Who's the Bad Guy: Coinbase or the SEC?
Pongo Points:
• Coinbase filed a petition for the SEC to provide clearer rules for the digital asset space, arguing that the SEC is intentionally ambiguous in determining how crypto falls under existing laws and regulations. Meanwhile, the SEC maintains that it's only enforcing existing rules and most cryptocurrencies fall squarely within those rules. Who's right?
• Coinbase's position might be self-serving, since a large portion of its income is derived from non-Bitcoin/Ethereum trading on its platform, but its arguments benefit the industry as a whole. However, its petition relies on circumstantial evidence and self-reference to build an argument that the SEC is dragging its feet in creating clear regulations and instead wishes to rule by enforcement.
• The SEC replies to the petition by quoting Coinbase's own references and reframes them in support of its position: You cannot compel rulemaking. The agency relies heavily on the premise that there is no legal mandate that requires them to act on any timeline, but crypto has been around for over 10 years and there's still a lot of uncertainty among industry and regulatory actors alike.
Collective Intelligence
On March 22, 2023, Coinbase received a “Wells notice” from the SEC, which is a warning by the SEC that they intend to pursue enforcement actions regarding possible violations of securities laws. While not a formal charge, it oftentimes leads to a lawsuit. In response, Coinbase launched a petition for writ of mandamus against the SEC on April 24, 2023. As the legal battle heats up between Coinbase and the SEC, who is in the right? The company in a new space seeking clear rules for its industry, or an established agency that believes existing rules are sufficient?
This ape’s answer is: Both. Coinbase is right to seek clear guidelines for crypto’s path forward in the US, but the SEC is right in that many securities laws likely already apply to a wide range of cryptocurrencies. Coinbase is wrong to pursue aggressive legal action against a government agency, as it erodes trust in our federal authorities and makes the crypto industry appear hasty or provoking. However, the SEC is wrong to not engage in conversations from industry players seeking to formalize regulation.
Ultimately, the actions taken by both Coinbase and the SEC amount to basic survival behaviors seen in the wild. Coinbase’s efforts are self-preservation; clear rules means they can navigate crypto much more easily and avoid Wells notices or enforcement actions in the future. The SEC is applying anti-predation tools; under the guise of “investor protections,” it is free to pursue enforcement cases that will lead to precedent for future rulemaking. Neither is wrong to engage in this way, but this ape thought humans were more evolved!
Coinbase is clearly frustrated with its efforts and conversations with the SEC, so it deemed legal action to be the remedy of last resort. While this might compel the SEC to engage, it may not yield the result it hopes for or expects - i.e. the court might uphold the agency’s efforts to enforce first and make/amend regulations later. Ironically, by casting the first stone, Coinbase may have made itself (and the crypto industry) look impatient, impertinent, and persnickety - not the eager to participate, “let’s all work together” company it aims to be. All the while, the SEC continues to play the game it’s been winning all along…
Self-Preservation
Coinbase has an obvious interest in having clearer legal frameworks to work from: More revenue from “SEC-approved” tokens. While Bitcoin and Ethereum are the behemoths of the crypto industry with over 63% of the market share, they made up around 54% of Coinbase’s transaction revenue in Q1 2023 and only 43% in Q4 2021 (the height of the last bull run). Retail investors clearly love trading smaller market cap coins and a significant amount of Coinbase’s income depends on it!
Assuming Bitcoin and Ethereum get a pass from the SEC but every other token is deemed an unregistered security, it becomes a major pain point for Coinbase and its shareholders. Coinbase’s transaction revenue accounts for approximately 80-85% of its total revenue each year, so a 40-50% decline to that income would be devastating for its stock price. Further, since many of the tokens traded on Coinbase are based on Ethereum (ERC-20 tokens), any reduction in the trading volumes for those tokens might reduce demand for Ethereum - a doubly painful hit to earnings.
To be clear, even though Coinbase is proactively seeking rulemaking to protect its own interests, it doesn’t make its actions totally self-indulgent. Other crypto exchanges will benefit from clearer rules and regulations as well, so Coinbase is “altruistically” helping its competition too. Ultimately, because of its position as a pioneering crypto company in the US, it aims to lead the charge for the industry as the fight with regulatory agencies heats up. It’s a respectable and honorable pursuit.
As part of its opening salvo in its lawsuit against the SEC, Coinbase issued a petition for writ of mandamus - which is a fancy, legal way to force the SEC to respond to the rules Coinbase would like made. It’s an unusually strong action that is currently being contested by the SEC (more on that below), but highlights Coinbase’s resolve to help sort out the regulatory landscape for crypto in the US. Of course, this was met with an equally strong rejection by the SEC…
Anti-Predator Adaptations
In response to Coinbase’s writ of mandamus, the SEC issued a strongly worded and well-researched rebuttal on May 15, 2023 claiming that Coinbase was not entitled to special policy creation for crypto. Instead, the agency’s answer used Coinbase’s initials arguments and citations against them in what is best summed up as: “You can’t force us to make rules as fast as you want them.” The difference in language between the SEC’s response and Coinbase’s original petition appeared like that of a parent scolding a child for throwing a tantrum when they don’t get the toy they wanted.
This isn’t to say the the SEC is exculpable of blame: Crypto has been around for the better part of 10 years and there really isn’t much clear guidance on how its regulated under existing laws. Congress and its regulatory tentacles have been slow to create rules for an asset class that was seen as a fad due to its explosive boom-bust cycles. In their eyes, why waste time debating proposed laws for an asset class that drops 90%+ every four years? (The answer is because people keep coming back!)
For context, after the 2007-2008 Great Financial Crisis (GFC), Congress worked with various regulatory agencies to develop and pass the Dodd-Frank Act in just 13 months. This act impacted 11 other acts by creating and modifying the powers of the FDIC, SEC, OCC, the Fed, and SIPC. It’s estimated that the losses for US and European banks during 2007-2009 exceeded $1 trillion, yet is still less than the $2.2 trillion in losses that the crypto market suffered peak-to-trough from 2021-2022 (which is around $800 billion more than 2007-2009 losses when adjusted for inflation).
Comparing losses highlights the fact that crypto is a massive market and deserves some regulatory clarity. Whether or not that comes from agency enforcement or rulemaking is not Coinbase’s decision to make, however the onus is on the SEC to provide a responsible and equitable foundation for crypto companies in the US to innovate and compete in international markets. Failure to do so will motivate development teams to build elsewhere at the expense of the US’s global dominance.