The Breakdown - The Crypto Community's Defiant Reaction to Gensler's Coinbase Lawsuit

Episode Date: June 7, 2023

Are we at the SEC Crypto endgame? This week the regulator has sued Binance and Coinbase and made it clear they want crypto gone from America. Unfortunately for them, the industry isn't backing down.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Wednesday, June 7th, and today we're digging into the SEC's lawsuit against Coinbase. Before we dive in, a quick note. If you are enjoying the breakdown or Bitcoin Builders or the AI breakdown, I would really, really appreciate it if you would take the time to leave a rating or a review. Believe it or not, reviews are how a lot of people decide which podcast are going to try next. And so if this show is providing value, I would love for you to share why and see if we can't get some more people as part of this community. As always, I appreciate you guys listening.

Now, to today's conversation. It is a hell of a thing, being in an industry that powerful people are actively trying to kill. It really does give you a totally different sense of the capricious and arbitrary nature of power. And the damnable thing about what's going on right now in the U.S. is that it was so, so predictable. I remember being in South America and the sick feeling as the depths of Sam's fraud was uncovered and shared for the world to see. I've talked extensively about the feeling of having been betrayed and lied to as part of that company, but there was another part of that sick feeling as well. And that was the sense that, of course, after SBF had done so much to cultivate favor with the political establishment, in the U.S., of course they were coined to come back viciously, if for no other reason out of sheer

embarrassment and egg on their face. