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SEC Warning to Coinbase Is Part of a Worrisome Trend for Crypto

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Global fell sharply on Wednesday after the U.S. Securities and Exchange Commission warned that it would sue the crypto exchange company if it went ahead with a plan to allow users to earn interest by lending crypto assets.

Beyond the blow to the growth plans of Coinbase (ticker: COIN), the move by the SEC signals a new phase in its enforcement actions. The agency is now questioning whether some of the fastest-growing parts of the crypto industry are legal at all.

In particular, the SEC and other regulators seem concerned about crypto companies offering high interest rates for people to lend out their assets, a service traditionally performed by banks.

“The SEC has been flirting with crypto regulations for some time, but today’s news of Coinbase receiving a Wells notice from the SEC feels very much like the first salvo of a long and drawn out conflict that may engulf the whole space,” said Webull CEO Anthony Denier, whose brokerage offers crypto trading.

BTIG analyst Mark Palmer wrote in a note after the Coinbase news that the SEC appears to be creating “regulation by litigation,” a problematic practice for the industry.

If the SEC deals with crypto on a case-by-case basis, it could make it more difficult to launch products whose legality is not clear. Two of the five SEC commissioners, Hester Peirce and Elad Roisman, have warned that this approach is “not the best way to move forward.”

“In this void, litigated and settled commission enforcement actions have become the go-to source of guidance,” they wrote in July. “People can study the specifics of token offerings that become the subject of enforcement actions and take clues from particular cases; however, applying those clues to the facts of a completely different token offering does not necessarily produce clear answers.”

Crypto companies have worked nimbly with regulators before, but this latest move could spell trouble for the industry. Crypto is not overseen by a single regulator. Of the agencies that do oversee it, the Commodity Futures Trading Commission (CFTC) has arguably been more accommodating than the SEC. Former CFTC Chairman Christopher Giancarlo was even called “crypto dad.”

SEC Chairman Gary Gensler, however, has signaled a less laissez-faire approach, and has said that the agency may have authority to regulate areas like decentralized finance, or DeFi, where crypto-holders lend their tokens to a pool and often earn interest. The SEC is reportedly investigating Uniswap Labs, a company that started a DeFi exchange.

Gensler, like his predecessor Jay Clayton, has said that many cryptocurrencies are securities, meaning they ought to have much more disclosure of their risks. 

In an interview with Barron’s last week, Gensler noted that the SEC has already taken action against 75 or 80 crypto coins. Asked why the SEC doesn’t make rules for the 1,500 or so other coins now trading, Gensler said that each case is different.

“Every case has facts and circumstances, every case has to be very carefully put together, and so forth,” he said. “Our laws are clear. And yet, it still takes the time, month after month to put them together.”

Gensler also urged the trading platforms to speak with the SEC about products.

“I also have said to the various trading platforms and lending platforms, come in, talk to us, talk with us,” he said.

Coinbase CEO Brian Armstrong wrote on Twitter that he tried to meet with the SEC in May, but was rebuffed. When the company did tell the SEC about its plan to offer interest-bearing accounts, the agency said the product was a security and then “refuse[d] to tell us why they think it’s a security,” he wrote, calling the episode “sketchy behavior.” 

“So if the SEC wants to publish guidance, we are also happy to follow that (it’s nice if you actually enforce it evenly across the industry equally btw),” he wrote. “But in this case they are refusing to offer any opinion in writing to the industry on what should be allowed and why, and instead are engaging in intimidation tactics behind closed doors. Whatever their theory is here, it feels like a reach/land grab vs other regulators.”

In response to questions about Armstrong’s statement, an SEC spokesperson wrote, “The SEC does not comment on the existence or nonexistence of a possible investigation.”

Because of the so-called Wells notice from the SEC, Coinbase will delay the launch of its Lend product “until at least October,” wrote the company’s chief legal officer, Paul Grewal, in a blog post. He argued that the Lend program was not a security.

DeFi platforms have drawn nearly $200 billion in assets, indicating that Coinbase’s Lend business could become a major profit center if it taps into that excitement.

Shares of Coinbase were down nearly 4.5%, to $255, in Wednesday morning trading.

BTIG’s Palmer remains bullish on Coinbase and has a $500 price target on the stock. He wrote in his note that Coinbase might be the best company to take this fight on, because it has more resources than most crypto companies and has a history of regulatory compliance in other matters.

Despite Palmer’s contention, it is not clear that Gensler does want to impose “regulation by litigation.” It could be that it is simply unclear who has authority over crypto activities, because so many agencies have a piece of it. So writing rules for the industry isn’t going to happen quickly without more obvious authority. The faster that happens, the better it will likely be for crypto. Gensler said he’s working on figuring out the framework, and will need Congress’ help.

“And I’ll be engaging with Congress, along with the Commodity Futures Trading Commission, along with the Department of the Treasury, the opposite controlling currency, the Federal Reserve,” Gensler said in the Barron’s interview. “We all have a piece of this. It’s not just the market side. It’s also the lending side, and the monetary policy side and the money laundering side.”

Write to Avi Salzman at avi.salzman@barrons.com and Pierre Briançon at pierre.briancon@dowjones.com

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