It's a bad day for Coinbase.
The most popular U.S. cryptocurrency exchange knew what was coming -- and on June 6 it showed up.
Since March, Coinbase (COIN) had been on notice that the U.S. Securities and Exchange Commission was considering filing a complaint against it, accusing it of not registering properly with the agency in order to offer certain cryptocurrencies and services.
"Today Coinbase received a Wells notice from the SEC focused on staking and asset listings. A Wells notice typically precedes an enforcement action," Chief Executive Brian Armstrong said on Twitter on March 22.
Coinbase Accused of Operating Illegally
A Wells Notice is often issued at the end of an investigation. The regulator gives the company the opportunity to argue its case. The warning can lead to an enforcement action, lawsuits or settlements.
Coinbase warned that day that "the potential civil action may seek injunctive relief, disgorgement, and civil penalties."
"We're disappointed that the SEC is considering courts over constructive dialogue. But if courts are required, so be it. We'll defend the rule of law," Coinbase's chief legal officer, Paul Grewal, said.
"We don’t list securities. Of the thousands plus crypto assets CB has reviewed over the years, only roughly 240 of those have met our standards to list on our platform."
Less than three months later, the SEC has filed a complaint against the firm, alleging that it was operating illegally because since 2019 it has been "an unregistered national securities exchange, broker, and clearing agency."
The SEC also charged Coinbase "for failing to register the offer and sale of its crypto asset staking-as-a-service program," according to a statement.
"We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions,” said SEC Chairman Gary Gensler.
"In other parts of our securities markets, these functions are separate. Coinbase’s alleged failures deprive investors of critical protections, including rulebooks that prevent fraud and manipulation, proper disclosure, safeguards against conflicts of interest, and routine inspection by the SEC."
He continued: "Coinbase never registered its staking-as-a-service program as required by the securities laws, again depriving investors of critical disclosure and other protections.”
Coinbase Stock Slumps
These allegations had a major impact: Coinbase stock at last check was down around 21%. The day before, Coinbase shares fell more than 9%.
In turn Coinbase's setbacks had a big impact on the cryptocurrency market, which fell 4.2% to $1.14 trillion, according to data firm CoinGecko. Bitcoin, the most popular cryptocurrency, fell 4.4% to $25,530.41 in the past 24 hours.
The feud between the SEC and Coinbase revolves around two points: Is a cryptocurrency a security? And what about the staking service? For the SEC they are securities.
A security is, according to the agency, "an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others.”
The SEC references a Supreme Court judgment of 1946, the Howey Test, that sets what an "investment contract" is and therefore would be subject to U.S. securities laws. An investment contract exists if money is invested with expectations of profits.
Seen in this light, any coin except bitcoin is a security, according to the SEC.
In addition to coins, the SEC is also targeting staking, which is is a way in which investors lock up – or stake – their crypto tokens with a blockchain validator. The goal is to be rewarded with new coins when their staked crypto tokens become part of the process for validating data on the blockchain.
"The reason your crypto earns rewards while staked is because the blockchain puts it to work," explains Coinbase.
The fall in cryptocurrency prices last year and the resulting drop in trading volumes caused many crypto exchanges to rely more and more on staking services as a source of revenue. Basically, cryptocurrency exchanges offer services other than buying and selling tokens.
But for crypto players, including Coinbase, the SEC does not want to establish clear rules and prefers to regulate by enforcement actions. The platform sued the SEC in April, asking the judge to force the regulator to give clear guidance to crypto firms.
"We need a clear rulebook in the US to achieve the full promise of crypto. Until rules and laws are developed that reflect the realities of this new economic system, we cannot realize the full potential of making our financial system faster, fairer, and more affordable," Coinbase's Grewal tweeted on June 5.
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