SEC’s Coinbase lawsuit likely to lead to deeper cryptocurrency clampdown by the US

The case against Coinbase, coupled with Monday’s against Binance, forms a one-two punch against the industry

A representation of cryptocurrency in front of the Coinbase logo. AFP

The Securities and Exchange Commission widened its sweeping clampdown on cryptocurrency by accusing Coinbase Global of running an illegal exchange, a move that could make it harder for the industry to operate and for US citizens to trade.

In a 101-page lawsuit filed on Tuesday in a federal court in New York, the SEC alleged that Coinbase evaded its rules for years by letting users trade numerous crypto tokens that were actually unregistered securities.

A day earlier, the regulator sued rival Binance Holdings, accusing it of a series of offences.

The SEC moved against Coinbase, the biggest US crypto exchange, after chairman Gary Gensler repeatedly argued that most tokens were subject to his agency’s oversight and that large parts of the industry had been breaking the law.

At the same time, US regulators warned banks to steer clear of cryptocurrency because of potential risks to the financial system, making it harder for Americans to invest.

The SEC’s civil lawsuit stands out because of Coinbase’s high profile in the US, and its status as a publicly traded company.

The stock fell 12 per cent to close at $51.61 in New York trading. At one point on Tuesday, the declines shaved about $1.5 billion off the company’s market capitalisation.

The case against Coinbase, coupled with Monday’s lawsuit against Binance, forms a one-two punch against the industry.

The SEC alleged that Binance, the world’s largest cryptocurrency platform, and its chief executive, Changpeng Zhao, mishandled customer funds, misled investors and regulators, and broke securities rules.

The regulator sought a temporary restraining order on Tuesday to freeze some assets as part of that case.

“The SEC under Mr Gensler is dead set on enforcing rules that, if followed, would kill off almost all of crypto,” said Omid Malekan, an adjunct professor at Columbia Business School who has consulted on cryptocurrency.

Mr Gensler said in an interview on Bloomberg Television that the SEC worked with 10 states to bring its complaint against Coinbase.

He cast the agency’s efforts to clamp down on cryptocurrency as one of both investor protection and US market integrity.

“Why should the New York Stock Exchange or broker dealers we all know and respect be undermined by this other corner of the capital markets, which is sort of … thumbing their nose and saying ‘Catch us if you can’?,” he said.

Coinbase was cofounded in 2012 by Brian Armstrong, its chief executive. He was not accused of wrongdoing in the SEC’s complaint.

Although Binance is bigger globally, Coinbase is the largest US cryptocurrency exchange, with more than 150 different tokens that trade.

Paul Grewal, the company’s top lawyer, has previously said that those tokens are not securities.

Paul Grewal, right, chief legal officer of Coinbase, speaks during a House Agriculture Committee hearing in Washington on Tuesday. Bloomberg

“The SEC’s reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance,” he said on Tuesday.

Wall Street’s main regulator is seeking an order that would require Coinbase to comply with securities laws, and give up what the agency says are ill-gotten gains.

The regulator also alleged that Coinbase acted as an exchange, broker-dealer and clearing house – all without registering with the SEC for any of those roles.

“This back-to-back, double whammy of actions by the SEC against Binance and Coinbase confirm that US regulators believe strongly that these entities have, for years, ignored the securities laws,” said Ashok Ayyar, counsel at Ashbury Legal.

A virtual currency may fall under the SEC’s remit if investors buy it to fund a company or project with the intention of profiting from those efforts.

That determination is based on a 1946 US Supreme Court decision defining investment contracts.

In its complaint, the SEC said that numerous tokens offered on Coinbase were securities, including Sol, Ada, Matic, Fil, Sand, AXS, CHZ, Flow, ICP, Near, VGX, Dash and Nexo.

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  The crypto market, which includes currencies such as Bitcoin, pictured, has lost $2 trillion of its value in six months. Unsplash

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  The price of Ethereum, the second largest cryptocurrency by market size, has fallen by 70 per cent this year. Investors and analysts are watching to see if it will dip below $1,000. Unsplash

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  The government of El Salvador has invested $105 million in Bitcoin. President Nayib Bukele's embrace of the cryptocurrency as legal tender is being questioned as the market crashes. Getty

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  Changpeng Zhao, founder of crypto exchange giant Binance, has compared the current market turmoil to the dotcom bubble of the early 2000s. Still, the company is aggressively pursuing licensing in international jurisdictions and introducing new products. Getty

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  Tether is the biggest issuer of stablecoins, a type of cryptocurrency pegged to a traditionally stable asset like the US dollar. Most stablecoins are meant to maintain a constant price of $1 and are backed by real reserve funds, making it easy to convert crypto investments into cash. But Tether's financial statements show that may not be true, leaving the issuer and its investors vulnerable. Unsplash

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  The recent crypto crash can in part be attributed to the collapse of TerraUSD, a stablecoin pegged to the US dollar through algorithms and linked to a "sister" cryptocurrency named Luna. When the price of Luna plummeted, TerraUSD also fell, creating a “death spiral” to practically zero for both coins. Unsplash

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  On June 12 crypto lender Celsius Network said it had paused customer withdrawals, saying it needed “to stabilise liquidity and operations”. Investors are still waiting, with no signs that the current meltdown will let up. Getty

“One thing that stands out for me is the number of prominent tokens the complaint alleges to be securities,” said Philip Moustakis, a former prosecutor in the SEC’s enforcement division who is now a partner at Seward & Kissel.

“Each of those tokens have stakeholders who will surely want to be heard on the subject.”

The question of whether certain tokens are securities has hung over the cryptocurrency industry for years.

In 2020, the SEC sued Ripple Labs, contending that its XRP token was a security and subject to SEC regulation. A ruling in the case is expected this year.

The SEC also accused Coinbase of breaking the agency’s rules with its “staking” service. That product offers customers a return in exchange for providing their tokens to be used to enable transactions on a blockchain.

Coinbase also said it was willing to take its legal fight with the SEC all the way to the nation’s highest court.

“If it takes going to the Supreme Court, that’s what we’re prepared to do,” Mr Grewal, said in an interview, adding that he believes the company will prevail.

“I think that every court that looks at this issue is going to conclude the SEC has fundamentally gotten this wrong.”