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Some crypto exchange bosses looked on with horror last week as Coinbase’s chief executive decided to accuse the Securities and Exchange Commission of “sketchy behaviour”. Others, however, applauded.
The Twitter salvo by Coinbase boss Brian Armstrong reflected rising anger among crypto entrepreneurs who argue regulators are holding back innovation, and have been too slow to offer clear rules for the nascent digital assets industry.
“Coinbase is fighting the good fight. If they lose . . . the SEC will get even more aggressive. They will draw the lines way into crypto territory,” said Alex Mashinsky, chief executive of crypto lending platform Celsius Network.
Tensions had escalated when Coinbase disclosed that the SEC had threatened to sue the exchange if it launches a product called Lend, which is designed to allow users to earn interest on certain digital assets on the platform. The company insists Lend falls outside the regulator’s jurisdiction and that the SEC has not explained its concerns.
On Tuesday, however, as US senators pressed for more guidance to be published, SEC chair Gary Gensler said existing law and Supreme Court precedents are clear.
He also complained about a lack of consumer protection in lending products in particular and said Coinbase had not registered with the SEC “even though they have dozens of tokens that may be securities”.
The pending showdown with the largest US crypto exchange could help determine the scope of the SEC’s power over digital assets in future, and has unnerved other crypto groups — particularly the ballooning number of platforms that also offer traders juicy yields of about 7 to 12 per cent on crypto deposits.
“This is regulation by enforcement,” said John Collins, partner at fintech advisory firm FS Vector and a former head of policy at Coinbase.
“These products are very much in operation all across the crypto space right now . . . I’d be very surprised if responsible companies in the space are not taking a moment to assess what they offer if it’s a [similar] product.”
The SEC has clamped down on the initial coin offering market, by pursuing enforcement actions. In December, it sued crypto group Ripple for allegedly offering its XRP token as an unregistered security. It also agreed a settlement with Telegram, claiming the messaging app conducted a $1.3bn unregistered securities offering.
Similarly, at the heart of the SEC’s tussle with Coinbase is the question of whether Lend qualifies as a security under US law. Some argue the crypto exchange’s guarantee to provide a return to all its customers from its lending programme pushes it closer to the definition of a security under a US Supreme Court precedent called the Howey test, which states that an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others” is a security.
Coinbase told the Financial Times it did not know why this particular product had been targeted, given the existence of other similar offerings.
The calls for clarity come as an increasing number of crypto platforms have started offering yield-hungry traders complex — and highly risky — interest-bearing products, in an era of ultra-low interest rates. While the products tend to be structured differently from issuer to issuer, the Coinbase dispute leaves many wondering about their future.
“Right now we are armchair quarterbacks that are guessing,” said Stephen Ehrlich, chief executive of Voyager Digital, a Toronto-listed crypto exchange that offers yield on deposits to US customers.
Antoni Trenchev, chief executive of digital assets platform Nexo, said his company’s lawyers were working on the presumption that “everybody in the industry will get the same questions” from regulators as Coinbase.
He said Nexo’s interest-bearing products did not break any rules, but added the company was nevertheless exploring other options should Coinbase pursue and then lose its case. These included “whether to allow sale of these products only to accredited investors” or strike up a partnership with a bank for example, he said.
Coinbase said it was concerned about similar products that it offers because of the lack of clarity. Celsius said it was confident that none of its offerings in the US are securities. Gemini, which offers annual interest of 8 per cent on its Gemini US dollar coin, declined to comment.
Rather than ditch lending products altogether or risk being sued, Coinbase and others have a third option: register their products as securities. It is an approach that Gensler has encouraged, arguing that crypto exchanges should be “asking for permission” rather than “begging for forgiveness”.
However, Voyager’s Ehrlich argued that, given the nuances of digital assets, this too might prove difficult. “How could you account for crypto [as] nowhere does it say how to cover digital assets?” he said, pointing to a lack of clarity on auditing crypto.
The stand-off highlights a debate about whether it is better for digital assets to be brought under the existing regulatory framework or whether regulators should carve out a specific crypto regime, as has been done in some jurisdictions.
Gensler on Tuesday said “companies since the 1930s on, for 90 years, have found ways to innovate” within the agency’s registration requirements for securities.
But Isaac Boltansky, director of policy research at Compass Point Research & Trading, said: “We are talking about trying to take a regulatory regime from the civil war era and put it on a highly disruptive digital asset class.”