SEC vs. Coinbase

The Securities and Exchange Commission alleged in a complaint that Coinbase violated securities laws with its failure to register as an exchange and its failure to register certain tokens and its cryptocurrency staking. “Staking” is a process that allows cryptocurrency to validate transactions and earn rewards. The SEC argues that this process meets the definition of an investment contract, therefore necessitating its registration with the SEC.

The SEC further alleges that as an exchange, Coinbase acts as both a securities depository and as an intermediary in settling transactions in crypto asset securities. In the securities industry, brokerage firms and exchanges are separate entities. According to the SEC, commingling these functions presents conflicts of interest.

Why Does the SEC Want Coinbase to Register?

Registration with the SEC is supposed to reveal potential conflicts of interest and other potential dangers to investors. Without the oversight of the SEC, investors may be unnecessarily vulnerable to losses.

Gurbir Grewal, Director of the SEC’s Division of Enforcement, said in a press release that “Coinbase was fully aware of the applicability of the federal securities laws to its business activities, but deliberately refused to follow them. While Coinbase’s calculated decisions may have allowed it to earn billions, it’s done so at the expense of investors by depriving them of the protections to which they are entitled.”

In addition, SEC Chair Gary Gensler stated in response to a rulemaking petition by Coinbase Global that Coinbase is not entitled to an exception from existing SEC rules, and that the failure of Crypto exchanges to register with the SEC and its resulting lack of oversight led to their eventual collapse.

What Does This Case Mean for Crypto Investors?

This case highlights the ongoing conversation between regulator(s) and cryptocurrency. This suit could finally determine whether cryptocurrencies are, in fact, securities that should be regulated by the SEC, which is the regulatory body that oversees securities and stock exchanges.

Two questions are at the center of this suit:

• Is cryptocurrency an investment, a currency, or a commodity?
• Do cryptocurrency exchanges fall under the regulatory purview of the SEC?

What is the Definition of an Investment?

The SEC relies on the “Howey Test” to define an investment contract, also known as a security. The test takes its name from the Supreme Court case SEC vs. W.J. Howey Co., in which the court determined that W.J. Howey Co’s sales of orange grove real estate, with the option to lease the land back to another one of Howey’s companies to service the land and tend to the business of growing oranges. The Supreme Court determined that this was an investment that needed to register with the SEC. As part of the ruling, the Supreme Court determined that a security was “an investment of money in a common enterprise, with profits to come solely from the efforts of others.”

Because staking comes with rewards in the form of additional cryptocurrency, the SEC alleges these transactions count as investment contracts according to the Howey Test.

Coinbase Response

According to Coinbase, cryptocurrencies are not securities, but commodities, like oil and gold. Their value comes from their utility in making purchases and trades and is not based on the efforts of others, therefore failing to meet one of the requirements of the Howey Test. While purchasers may hope that the value of the coins increases, the cryptocurrency exchange is not promising to make efforts to increase their value, and there are no contracts entitling them to the proceeds of a common enterprise.

Coinbase vs. SEC: Will the Case Be Dismissed?

As of January 2024, a U.S. District Court Judge is considering the Motion Coinbase filed to dismiss the SEC’s lawsuit. Judge Failla told SEC lawyers, “I want to understand how your standard does not sweep in the collectible market or commodities. It is a real fear that I have that your argument is just sweeping too broadly.”

An Oppenheimer analyst upgraded Coinbase saying that he believes that Coinbase could win its SEC lawsuit. A Bloomberg Intelligence analyst stated the same. Coinbase seems to believe in its chances as well – while previous crypto exchanges have chosen to settle with regulators, this case may reach the Supreme Court.

Cryptocurrency is a Risky Bet, Security or Not

Whatever the outcome of this suit, investors should exercise caution when making cryptocurrency purchases. If the SEC establishes its authority, certain cryptocurrencies may fail to meet regulatory requirements. The lack of regulation in the cryptocurrency space makes it attractive to scammers. Cryptocurrency is at the subject of many recent alleged pump-and-dump scams and Ponzi schemes.

What Can I Do If I Lost Money with Coinbase?  

If you lost money on a cryptocurrency scam, report it to the FBI Internet Crime Complaint Center. If a FINRA-registered broker recommended a failed cryptocurrency investment, you may be able to recover by seeking a settlement from the brokerage firm. (You can check if your broker is registered by looking up their CRD number on FINRA BrokerCheck.) Call (877) 600-0098 for a free consultation with an investment fraud lawyer.