Coinbase Faces Huge Challenge — Which May Affect All of Crypto

In the middle of a crypto industry trying to take a breather after months of falling digital-currency prices, a bomb may be primed to explode. 

The Coinbase platform faces a big problem, which has implications for the entire crypto industry.

In the middle of a crypto industry trying to take a breather after months of falling digital-currency prices, a bomb may be primed to explode.

The market has lost more than $2 trillion due to a market-shaking combination of recession fears, which have prompted investors to liquidate their positions in all risky asset classes, and scandals affecting crypto lenders.

These scandals caused a liquidity crisis and bankruptcy filings for the Celsius Network and Voyager Digital platforms.

But now the crypto industry will also have to deal with another serious threat: the U.S. Securities and Exchange Commission.

The crypto sector has long been calling for clear rules, and regulators have not fully responded. Now, the agency has turned close attention to one of crypto’s biggest players, and that has implications for the whole sector.

The SEC Has Opened an Investigation

According to Bloomberg News, the SEC is investigating Coinbase  (COIN) – Get Coinbase Global Inc Report.

The probe, which has not been made public, focuses on the listing of digital assets that should have been registered as securities. The inquiry follows insider-trading charges brought last week against a former Coinbase product manager, Ishan Wahi.

“[We] are confident that our rigorous diligence process — a process the SEC has already reviewed — keeps securities off our platform, and we look forward to engaging with the SEC on the matter,” Coinbase Chief Legal Officer Paul Grewal said on Twitter.

He headlined the tweet: Coinbase does not list securities. End of story.

“The SEC does not comment on the existence or nonexistence of a possible investigation,” a spokesperson told TheStreet in an emailed statement.

Insider-Trading Case

The regulator on July 21 said that nine cryptocurrencies listed on Coinbase, the most popular platform in the U.S., are unregistered securities.

The announcement came as the SEC and the Department of Justice filed charges against former Wahi and two others, accusing them of running an insider-trading scheme that earned them more than $1.1 million.

Wahi allegedly tipped off his brother, Nikhil Wahi, and his friend, Sameer Ramani, about upcoming token-listing announcements on the crypto exchange.

“Ahead of those announcements, which usually resulted in an increase in the assets’ prices, Nikhil Wahi and Ramani allegedly purchased at least 25 crypto assets, at least nine of which were securities, and then typically sold them shortly after the announcements for a profit,” the SEC said.

The nine tokens are: Flexa’s AMP, rally’s RLY, DerivaDEX’s DDX, XY Labs’ XYO, Rari Capital’s RGT, the Liechtenstein Cryptoassets Exchange’s LCX, Power’s POWR, DFX Finance’s DFX, and Kromatika Finances’s KROM.

What Is a Security?

This decision, which took the industry by surprise, has important repercussions because tokens, or coins, until now have not been considered securities.

This means that they escape strict regulatory supervision and are not subject to the same rules of financial transparency and disclosures as shares in a company, for example. The listing process is also less strict than that for a security.

“Each of the nine companies invited people to invest on the promise that it would expend future efforts to improve the value of their investment,” the SEC argued.

The regulator wants to refer to a Supreme Court judgment, the Howey Test, that sets out certain criteria for defining an asset as a security.

The SEC’s decision drew a torrent of criticism from the industry, other regulators and lawmakers alike.

Coinbase filed a petition with the SEC, asking the agency to say how it would apply federal securities laws to crypto assets, according to a blog post.

“The case SEC v. Wahi is a striking example of ‘regulation by enforcement,'” Commodity Futures Trading Commission Commissioner Caroline Pham said in a statement posted on Twitter.

The crypto industry accuses the SEC of remaining vague in its rules and demands clarity.

For five years, the SEC has been regulating the crypto industry via enforcement actions, targeting startups that raised funds through initial coin offerings.

The regulator is, for example, in a showdown with Ripple, a blockchain payment firm based in San Francisco. In a lawsuit, the commission says that XRP, a token associated with Ripple, should be seen as a security. The firm rejects the claim.

Another sign of the tensions: The SEC has said that it does not consider bitcoin and ether, the first two cryptocurrencies by market cap, as securities.

But the current SEC chairman, Gary Gensler, remains vague about ether. He told lawmakers last May that bitcoin is a “commodity token” but sidestepped questions about ether.