Will SEC Suit Against Coinbase Land Heads or Tails for Crypto?

There are over 10,000 cryptocurrencies, and the Securities and Exchange Commission (SEC) can’t sue them all.

But the U.S. regulator can, in essence, jump the queue by going after the exchanges that allow American customers to trade many of the 10,000 crypto tokens in circulation.

And that’s just what the SEC has done.

In two lawsuits filed this week, the Securities and Exchange Commission (SEC) kicked off its most aggressive crusade yet — one that touches on nearly every facet of the crypto sector.  

Fresh on the heels of successful enforcement actions against crypto exchanges Bittrex, Kraken and Gemini, the Gary Gensler-led agency is now trying to shut down Coinbase, the biggest U.S.-based crypto exchange, as well as force Binance, the most substantial global exchange, to cease its U.S. operations.

As one might expect, the crypto platforms aren’t too happy about this latest development.

“Crypto can’t be uninvented. It’s here to stay. What we need now are sensible policies and rules so we can all move forward together,” tweeted Coinbase CEO Brian Armstrong.

Importantly, the SEC itself isn’t a lawmaking body — the agency is responsible only for taking actions based on existing laws, which then need to be proven in court before being enforced.

The SEC’s case against Coinbase is focused entirely on the firm’s failure to register with the SEC as a securities exchange, and no criminal or fraudulent actions have been alleged.

The company has promised “business as usual” while it fights the regulator’s claims.

Read MoreIt’s U.S. Versus Them as SEC Suits Upend Crypto Optimism

SEC POV: Crypto Assets Are Securities, and Every Exchange is Violating Securities Law

The Coinbase lawsuit asserts that, in the SEC’s view, at least 13 of the around 254 cryptocurrencies available on Coinbase are securities.  

The 13 tokens named in the Tuesday (June 6) suit have a combined market value of $37 billion.

When taking into account the six additional tokens listed in the Binance suit, the SEC has so far officially alleged that a total of 19 cryptocurrencies, among them many of the most popularly traded, are all securities.

“The Coinbase suit is very different from others out there — the complaint filed against us is exclusively focused on what is or is not a security. And we are confident in our facts and the law,” stated Armstrong, the exchange’s CEO.

SEC Chair Gary Gensler has repeatedly insisted that, in his view, a majority of the 10,000 cryptocurrencies currently being traded in the market are securities.

The Securities Exchange Act of 1934 regulates the trading of securities. It has rules for stock exchanges and brokers, rules against fraud in stock trading and rules for continuing disclosure by companies with publicly traded stock. This is the law Coinbase is accused of running afoul of.

Because Coinbase has allegedly failed to register as a securities exchange, broker and clearing house as required by law — it is operating as an unregistered securities exchange.

The SEC’s central legal claim is that, since at least 2019, Coinbase has pocketed billions of dollars by collecting transaction fees from investors without the legally required disclosures and protections of securities registration — exposing its customers to risk.

This, while Coinbase leadership has consistently accused the SEC of refusing to provide it with a clear way to register as a compliant platform, despite years of trying.

Coinbase has also been charged with the “unregistered sale and offering of securities” in connection with its staking-as-a-service program.

Coinbase Bets the House on Winning in Court

From the point of view of Coinbase, the SEC suit has a fatal flaw — none of the digital assets under discussion represent investment contracts, even if they may be the objects of those contracts.

When the SEC sent Coinbase a Wells Notice earlier this year, Coinbase’s lawyers sent the SEC a Wells submission back, arguing why the agency shouldn’t sue Coinbase.

“Digital assets are computer code that operate on blockchain technology. They do not necessarily memorialize any contractual relationship with an issuer or other party, or inherently constitute securities. Courts have consistently found that the ‘object’ of an investment contract is distinguishable from the investment contract,” reads the firm’s response.

Basically, the exchange is saying that crypto tokens — which may have been defined as a securities offering during their initial first minting — are not securities for their entire lifetime (if they ever were at all) and that the exchange only offers its customers those tokens whose utility exists independent of the minting conditions.  

That argument is likely to form the foundation of the exchange’s go-forward legal defense and could define the future of the crypto industry in the U.S.

Adding color to the ongoing back and forth between Coinbase and the SEC is the fact that Coinbase technically sued the SEC first.

As a result of that legal poke, the SEC may have to issue crypto rules in advance of the Coinbase court hearing.

If the ongoing, multi-year SEC lawsuit against crypto firm Ripple, which involves whether a single token (XRP) represents a security, offers any clues into the Coinbase détente — it is that things may take some time to resolve, particularly when there is sizable economic interest on either side of the outcome of the litigation.

Still, observers believe that the recent SEC actions could motivate Congress to prioritize — and push through — effective legislation for the digital asset sector.

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