It has been revealed that the SEC is investigating Coinbase over the sale of unregistered securities, which could potentially have consequences for the cryptocurrency and greater blockchain industry. The outcome of this case could have severe consequences for the American crypto exchange, and could establish precedent for changes to crypto trading regulations. With bills like the America Competes Act targeting crypto projects, regulations are inevitable for the cryptocurrency industry, for better and for worse.
The United States Securities Exchange Commission (SEC) oversees the registration and trading of American stocks and securities, or "investment contracts". Created in the aftermath of the Wall Street Crash of 1929, the SEC's purpose is to protect investors by enforcing the requirements of public disclosure and registration for companies selling investment products, so investors can make informed decisions about what they are buying. The SEC has a very rocky history with cryptocurrency. Notorious for suing benevolent projects that provide services while falling behind on targeting crypto scams that defraud investors, the regulator has failed to provide concrete guidance yet often fines projects for violating securities laws, often resulting in catastrophic losses for retail investors.
A report by Bloomberg revealed that the SEC has been probing Coinbase for some time now. Insiders familiar with the case, who spoke under anonymity, revealed that this investigation has been ongoing prior to the recent charges against a former Coinbase employee for insider trading. This is not the first run-in Coinbase has had with the American regulator, as Bitcoin.com reported last year on the SEC threatening to sue Coinbase if it proceeded with rolling out its Lend program to customers, yet provided no explanation as to why this program constituted a securities offering.
Crypto Must Follow Rules That The SEC Never States
The Securities Exchange Commission has earned an infamous reputation within the blockchain and cryptocurrency industry for its behavior of enforcing unstated policies. While SEC Chair Gary Gensler has stated that the majority of cryptocurrencies are unregistered securities, he has also stated that the United States will not ban crypto, resulting in mixed messages. This makes starting innovative blockchain projects a legal minefield, as just about any use of a digital asset as part of the functionality of a new project may likely be viewed as an "unregistered security" by the regulator, and thus fined for millions of dollars in the future. However, the SEC seems to have turned a blind eye to non-fungible blockchain tokens (NFTs), but this will likely change over time as well. To date, the only public guidance the SEC provides for blockchain projects is the "Howey Test".
According to Investopedia, the Howey Test is a set of qualities which determine whether an asset/commodity is an "investment contract" of a company, and therefore falls under disclosure requirements. The four points of the Howey Test are: 1. An investment of money, 2. In a common enterprise, 3. With the expectation of profit, and 4. To be derived from the efforts of others. Most cryptocurrencies fall under the first three requirements, which leaves the fourth to be interpreted for each token. Bitcoin is not considered a security because its value is not derived from the efforts of a third party, whereas any cryptocurrency that was sold to raise money via an ICO (Initial Coin Offering) is almost guaranteed to suffer a lawsuit from the SEC. Under this framework, most cryptocurrencies sold on Coinbase could be seen as securities, which is why they are investigating Coinbase and other exchanges.
Predicting what may come out of this can be difficult. The SEC's clearly stated position is that most cryptocurrencies (except for bitcoin and ether) are securities of the projects/companies that created them, and offers no guidance for decentralized DAO-governed blockchain projects. If the SEC wins, then Coinbase will likely be issued a massive fine, several cryptocurrencies will be delisted, and the SEC will gain precedent for suing other American exchanges and delisting more tokens. Coinbase would survive just fine, but an SEC victory could have severe consequences for American blockchain projects that use cryptocurrencies in their operation.
Sources: Bloomberg, Bitcoin.com, Investopedia