By Amy Castor and David Gerard
“A decent rule of thumb is that all cryptocurrency exchanges are doing crimes, and if you’re lucky your exchange is doing only process crimes.” — Matt Levine
Boom! After a year of warning them repeatedly, the SEC has finally taken action against Coinbase, the biggest US crypto exchange, for operating as an illegal securities exchange and selling unregistered securities. [Press release; Complaint, PDF]
In a 101-page complaint, filed in a Manhattan court on Tuesday, just one day after the SEC filed a suit against the Binance exchange — which we’ll be covering next time — the SEC says that Coinbase has operated illegally “since at least 2019” by:
- dealing in unregistered securities (at least 13 crypto tokens);
- running an exchange, a broker-dealer, and a clearinghouse as part of the same operation and without registering any of them. (See also the Bittrex complaint);
- offering staking services, which are also securities, without registering.
SEC wants Coinbase to be enjoined from doing any of this again, pay disgorgement and interest, pay a civil money penalty, and pay “equitable relief” to investors.
There are no surprises in the charges — and unlike the Binance lawsuit, no claims of fraud. Coinbase CEO Brian Armstrong was also not named in the complaint, unlike the Binance complaint where founder CZ was named.
The complaint outlines how Coinbase executives understood the laws governing the market and sale of securities in the US, even as they failed to abide by those laws.
None of this should come as a surprise. The SEC sent Coinbase a Wells notice in March, giving them a heads-up that an enforcement action was coming down the pipes.
The SEC warned crypto exchanges about offering illegal securities in its DAO report in July 2017.
Even a year before the DAO Report, Coinbase demonstrated it understood the Howey test when it began assessing tokens before listing them:
In or around December 2016, Coinbase released on its website a document entitled, “A Securities Law Framework for Blockchain Tokens.” This document included a section on “How to determine if a token is a security,” and explained: “The US Supreme Court case of SEC v Howey established the test for whether an arrangement involves an investment contract. An investment contract is a type of security.” This “Framework” acknowledged that “[f]or many blockchain tokens, the first two elements of the Howey test” — i.e., investment of money and common enterprise — “are likely to be met.”
Starting in 2019, Coinbase relied on its “Crypto Rating Council” (CRC) to determine if an asset was a security.
It turns out Coinbase offered some tokens even after their own internal report said they were very likely securities:
Meanwhile, between late 2019 and the end of 2020, Coinbase more than doubled the number of crypto assets available for trading on the Coinbase Platform, and it more than doubled that number again in 2021. During this period, Coinbase made available on the Coinbase Platform crypto assets with high “risk” scores under the CRC framework it had adopted. In other words, to realize exponential growth of the Coinbase Platform and boost its own trading profits, Coinbase made the strategic business decision to add crypto assets to the Coinbase Platform even where it recognized the crypto assets had the characteristics of securities.
Coinbase also contacted some token promoters to suggest they use less security-like phrasing in their documents — as if the SEC cares what you call your thing, and not how it works.
The complaint names 13 tokens on Coinbase as securities — Solana (SOL), Cardano (ADA), MATIC, Filecoin (FIL), Sandbox (SAND), Axie Infinity (AXS), Chiliz (CHZ), Dapper Labs FLOW, ICP, NEAR, Voyager Token (VGX), DASH, and Nexo’s in-house token NEXO.
(Oh no, not Axie infinity! That was our retirement!)
NEXO was not actually on the Coinbase Platform, only in the Coinbase Wallet, which trades via DEXes — but the SEC is still going after Coinbase as offering NEXO for trading. The first DEX the SEC busted was EtherDelta in November 2018, so it absolutely considers activity on DEXes within its ambit.
The complaint goes through each of the 13 tokens and spells out precisely why each qualifies as a security according to the Howey test.
The SEC notes that for Exchange Act purposes, it only needs to show that one of these tokens is a security. But it’ll show its working on all thirteen, just to bludgeon the point home.
In three cases — SOL, FIL, and FLOW — the tokens literally filed with the SEC as offerings of securities, but ones exempt from registration. So Coinbase may have some trouble now claiming those tokens aren’t any sort of security.
The SEC notes that it outlined why AMP, DerivaDAO (DDX), LCX, Omegle (OMG), Powerledger (POWR), Rally (RLY), and XYO were securities in previous actions. All of these tokens are or were listed on Coinbase.
