Analysis: Coinbase, SEC on Collision Course for ‘Existential’ Clash Over Crypto Industry

NEW YORK/WASHINGTON, March 24 (Reuters) – Coinbase ( COIN.O ) debuted on the U.S. stock market on April 14, 2021 – the same day U.S. senators confirmed Gary Gensler to head the Securities and Exchange Commission (SEC), the country’s top market regulator.

Gensler, who has called the crypto sector a “wild west” full of fraud, is now embroiled in a battle with the world’s largest publicly traded crypto firm over a core debate: whether digital assets are investment contracts similar to stocks or bonds that should be regulated by the SEC.

Friction between crypto supporters and the regulator has been brewing under Gensler’s leadership, with both sides becoming increasingly vocal in their criticism.

The escalating tension exploded into public view on Wednesday when Coinbase CEO Brian Armstrong and the company’s chief legal officer Paul Grewal posted online that the firm had been told SEC staff intended to recommend enforcement action, adding that Coinbase was willing to fight against it in court.

Coinbase shares have fallen 14% since Wednesday’s disclosure.

Spokesmen for the SEC and Coinbase declined to comment. For months, the two have been in discussions about regulation and the agency’s investigation into Coinbase, according to two sources.

In July, the firm disclosed an SEC investigation into its asset listing processes, stake programs and return-generating products.

Discussions between the SEC and Coinbase broke down in recent weeks, with a source saying the two sides had moved “further apart.” The SEC appears to be going after Coinbase’s entire business, which operates outside U.S. laws, the source said.

The crypto industry believes it operates in a regulatory gray area that is not governed by existing US securities laws – and that new legislation is needed to regulate the industry.

“We continue to believe that regulations and legislation are better tools for defining the law for our industry than enforcement actions,” Coinbase’s Grewal said Wednesday. “But if necessary, we welcome the opportunity for Coinbase and the broader crypto community to get clarity in court.”

Before Gensler’s arrival, the SEC engaged in targeted enforcement, but the Democratic leader has increased his focus on the crypto platforms themselves. The SEC’s crackdown on crypto gained momentum after November’s collapse of Sam Bankman-Fried’s FTX exchange.

Gensler has raised questions about whether crypto firms rely on a business model that is fundamentally inconsistent with the law, adding that crypto intermediaries offer a variety of functions, such as operating as an exchange, broker-dealer, clearing agent and custodian. should be regulated by the SEC.

“This is probably existential for Coinbase,” said Joshua White, a finance professor at Vanderbilt University. “It may be existential for the industry, at least in the US”

The SEC issued an investor alert on Thursday that firms offering crypto-asset securities may not be complying with US laws.

Kristin Smith, executive director of the Blockchain Association, voiced the crypto industry association’s support for Coinbase, noting, “The SEC doesn’t make the law — it just makes allegations, which ultimately have to be tested in the courts.”

The SEC has taken legal action against many crypto firms, including a case against San Francisco-based crypto and cross-border payments company Ripple Labs Inc that some say could clarify when a digital asset is considered a security.

But the SEC and Coinbase debate over an “unspecified portion” of the publicly traded digital assets sets the stage for a more expansive and potentially defining courtroom battle. Coinbase’s website lists over 150 cryptoassets for trading.

Coinbase flagged potential regulatory risks when it filed to go public in 2021, noting on Wednesday that its staking and exchange services have been “largely unchanged” since then.

“It couldn’t be a more significant development for crypto markets and crypto investors,” said Philip Moustakis, former SEC enforcement attorney and partner with Seward and Kissel LLP in New York.

Reporting by Chris Prentice and Hannah Lang; editing by David Gaffen and Nick Zieminski

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