Coinbase defends listing process despite SEC pressure

Coinbase defends listing process despite SEC pressure

Coinbase has a problem. US regulators are reportedly investigating whether it masquerades as an unregistered securities exchange and allows trading in digital assets that fall under the jurisdiction of the SEC.

The investigation was first reported as the SEC disclosed insider trading allegations against former Coinbase product manager Ishan Wahi and two others involving at least 25 digital assets.

The SEC believes that at least nine of these cryptocurrencies are securities. Securities issuers, just like publicly traded companies, must file financial statements and other disclosures to provide transparency to support informed investment decisions.

A week after news of Wahi's indictment broke, Bloomberg reported details of an open SEC investigation into Coinbase that predated the insider trading case. Coinbase shares fell the next day.

Coinbase wants to list every possible token

According to Bloomberg, the SEC increased its scrutiny of Coinbase after the platform began expanding the range of digital assets available to traders in the US.

In January last year, Coinbase “opened the door” to token issuers through its then-new “Asset Hub,” effectively a form that startups can fill out in the hopes of getting their digital assets listed on Coinbase.

Coinbase has detailed its listing criteria, which range from whether the asset is considered an investment or has expectations of profit, to centralization concerns regarding control over the protocol or user funds, to overall code quality.

Brian Armstrong, Coinbase's billionaire CEO, later tweeted that Coinbase's goal is to "list every asset where it is legal to do so," but warned that markets should not view the listings as Coinbase's endorsement of that asset - aside from meeting its minimum standards.

The listing framework reflects the “ Howey test,” a four-part quiz that U.S. regulators rely on to decide whether an asset is an investment contract and therefore should be regulated as a security.

“Sufficiently decentralized” was not part of the Howey test

The SEC has explicitly confirmed its stance on only one digital asset: Bitcoin, which the watchdog says is a commodity.

In 2019, former chairman Jay Clayton noted this ether may have once been a security, but has since evolved into something else. Current Chairman Gary Gensler muddy waters in January by not listing Ether alongside Bitcoin as a non-security digital asset.

Dario de Martino, a partner at law firm Allen & Overy, told Blockworks in an email that SEC staff had emphasized the importance of decentralization in deciding whether a token should be regulated as a security. “However, no helpful guidance has been offered to define or achieve ‘sufficient decentralization,’ leaving market participants puzzled,” de Martino said.

Coinbase, like countless other cryptocurrency companies over the past half-decade, has still complained about a lack of regulatory clarity when it comes to digital asset securities, despite the SEC's lengthy 2019 paper explained his methods.

Coinbase Chief Legal Officer Paul Grewal claimed in a Blog entry Last week, the SEC reviewed its internal framework for deciding which tokens to list, part of which determines whether those assets could be considered securities. "Coinbase does not list securities on its platform. Period," Grewal wrote.

Cat and mouse games with word games

According to Preston Byrne, partner at New York law firm Anderson Kill, Coinbase made a business decision to gain maximum market share by listing as many tokens as possible in the United States.

More than 150 cryptocurrencies are available to US traders. So when Coinbase says it doesn't list securities on its platform, it may simply be playing with its language, Byrne said.

"A token is not a security. It is an investment contract that is regulated by the Securities Act just like securities," Byrne explained.

“In my professional opinion, there is a very strong possibility that a lot of things on Coinbase are investment contracts,” he added.

According to Byrne, the conundrum for Coinbase is how deliberately blind the regulator can keep the exchange to the reality of the assets it sells.

“Because regulators have not explicitly said that most things on their platform are securities, Coinbase operates on the basis that they are not until they are told otherwise,” Byrne said.

This game of cat and mouse took place in December 2020 when the SEC sued Ripple Labs and its top executives about their XRP token. Coinbase almost immediately delisted XRP in response to the case.

Coinbase also pulled the plug on its interest-bearing crypto account product last year - which would have promised customers a 4% return on USDC deposits - after the SEC threatened a lawsuit and after crypto lender BlockFi had its own similar product questioned by regulators.

The Howey test is still “mushy” when it comes to classifying investment contracts, Byrne said, regardless of whether the associated assets are on the blockchain or not.

“There is no agency in the United States charged with putting every investment contract through this mushy test and reaching a legally final conclusion that everyone else can rely on,” Byrne said.

Instead, law enforcement agencies like the SEC have placed this obligation on token issuers and their attorneys - gatekeepers to the public markets by not making false or stupid opinions, and issuers are expected to obey the law and follow counsel's advice, Byrne argued.

Coinbase, in its current form, has an overarching legal responsibility: not to operate as an unregistered securities exchange. “That means if they are reckless or negligent or intend to trade securities on their platform, they could have a problem,” Byrne said.

In an emailed statement to Blockworks, a Coinbase spokesperson said it initiated its “robust review process” because it believes existing securities regulations are not working for digital asset securities.

"The rules governing securities markets were developed decades before the advent of crypto. When these authors wrote rules to regulate square pegs, they did not consider how those rules would impact the unpredictable round holes of the future," they said.

Despite Coinbase's stated confidence in its process, the effort to list the maximum possible number of tokens has led to conflicts with the SEC. In a race for market share, Coinbase's ambition may have just returned.

Attend DAS, the industry's most popular institutional crypto conference. Use code NYC250 to get $250 off tickets (available this week only).

The post Coinbase Defends Listing Process,Despite SEC Pressure is not financial advice.