Coinbase’s CEO, Brian Armstrong, shared a powerful insight with the FT, claiming that before proceeding with its lawsuit against the company, the Securities and Exchange Commission (SEC) asked the exchange to delist every token except for Bitcoin because it maintained they were securities.
Such a broad and disruptive move would have essentially crippled the exchange’s operations, and the broader U.S. crypto industry as well. Armstrong said that this move made it an easy choice to fight the regulator in the courts, as it’s difficult to imagine worse punishments as a result of a full trial.
The episode highlights a growing frustration with the SEC by the crypto industry at large, as well as a number of Congressmen who are working on a bespoke crypto asset legal framework.
The question of what, if any, crypto assets are securities remains controversial, and its resolution could be a watershed moment for both the U.S. and the global crypto industry.
Both the SEC and the legal concept of a security came off the heels of the Great Depression. The Securities and Exchange Act of 1934 was born to regulate stock market activity and prevent some of the financial excesses of the 1929 bubble. At the time, stock markets were somewhat of a Wild West. For example, we saw billions of dollars of “investment trusts,” a holding company for making investments, trading at significant premiums over their true asset value. Goldman Sachs was one of the most notorious operators of such trusts.
In 1934, the SEC was born to regulate how “securities” could be offered, sold and traded. For example, it introduced strict disclosure requirements for companies wishing to offer their own stock for trading, requiring accurate and detailed balance sheets, disclosures of conflicts of interest, business risks and many more items — Coinbase’s S-1 filing is about 300 pages long.
Over the years, the regulations also focused on the platforms selling the securities, and generally, only registered “broker-dealers” can offer securities trading to the general public. This is particularly relevant for Coinbase, as the SEC’s argument boils down to the alleged fact that it offered securities trading without going for the appropriate registration path.
Broker-dealer regulations provide a lot of meaningful protection to customers, including requirements such as full capitalization, insurance and separation of custody. However, many of the requirements were designed for traditional stocks and other financial assets and are difficult to apply to crypto literally.
Hence, the most important legal battlefield in the Coinbase vs. SEC lawsuit is whether the assets it lists are securities. Here, some precedent exists, with the Howey test being the most famous.
In its lawsuit, the SEC chose to focus on “13 mostly lightly traded cryptocurrencies” per the FT, which it alleges are securities. Notably, Coinbase has listed over 200 assets, and the SEC’s alleged request to delist all but one of them falls quite a bit further than the ultimate scope of the lawsuit. Presumably, the regulator chose to focus on the “lowest-hanging fruit” that it felt could be reasonably argued to be a security.
Coinbase’s choice to fight the SEC head-on will have important ramifications for the industry. If the SEC were to secure a meaningful victory, this would establish solid legal precedent and all but cripple the U.S. crypto industry. Current regulations would force a stocks-like framework on cryptocurrencies, nullifying many of the benefits of the global, distributed technology.
Crypto firms in the U.S. would most likely flee the country or be forced to shut down, moving the entire industry off-shore. Coinbase has already been making backup plans for this eventuality, eyeing Dubai as an international hub.
A victory by Coinbase would instead give much-needed regulatory clarity on what is allowed and what isn’t when working with crypto assets in the U.S.
At the same time, the issue is highlighting a deeper philosophical debate: Do securities laws need to be updated for modern realities, and if so, how? Many of the registration requirements would be deeply beneficial for users, preventing collapses like FTX, BlockFi, Celsius and others.
But as of right now, the SEC seems to be trying to fit a square peg into a round hole — and while trying to bash its way in, the hole still remains open.
Nikolai Kuznetsov is a financial analyst and professional trader.
(Opinions expressed in this article are the author’s own.)