Because Coinbase listed those tokens on its platform, which the SEC says are securities, Coinbase was required to register as an exchange, brokerage, and clearing agency — all businesses it was clearly operating — but just didn’t.
A stake through your heart
Staking as a service is incredibly obviously an investment contract — a security offering. In 2019, the SEC started looking into this.
The SEC worked with 10 state securities regulators who have said that Coinbase’s staking product is an unregistered security.
An unsettled SEC case can take months to go through — but several state regulators have issued immediate cease and desist orders. [Alabama press release, PDF; California press release, order, PDF; Illinois press release, notice of hearing, archive, PDF; Kentucky order, archive, PDF; Maryland order, PDF; New Jersey press release, order, PDF; South Carolina press release, order, PDF; Vermont show cause order, PDF; Washington press release; Wisconsin summary order, PDF; Bloomberg]
Alabama, Illinois, Vermont, and Washington are giving Coinbase a month to respond. California, Kentucky, Maryland, New Jersey, South Carolina, and Wisconsin have told Coinbase to cease and desist offering staking in their states immediately.
Most states are also fining Coinbase per violation — that is, per investor.
But the SEC allowed Coinbase to go public!
Crypto fans have been crying how unfair it is that the SEC is filing an action against Coinbase when they approved the S-1 for Coinbase’s public listing! The legal theory that Coinbase and its chief legal officer Paul Grewal are pushing is that approving the listing meant the SEC approved of Coinbase’s business.
This theory is obviously inane. That Coinbase seems to be leaning hard on this theory looks like desperation — that this is really the best they’ve got.
The SEC had warned Coinbase that approval of the registration statement did not mean the agency had approved the underlying business activity. The SEC says in the complaint:
Declaring effective a Form S-1 registration statement does not constitute an SEC or staff opinion on, or endorsement of, the legality of an issuer’s underlying business.
The SEC also points out that since going public in 2021, Coinbase has acknowledged in its S-1 and in subsequent filings the risk that cryptos it lists could be deemed securities.
According to the SEC:
Coinbase has elevated its interest in increasing its profits over investors’ interests, and over compliance with the law and the regulatory framework that governs the securities markets and was created to protect investors and the U.S. capital markets.
Coinbase remains extremely good friends with its early investor Andreessen Horowitz and still has two directors (Marc Andreessen and Katie Haun) from a16z on its board. Coinbase was also the exchange of choice for a16z Crypto to cash out their Web3 token dumps on retail investors. As well as Coinbase’s own venture arm’s token dumps.
The searing light of regulatory clarity
This is the beginning of the end for crypto in the US.
Every crypto exchange in the US has been operating illegally, and it was only a matter of time before the SEC would start shutting them down. They knew it was coming. The SEC sued Bittrex in April.
At best, Coinbase will try to reestablish itself overseas — but the writing is on the wall. Coinbase is the US dollar cashier’s desk for the broader crypto casino. Volumes are through the floor — Coinbase can’t make the money it needs to make from trading on bitcoin and ether alone.
Coinbase is relatively well-behaved for a crypto exchange — though it ran an entire fake market in Litecoin through 2018, for which the CFTC duly busted and fined it. But hey, it’s better than Binance, probably.
Grewal tells Bloomberg he’ll take the SEC fight to the Supreme Court if he has to! Of course, he would say that. As with the SEC suit against Ripple, this suit is existential for Coinbase. [Bloomberg]
Coinbase’s strategy all along has been to avoid regulation and hope it could lobby Congress to make special rules for it.
The new bill on crypto markets that House Republicans hope to put through would make it easier for exchanges like Coinbase to trade tokens that would previously have been unregistered penny stocks at best. [Bloomberg]
They might be lucky? But crypto equals fraud in the minds of the public these days, and hence in the minds of politicians.
In any case, Brian Armstrong of Coinbase reassures us that this complaint is good news. [Twitter]
Preston Byrne would like to point out that, as usual, he told you so. In 2014. [blog post]
Good news for Coinbase?
Coinbase’s writ of mandamus demanding that the SEC look into its proposed new rules for crypto is going a bit better than its attempts to dodge a suit. Judge Cheryl Ann Krause of the Third Circuit Court of Appeals has told the SEC to answer within seven days whether it’s denying Coinbase’s petition or not, if not then to tell her how much time the SEC needs to decide, and to give status reports on how the work is going. [Order, PDF; case docket]
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