Starting from the grievances between SEC and Coinbase, where will US cryptocurrency regulation go?
What is the future of US cryptocurrency regulation after the SEC and Coinbase disputes?
Author: Michael Nadeau
Translation: Luffy, Foresight News (This article was published before the SEC filed a lawsuit against Coinbase)
Whether you’re an entrepreneur, developer, or investor, if you’re in the cryptocurrency industry, understanding upcoming regulations and policies is a must. With regulatory topics heating up in the US and MiCA becoming law in Europe, it’s time to take a deeper dive.
Regulation is a broad topic, and to make it easier to read and understand, we’ll break this content into two parts. In Part 1, we’ll discuss:
- The role of the US Securities and Exchange Commission (SEC)
- The love-hate relationship between Coinbase and the SEC
- Disagreements between the executive and legislative branches
- Cryptocurrency users and the 2024 election
- Complete inventory: Institutions that were among the first to come ...
- Despite the impact of regulation on the market, the outflow of fund...
- Identifying Investment Bubbles: How to Exit Before the Music Stops?
Image source: Times Higher Education
The Role of the SEC
- Protect investors;
- Maintain fair, orderly, and efficient markets;
- Facilitate capital formation.
The SEC promotes full public disclosure by companies, protects investors from fraud and manipulation, and oversees corporate takeover actions.
The SEC is responsible for maintaining the orderly operation of the world’s largest capital market. They also have the authority to create new rules, as long as they comply with the framework established by Congress in 1933/1934. The SEC enforces this framework to create an environment that holds bad actors accountable and provides innovative opportunities for good actors.
Without thoughtful regulation, the cryptocurrency industry cannot mature and realize its full potential. But the current regulatory framework was created in 1933/1934, and we don’t yet have a new set of laws or regulations that apply to new types of cryptocurrency assets.
Cryptocurrency assets differ in many ways from traditional securities, including:
- No investment contract (secondary trading).
- Cryptocurrency assets do not represent legal ownership.
- Cryptocurrency assets do not grant holders the right to interest or dividends.
- Many cryptocurrency assets have commodity-like characteristics, where assets are used to pay for or consume services.
- Cryptocurrency assets are digital bearer instruments that can be self-custodied.
- Cryptocurrency assets can be traded peer-to-peer.
- Cryptocurrency assets can be traded globally with nearly instant settlement around the clock.
- Due to the characteristics of public chains, custody, ledger/accounting/transfers agents, trading, audit, etc. services can be bundled.
- Smart contracts support new peer-to-peer business models and asset trading, and automation of markets.
- The transparency and automatic audit/verification functions of public chains create new tools for regulators to comply with investor disclosures in new ways.
- As cryptocurrency networks mature, they become more decentralized. Lack of centralization makes it difficult to comply with current traditional securities disclosure requirements.
It is not feasible for the SEC to place cryptocurrencies and traditional securities under the same regulatory framework. However, we should not give up the goal of protecting investors while improving capital efficiency. We only need to adjust the rules or create new ones. This work will fall on Congress, not the SEC.
Of course, cryptocurrencies are not immune to political complexity.
Enforcement Regulation
Unfortunately, the current approach of the US Securities and Exchange Commission – regulating through enforcement – has not promoted innovation, protected investors, or held wrongdoers accountable, punishing many companies seeking compliance while pushing investors towards high-risk, opaque offshore entities.
The results of this strategy seem to be contrary to the SEC’s mission.
I don’t want to explain why this happens here. Cryptocurrencies are not the first industry to face such challenges. Our job is to look at this area with a clear eye. Ultimately, we just want to predict the direction of things. Understanding regulation and policy making is crucial for industry operators and investors to assess risks.
For this, let’s take a look at the case of Coinbase.
The Love-Hate Relationship Between Coinbase and the SEC
As a publicly traded company, Coinbase is one of the most trusted brands in the cryptocurrency field.
The auditing firm behind Coinbase is Deloitte, and it has long sought compliance through voluntary cooperation with regulatory agencies. Here is a brief overview of Coinbase’s history with the SEC:
- Before 2020: Coinbase obtained remittance licenses in all relevant states (2014), a BitLicense in New York State (2017), an SEC-recognized alternative trading system company ATS (2018), and an SEC-registered proprietary broker-dealer license (2019). ATS and the trading broker-dealer license are currently awaiting regulatory approval.
- October 2020: Coinbase submitted an initial draft S-1 for listing to the SEC.
- December 2020: Coinbase submitted a legal analysis of its pledging service.
- February 2021: The SEC issued a second comment letter, and Coinbase responded with a legal analysis of whether the tokens listed on its spot exchange are securities.
