Despite SEC pressure, Coinbase defends its listing process

Something is wrong with Coinbase. It seems that US officials are looking into whether or not it is operating as an unregistered securities exchange and letting people trade digital assets that are regulated by the SEC.

The investigation began when the SEC charged Ishan Wahi, a former Coinbase product manager, and two other people with trading on inside information about at least 25 digital assets.

At least nine of the cryptocurrencies are securities, says the SEC. Securities issuers, like public companies, have to give out financial statements and other information so that investors can make smart investment decisions.

A week after Wahi’s charges were made public, Bloomberg reported that the SEC was already looking into Coinbase before the insider trading case. The next day, Coinbase’s shares fell by a lot.

Coinbase wants to list all possible tokens.

Bloomberg says that the SEC started keeping a closer eye on Coinbase when the platform started giving US-based dealers access to a wider range of digital assets.

Coinbase “opened the door” to token issuers when it launched its “Asset Hub” in January of last year. The “Asset Hub” is basically a form that entrepreneurs can fill out if they want Coinbase to list their digital assets.

Coinbase has explained its listing criteria, which include whether or not the asset is seen as an investment or if there is an expectation of a profit, whether or not there are concerns about centralization in terms of control over the protocol or user money, and the general quality of the code.

Brian Armstrong, the CEO of Coinbase and a millionaire, later tweeted that the company’s goal is to list “any asset where it is legal to do so,” but that the market shouldn’t think that listing an asset means that Coinbase supports it if it doesn’t meet its basic requirements.

The listing method is similar to the “Howey Test,” a four-part test that US regulators use to decide if an asset is an investment contract and should be regulated as a security.

The phrase “sufficiently decentralized” is not a part of the Howey Test.

The SEC has only said what it thinks about one digital asset, bitcoin, which it calls a commodity.

In 2019, Jay Clayton, who used to be chair, said that ether used to be a security but has changed into something else. In January, the current head, Gary Gensler, made things more complicated by forgetting to include ether as a non-security digital asset along with bitcoin.

In an email to Blockworks, Dario de Martino, a partner at the law firm Allen & Overy, said that SEC officials had stressed the importance of decentralization when deciding if a token could be regulated as a security. “However, no good advice has been given on how to define or reach “sufficient decentralization,” which has left market players confused,” de Martino said.

Even though the SEC released a long document in 2019 that explains how it works, Coinbase and many other cryptocurrency businesses have continued to complain that there isn’t enough regulatory clarity when it comes to digital asset securities.

In a blog post this week, Paul Grewal, the chief legal officer of Coinbase, said that the SEC looked at its internal system for deciding which tokens to list, which includes a part that decides if these assets might be considered securities. “Coinbase does not list securities on its platform.” Grewal penned, “Period.”

Wordplay-based games of cat-and-mouse

Partner at the New York law firm Anderson Kill Preston Byrne says that Coinbase made a business decision to try to get the most market share by listing as many coins as possible in the United States.

US traders can buy and sell more than 150 cryptocurrencies, so Byrne thinks that when Coinbase says it doesn’t list any securities on its platform, it’s just playing with words.

“A token is not a way to keep things safe”

“It’s an investment contract, and like securities, it’s governed by the Securities Act,” Byrne said.

“From a business point of view, I think it’s likely that a lot of the things on Coinbase are investment contracts,” he said.

Byrne says that Coinbase’s problem is that the regulator is willing to let the exchange stay willfully ignorant of the truth about the assets it sells.

“Because regulators have not affirmatively said that most of the things on their platform are securities, Coinbase is operating on the basis that they’re not until they’re told otherwise,” Byrne said.

This game of cat and mouse ended in December 2020, when the SEC sued Ripple Labs and its top executives over its XRP coin. In response to the lawsuit, Coinbase took XRP off its site almost right away.

Last year, Coinbase stopped offering interest-bearing crypto accounts, which would have given customers a 4% return on USDC deposits. This was done after the SEC threatened to sue and after authorities questioned a similar product from crypto lender BlockFi.

Byrne said, “There is no agency in the United States tasked with running every investment contract through that mushy test and giving a legally definitive conclusion which everyone else can rely on.”

Instead, law enforcers like the SEC have given this job to token issuers and their lawyers. These people are now the gatekeepers of public markets by not giving false or stupid information. According to Byrne, token issuers are required to follow the law and their lawyers’ advice.

In its current form, Coinbase has one major legal obligation: it can’t act as an unregistered securities exchange. Byrne said,“Which means that if they are reckless or negligent or intend for securities to be traded on their platform, they might have a problem on their hands.”

In an email to Blockworks, a spokeswoman for Coinbase said that the company has a “strong review process” because it doesn’t think that current securities rules apply to digital asset securities.

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

Even though Coinbase says it is confident in its processes, the company’s desire to list as many tokens as possible has put it in conflict with the SEC. Coinbase’s desire to be the market leader may have just come back to haunt them.