligence process — a process the SEC has already reviewed — keeps securities off our platform, and we look forward to engaging with the SEC on the matter.”
I’m happy to say it again and again: we are confident that our rigorous diligence process—a process the SEC has already reviewed—keeps securities off our platform, and we look forward to engaging with the SEC on the matter. A refresher: https://t.co/SaacvrZEiU
— paulgrewal.eth (@iampaulgrewal) July 26, 2022
He added: “Coinbase does not list securities. End of story.”
And for all the criticism of the SEC by Coinbase and the rest of the crypto industry, the actual lawsuit makes the commission’s argument about why a token is or isn’t a security argument pretty clear. The regulator spends more than 20 pages explaining in detail why each of the nine cryptocurrencies at issue meet the definition of a security under the U.S. Supreme Court’s four-part Howey Test for determining whether a transaction qualifies as an investment — an investment of money, in a common enterprise, with the expectation of profit derived from the efforts of others.
Nor is it the first time that agency has made its reasoning in calling these tokens securities. Several legal experts have noted over the years that the SEC has been very clear, but it just wasn’t the answer the crypto industry wanted to hear.
If the SEC can win this case, it might overcome its handicap against the CFTC. Everybody in regulatory positions — including the members of the House and Senate writing the rules, and the agencies like the Treasury Department that are proposing them — has said some version of a token can be both a security and a commodity.
So from Gensler’s perspective, if he can get a firm ruling — backed by a criminal case in this instance — that cryptocurrency other than bitcoin are securities, it won’t matter if digital assets are defined as commodities. As he, CFTC Chairman Rostin Behnam, and more than a few members of Congress have noted, something can be both a commodity and a security.
More news: SEC Chair: All Agencies Regulating Crypto Should Follow ‘One Rulebook’
That could explain why Wood has chosen now to start backing away from Coinbase.
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