Coinbase has faced a torrid time since tech stocks peaked back in November

Coinbase and the SEC

Along with the whole cryptocurrency world, Coinbase has faced a torrid time since tech stocks peaked back in November. The crypto exchange lost over 88% of its value between then and May this year. While the stock price has managed to steady over the last 10 weeks, news that the US Securities and Exchange Commission (SEC) is planning to launch an investigation into the company saw the share price slump by over 21%, wiping out recent gains.

Defining cryptos

The SEC’s probe is over concerns that the platform has offered unregistered securities to its customers. This suggests that the company illegitimately let users trade digital assets, which the SEC believes should have been registered as securities. It appears that the SEC has several tokens in mind which were central to a recent case of insider trading, brought by the SEC against an employee of Coinbase, and his associates. Coinbase’s chief legal officer Paul Grewal is confident that the platform does not offer securities, and the company is pushing back against the SEC for not providing clearer rules in defining cryptocurrencies.

The regulators

If there is any concern that a particular crypto offering is a scam, investigation would initially fall under the remit of the Federal Trade Commission. But aside from that, the regulatory question is basically whether a cryptocurrency is a commodity/currency, in which case it would be regulated by the Commodity Futures Trading Commission (CFTC), or if it is more like an equity, and therefore a security. If the latter, then the crypto in question would be regulated by the SEC. The difficulty in assigning which bucket each crypto falls in to is that as many crypto projects are financed by the sale of highly speculative tokens. SEC Chair Gary Gensler has said that “many of these underlying tokens have the attributes of securities” which, if so, would require full and proper regulation and supervision to protect investors. During the insider trading lawsuit, the SEC wrote: “A digital token or crypto asset is a crypto asset security if it meets the definition of a security, which the Securities Act defines to include ‘investment contract,’… if it constitutes an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others.”

What about Bitcoin?

According to a previous SEC chairman, Jay Clayton, cryptocurrencies such as Bitcoin and Ether which replace “sovereign currencies,” aren’t securities. But digital assets and tokens used in initial coin offerings are. That would appear to be in line with the SEC’s current approach. Of course, complicating matters is how profits and losses are taxed, but that is an issue for the Internal Revenue Service. Putting this all together shows that the current regulation of crypto assets is a bit of a mess. And that’s before considering how other countries are dealing with them.

Coinbase woes

The sell-off in Coinbase itself reflected fears that the troubled platform could be hit with a large fine, or worse. But there are implications for the whole cryptocurrency universe. Unlike many regulators, SEC Chair Gensler has a reputation for taking decisive action and doing it quickly. His move to regulate tokens will be seen as a shot across the bow of a largely unregulated industry. That could certainly crimp the style of many of the current players, but many would argue that that’s a good thing, if it leads to a strengthening of investor protections. The crypto world is certainly a New Frontier when it comes to innovation and investment opportunities. But it also has much in common with the Wild West. There’s no doubt that it has been the latest product to capture the imagination of people trying to get rich quick. Consequently, it has suffered severe reputational damage given the number and nature of the scams that have been built on it. But it’s far more than that. There are so many potential applications for crypto and the blockchain going forward. But these need to be built on solid ground. Sensible regulation which helps to push out the cowboys but allows the serious players to drive the industry forward should be a good thing. Cryptos are well known for their volatility, with dramatic price moves both up and down. The market is currently working through one of its periodic crashes, and yet again the Cassandras are out in force predicting its imminent demise. But there’s no reason to believe that cryptos are on their way out. So, let’s hope that carefully considered regulation will help encourage this fledgling market, rather than crushing it.