- April 2021: SEC announced Coinbase’s S-1 effective; Coinbase officially went public.
- November 2021: Coinbase met with SEC Chairman Gensler to discuss registering as a securities trading platform.
- July 2022: Coinbase submitted a formal rulemaking petition, including 140 specific questions to the SEC.
- Q4 2022: Coinbase met with SEC staff (including enforcement) 12 times to discuss registration paths and related matters, holding a total of 30 meetings within 9 months.
- January 2023: SEC enforcement staff notified Coinbase that they would continue to take enforcement action.
- March 2023: Coinbase received a Wells notice from the SEC.
- April 2023: Coinbase sued the SEC to respond to its July 2022 rulemaking petition.
- May 15, 2023: The SEC responded to Coinbase’s rulemaking petition.
At this time, we don’t know what the specific SEC enforcement action against Coinbase is, only that there is one.
Disclosure: We are not lawyers. We believe the most important factor in all of this is the fact that the SEC reviewed Coinbase’s business in April 2021 and approved the company’s S1 listing. Now, that does not preclude an enforcement action against Coinbase.
Here’s why:
Since Coinbase’s S1 was approved, the SEC has not put forth any new regulations. Congress has not passed any new laws related to crypto assets. Additionally, Coinbase’s core business has not changed.
Coinbase disclosed its asset listing process and staking business to the SEC during its listing. Additionally, the U.S. Securities and Exchange Commission knew how Coinbase was safeguarding user assets.
All of this suggests to the investing public that the SEC viewed the business as legal and compliant. Therefore, investors in Coinbase’s IPO had all the information they needed to evaluate risk.
Now, by issuing a Wells notice, the U.S. Securities and Exchange Commission is suggesting that Coinbase’s core business is illegal or non-compliant and enforcement action is forthcoming.
And Coinbase’s core business has not changed, nor have any new regulations or laws been put forth since Coinbase’s listing.
So it’s hard to determine exactly what the SEC’s issue is – and that’s a problem in itself. We believe that if the public, investors, entrepreneurs, and Coinbase itself don’t know what they did wrong, regulation will only backfire.
Hawley Test
Coinbase claims that they do not engage in securities trading. They shared their listing process with the SEC during their listing, claiming to have rejected over 90% of crypto assets seeking listing.
Meanwhile, current SEC Chairman Gary Gensler has stated publicly multiple times that “all crypto assets except for Bitcoin are securities.” It’s worth noting that this is not formal policy, but rather a public statement made by Gary Gensler.
He’s also made completely contradictory public statements. In fact, in 2018 he said that over 75% of ICO tokens were not securities.
He’s even made statements about how decentralized crypto networks become over time, changing how they should be treated as securities.
Ultimately, in order to meet the threshold of securities law, the SEC must prove that specific crypto assets being traded on Coinbase are part of an ongoing investment contract. Coinbase believes they are not, for two reasons:
There is no investment contract between Coinbase users who buy and sell cryptocurrency assets and the issuers of these assets. Token issuers cannot raise funds from users who trade on Coinbase.
The case previously applied to applying the Howey Test to cryptocurrency assets was against issuers who raised funds by selling unregistered securities. This is different from the secondary market trading on Coinbase. Coinbase believes that secondary market trading does not meet all four conditions of the Howey Test:
- Investment of funds: In the secondary market, investments do not flow to the issuer or originator.
- Joint venture enterprise: This does not exist for users who purchase cryptocurrency assets on Coinbase. Similarly, this condition applies to the primary market, not the secondary market.
- Profit expectation: There is no profit expectation for cryptocurrency assets with consumer/commodity characteristics. For example, Ethereum users need to buy tokens to pay gas fees to access services on the network.
- Profit from the efforts of others: Similarly, this applies to the primary market, not the secondary market.
What happens next?
Currently, it remains to be seen what enforcement action the SEC will take against Coinbase. Does it have anything to do with asset listing? Pledge? Custody? We don’t know. We only know that the SEC is planning to take action against Coinbase.
Coinbase has some of the best lawyers and policy experts working for it, and with $5 billion in cash, it may be better suited to challenge the SEC than any other cryptocurrency company.
The market seems to be pricing in the worst-case scenario. But we believe that Coinbase is likely to win or settle.
As for timing, it may take many years to figure this out.
Finally, we believe that expanding existing federal securities laws to include cryptocurrency assets is unnecessary and wrong. Policy issues related to the regulation of cryptocurrency assets should be addressed by Congress.
