The core of the SEC indictment is that Coinbase, as a crypto exchange that lists certain digital assets and provides certain services that constitute securities, must — and has not — registered under the Securities Act of 1933 and the Securities Exchange Act of 1933. 1934. Since at least 2017, the SEC has taken the position that a digital asset (such as cryptocurrency) will be considered a “security” subject to the registration requirements of these laws if it is an “investment contract” under the four-part test established by The United States. Supreme Court in SEC v WJ Howey Co. (1946). Below the how so test, a digital asset constitutes an investment contract if there is (1) an investment of money; (2) in a joint venture; (3) with an expectation of profit; (4) relying on the efforts of others. The SEC alleges that Coinbase’s business involves digital assets that fall under securities how so— and that Coinbase deliberately ignored applicable securities laws to make “billions” at the expense of “investors by depriving them of the protections they are entitled to.”
The SEC argues separately in its complaint that the “staking” services offered by Coinbase are themselves investment contracts how so. “Staking” or “proof of stake” is a mechanism used to validate certain cryptocurrency transactions on the blockchain. Blockchain transactions are not subject to centralized verification in the same way that financial institutions verify traditional currency transactions; rather, they need a decentralized authentication mechanism. A proof-of-stake protocol allows holders of certain cryptocurrencies to pledge or “stake” their digital assets, locking the assets in for a specified period of time during which the holder’s machine can be used to create blockchain-based validate transactions. Validators are randomly selected to confirm transactions and validate block information, and selected validators earn additional cryptocurrency as a reward. The SEC alleges that by pooling and deploying customers’ digital assets, earning rewards on behalf of customers, and returning those rewards to customers, Coinbase is offering and selling investment contracts subject to SEC regulation.
The SEC further alleges that Coinbase operated as an unregistered broker through two services offered to investors on its platform. The first is Coinbase Prime, which the SEC alleges Coinbase calls a “prime broker for digital assets” and is used to funnel crypto asset orders into the Coinbase platform or other third-party platforms. The other service mentioned in this suit is Coinbase Wallet, which routes orders through third-party digital asset trading platforms as a means of accessing Coinbase platform liquidity.
The Coinbase Answer
Coinbase filed its response on June 29, 2023. The response denies that any of the Coinbase services identified in the SEC complaint are or involve securities. Challenging the SEC’s common interpretation of how so in the context of digital assets, Coinbase claims that the digital assets traded on the exchange are not an “ongoing business venture whose management owes enforceable obligations to investors.” Rather, their value “lies rather in the things that are bought and traded than in the companies that spawned them.” If the asset’s value is inherent rather than a product of managerial activity, the “effort of others” may come into play how so cannot be met and the assets are not legally SEC regulated securities.
Coinbase’s response states that the SEC and its commissioner, Gary Gensler, have acknowledged for years that a “regulatory gap” prevented the Commission from overseeing digital asset exchanges. By filing this enforcement action against Coinbase, instead of engaging in drafting notices and comments, Coinbase is alleging that the SEC is abusing its discretion. For example, the SEC had declared Coinbase’s IPO registration statement effective in April 2021, without ever suggesting that Coinbase was required to register its activities or violated securities laws. Given the SEC’s role in protecting investors, Coinbase claims, the registration statement and offering should not have gone through had Coinbase broken securities laws at the time of the IPO. Coinbase thus accuses the SEC of changing its stance and adopting a completely new interpretation of its regulatory authority “by decree, arbitrarily and without congressional mandate”. This interpretation is allegedly baseless in federal securities laws, subject to formal regulatory requirements not met by the SEC, lacks due process, and, under the so-called major questions doctrine, an impermissible violation of Congress’s ongoing consideration of how regulatory authority is best assigned over cryptocurrency.
With regard to staking, Coinbase denies that staking constitutes an investment contract How so. It argues that it only provides its clients with a platform on which to bet, that is, to participate in the protocol of a particular token when that protocol allows for staking. Coinbase states that the staking process does not involve any investment, just an agreement by customers to participate in a staking process where digital assets held in a customer account are used to stake in exchange for rewards. Coinbase further claims that the staking services it provides are just IT services and not the management effort required for an investment contract under it how so, and moreover, betting on the Coinbase platform does not carry any potential risk of loss. Coinbase also denies that Coinbase Wallet and Coinbase Prime are brokerage services.
The ongoing Coinbase litigation highlights the significant gap between recent SEC enforcement action and market participants’ hopes for a more clearly defined regulatory structure. Such participants, including Coinbase— have publicly advocated for more formal SEC regulation or for Congress to pass legislation clarifying when U.S. securities laws apply to digital assets. The SEC has instead filed a wave of lawsuits under rules they claim are already clear. “Cryptomarkets suffer from a lack of regulatory compliance,” SEC Commissioner Gary Gensler stated during an April 2023 Congressional hearing, “not a lack of regulatory clarity.”
Regardless of one’s stance on how crypto is or should be regulated, it seems unlikely that the SEC will relinquish its current preference for litigating on such issues. Market participants may prefer formal SEC guidance or new legislation, but recent SEC actions against Coinbase, Binance, Kraken, Genesis, Gemini and others suggest the Commission is trying to define SEC jurisdiction over digital assets as aggressively as courts will allow . In June 2023 remarks, former SEC Chairman Jay Clayton criticized the SEC’s current stance, which he summarized as, “If we don’t lose cases, if we don’t get pushed back by the courts, we’re not doing enough. ”
An SEC victory in the Coinbase lawsuit could give the SEC expanded jurisdiction over the services provided by cryptocurrency exchanges. Moreover, the impact of this process is likely to extend far beyond just crypto exchanges. For example, a finding that Coinbase’s staking services are “investment contracts,” and thus regulated securities, could increase the likelihood that the SEC will also file similar claims against the cryptocurrency issuers that offer unregistered staking programs. Conversely, a Coinbase win based on its interpretation of how so and application of the top questions doctrine would be a major setback for the SEC, potentially depriving it of its most effective tool for regulating digital assets. In that case, and without new legislation by Congress, much of the digital asset industry would be largely unregulated.
While the United States has yet to adopt a comprehensive regulatory and enforcement framework for digital assets, the SEC is aggressively pursuing lawsuits against unregulated market participants that the SEC believes are endangering U.S. investors. Crypto issuers, exchanges and other industry players may be hoping for more guidance from the SEC and Congress, but further litigation seems more likely in the near term.
 In the U.S. Senate, Senators Cynthia Lummis (R-Wyoming) and Kirsten Gillibrand (D-New York) are working on bipartisan legislation that would create a broad regulatory framework for digital assets and give the CFTC most of the oversight responsibility. Senator Debbie Stabenow (D-Michigan) introduced another bill that would give the CFTC broad jurisdiction over digital assets and trading platforms. In the U.S. House of Representatives, a bipartisan group has introduced legislation that, among other things, allows regulation of the exchange of digital goods by the CFTC and establishes conditions for the sale of digital goods and the registration of exchanges. These accounts overlap but are not completely connected. What’s more, it’s just three of more than 50 bills and resolutions introduced in Congress to date that relate to the regulation of digital assets.
 To see Coinbase, Petition for Rulemaking – Digital Asset Securities Regulation (July 21, 2022) (requesting the SEC to “propose and adopt rules for the regulation of securities offered and traded through digital native methods, including possible rules to identify which digital assets are securities”) .