Coinbase Has Words for the SEC. Is It Listening?

Coinbase, the largest U.S. cryptocurrency exchange and one of the largest publicly traded cryptocurrency firms in the world, announced late Tuesday night that it has received a warning from the Securities and Exchange Commission about its planned Lend product, which would give users 4% interest on deposits of the stablecoin USDC, with other assets apparently to be added later. According to Coinbase, the U.S. regulatory agency last Wednesday sent the firm what’s known as a Wells notice, a warning of a planned lawsuit over the product.

(Disclosure: CoinDesk’s parent company, Digital Currency Group, is an investor in Circle, which issues USDC.)

But, according to Coinbase, the warning, which will likely block the launch of the Lend product, was issued after months of borderline stonewalling by the regulator. According to Coinbase CEO Brian Armstrong, that began as early as May, when he visited Washington, D.C., to meet with various lawmakers and regulators.

“The SEC was the only regulator that refused to meet with me, saying ‘we’re not meeting with any crypto companies,’” Armstrong wrote in a Twitter thread last night.

According to a blog post from Coinbase, the company has since presented the Lend product to the SEC and engaged in a long disclosure process before last week’s warning. Despite that effort at transparency, Armstrong says the SEC did not respond with any advice on how to properly structure the product ahead of issuing its Wells warning.

“We’re being threatened with legal action before a single bit of actual guidance has been given to the industry on these products,” Armstrong wrote.

Coinbase argues, plausibly, that Lend is not a security, because its returns are not formally tied to the company’s financial performance. Equally frustrating for the now-public startup is that similar products are widespread in the cryptosphere, offered by effectively unregulated entities including exchanges and DeFi protocols.

Other U.S.-regulated crypto companies have responded with empathy and frustration. “U.S. regulators are beating down good actors because it’s convenient,” wrote Jesse Powell, CEO of the Kraken crypto exchange. “Meanwhile, actual scams run unabated for years.”

Armstrong also questioned whether the SEC is really doing its job. “Who are they protecting here and where is the harm? People seem pretty happy to be earning yield on these various products, across lots of other crypto companies … Shutting these down would arguably be harming consumers more than protecting them.”

Armstrong is misdirecting here, at least slightly. The SEC is oriented towards protecting investors from risk, and whatever the returns on an unregulated crypto deposit product might be today, they are clearly very high risk on a longer timeline. Massive hacks of both DeFi products and exchanges remain disturbingly frequent, for instance.

Whenever you get interest, you’re essentially getting paid for your risk. And like it or not, in the current low-interest-rate environment, 4% interest on a stablecoin deposit implies substantial risk. With U.S. banks offering less than 1% on deposits and even 30-year Treasury yields under 2%, Coinbase’s offered rate certainly raises questions about where the premium is coming from.

In many of the DeFi “yield farming” programs Armstrong points to, for instance, supposed yield is actually paid in a platform’s native token. That makes most DeFi “loans” barely disguised securities because the value of the yielded tokens is based on the platform’s future performance. One plausible explanation of the SEC’s action is that it believes Coinbase is similarly subsidizing its interest rates from its own operating revenue.

That being said, Coinbase’s side of the story paints a disappointing picture of the SEC under new head Gary Gensler. As the exchange points out in its account, Gensler has repeatedly said he wants dialogue with crypto companies, but it seems he may not understand that that’s a two-way street.