Coinbase Announces Very Bad News

The cryptocurrency exchange says it received a warning from the Securities and Exchange Commission (SEC), suggesting a possible enforcement action.

It's a very bad news that comes at the wrong time. 

For nearly two weeks the cryptocurrency industry has been experiencing a kind of renaissance, emerging from the crypto winter in which it had been plunged since last year.

Cryptocurrency prices have rebounded strongly as the crisis of confidence rocking banks continues to worry investors.

Bitcoin was trading these days around $28,800, up 46% since March 10, when Silicon Valley Bank suddenly collapsed due to a bank run, according to data firm CoinGecko.

Bitcoin has benefited from the fact that it's viewed as an alternative to fiat currencies, experts say. The digital currency was created as a response to the 2008 financial crisis which had prompted the federal government to bail out the banks in order to avoid the collapse of the global financial system.

It is therefore no surprise that the prices of Bitcoin and those of cryptocurrencies rise when the traditional banking system has problems.

'Wells Notice'

But Coinbase  (COIN) - Get Free Report has spoiled the party. 

The cryptocurrency exchange has just announced that it has received a notice from the Securities and Exchange Commission (SEC). This means that the regulator may bring an enforcement action against the largest U.S. crypto exchange.

On March 22,  Coinbase "received a 'Wells Notice' from the staff of the Securities and Exchange Commission stating that the staff has advised the company that it made a 'preliminary determination' to recommend that the SEC file an enforcement action against the company alleging violations of the federal securities laws," the company said in a regulatory filing.

It added that: "Based on discussions with the staff, the company believes these potential enforcement actions would relate to aspects of the company’s spot market, staking service Coinbase Earn, Coinbase Prime and Coinbase Wallet."

For months the SEC has indicated that, excluding Bitcoin, most cryptocurrencies and crypto-related products are securities, which would give the regulator a lot of power over the industry.

A security is, according to the agency, "an investment of money, in a common enterprise, with a reasonable expectation of profit derived from the efforts of others.”

The SEC wants to refer to a Supreme Court judgment of 1946, the Howey Test, that sets out what is an "investment contract" and would therefore be subject to U.S. securities laws. An investment contract exists if there is an investment of money with expectations of profits. 

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 disclosure, as, for example, shares in a company would be. The listing process for tokens is also less strict than that for securities. 

What Is at Stake

In addition to coins, the SEC is also targeting staking, which is is a way in which investors lock up – or stake – their crypto tokens with a blockchain validator. The goal is to be rewarded with new coins when their staked crypto tokens become part of the process for validating data on the blockchain. 

"The reason your crypto earns rewards while staked is because the blockchain puts it to work," explains Coinbase. 

The fall in cryptocurrency prices last year and the resulting drop in trading volumes caused many crypto exchanges to rely more and more on staking services as a source of revenues.

But the SEC is determined. 

Last month, the regulator took an enforcement action against the Kraken exchange over its staking service. The SEC alleged that Kraken's staking service was an illegal sale of securities. Kraken settled the case without admitting or denying wrongdoing and paid a $30 million fine and was forced to shut down the service.

Coinbase warned on March 22 that "the potential civil action may seek injunctive relief, disgorgement, and civil penalties."

A 'wells notice' is often issued at the end of an investigation. The regulator gives the company the opportunity to argue its case. The warning can lead to an enforcement action, lawsuits or settlements.

"Today Coinbase received a Wells notice from the SEC focused on staking and asset listings. A Wells notice typically precedes an enforcement action," reacted CEO Brian Armstrong on Twitter.

"We're disappointed that the SEC is considering courts over constructive dialogue. But if courts are required, so be it. We'll defend the rule of law," Coinbase's chief legal officer, Paul Grewal, said. "We don’t list securities. Of the thousands plus crypto assets CB has reviewed over the years, only roughly 240 of those have met our standards to list on our platform."

This is not the first time the SEC has issued a 'wells notice' to Coinbase. Two years ago, the federal agency had sent a warning to the platform about “Lend”, a product, which would have allowed users to earn interest by lending out their crypto. The SEC considered it a security. 

Coinbase eventually abandoned the project.