We believe the bipartisan bill introduced by Senators Gillibrand and Lummis is a good start. We understand that an updated version of the bill is being worked on. In addition, a new market structure bill was passed last Friday: it was drafted by House Financial Services Committee Chairman Blockingtrick McHenry and House Agriculture Committee Chairman Glenn Thompson (R-Blocking). When describing the roles of the SEC and CFTC, the bill defines key terms such as decentralization, blockchain (limited to public blockchains), digital assets, digital asset issuers, stablecoins and other key terms in an effort to develop new laws related to cryptocurrency.
Congress’s View on Cryptocurrency
Broadly speaking, the US seems to be largely opposed to cryptocurrency innovation.
The media tends to focus on negative news, which can create fear, uncertainty, and doubt.
For example, Senator Elizabeth Warren has launched an “Anti-Crypto Alliance” movement, as well as recent enforcement actions by the White House.
However, data publicly available from Coinbase paints a more nuanced picture.
In particular, the attitude of the legislative branch of Congress seems to differ from that of the executive branch. There are more Republican and Democratic decision-makers who support cryptocurrency innovation than oppose it.
The following data concerns publicly available information related to legislative records, media statements, social media posts, caucus memberships, and public letters. Each member of Congress is then rated to determine whether they are supportive or opposed to crypto innovation. Members who cannot gather or publicly verify information are not rated.
Source: Coinbase Public Policy Legislation Portal
We also hear that there are indeed more intergenerational differences in Congress than ideological ones.
Interestingly, Coinbase’s data seems to align with a recent statement made by Congressman Ritchie Torres in a discussion with Bankless:
About crypto-skeptical senior Congress members:
Cryptocurrency is not a partisan issue. Most studies show that Democrats in the US have slightly more ownership and use of cryptocurrency than Republicans.
2024 Election Cycle
Remember, Twitter was initially a small platform where geeky engineers shared what they had for breakfast. Facebook was initially a Harvard intranet social club.
But within 10 years, both platforms had a significant impact on global election cycles.
We believe that Bitcoin and cryptocurrency (along with artificial intelligence) are likely to become hot-button issues in the 2024 election cycle.
Democratic Party
The Democratic National Committee has announced that it does not plan to hold a primary debate, indicating that Biden has secured the nomination.
Meanwhile, Biden, the White House, and current regulatory agencies appointed by the President (SEC, FDIC, Fed) seem to be largely opposed to cryptocurrency.
That being said, we believe that as we approach the next election cycle, their stance may change.
Remember that many young Congress members in the Democratic Party support cryptocurrency and so do many of their constituents.
According to a recent study by Grayscale, 52% of Americans (including 59% of Democrats and 51% of Republicans) agree that “cryptocurrency is the future of finance”; 44% of respondents say they want to invest in crypto assets in the future.
As previously mentioned, Democrats are more likely than Republicans to hold crypto assets.
Meanwhile, various estimates show that approximately 20% of U.S. adults own crypto assets. According to the Federal Reserve itself, one in ten U.S. adults held or used cryptocurrencies in 2022 (bear market year). Coinbase has 110 million verified users (Deloitte audit). Finally, 67% of Americans agree that the financial system needs significant reform or complete overhaul.
When all of this is taken together, we believe that as the election cycle approaches, the White House may have to adjust its policy towards cryptocurrency.
Republicans
Republican presidential candidates are more likely to support crypto innovation. Republican leader Ron DeSantis has said he would “ban CBDCs” and support innovation related to Bitcoin and crypto technology. As governor, DeSantis made Florida one of the most crypto-friendly regions in the U.S.
It is currently unclear where Trump stands on cryptocurrency. He has made negative comments about Bitcoin in the past, but also launched an NFT project last year. It is worth noting that states like Florida and Texas are largely supportive of the crypto industry.
As cryptocurrency is seen as “anti-establishment,” we believe it fits with Trump’s preferred campaign narrative. When we combine this with the fact that Republican congressmen tend to support crypto innovation, it is reasonable to predict that Trump will ultimately align with the industry.
Conclusion
Cryptocurrency users have a unique diversity and are non-partisan.
There are not many political issues that cover both parties like this. Therefore, we believe that cryptocurrency will bring some interesting challenges and incentives for policy makers. As Charlie Munger likes to say, “tell me the incentives and I’ll tell you the outcome.” Will politicians continue to be incentivized to use cryptocurrency as a scapegoat for some other agenda? Within a year at least, it’s hard to see that happening. Instead, it’s more likely to incentivize support for cryptocurrency on both sides.
We have seen this sign in public data and in the drafting of new legislative institutions.
As the Ripple and Coinbase cases progress, we will have the opportunity to see how the courts view the SEC’s enforcement actions.
We will remain vigilant, but the prospects may be brighter than the market expects.
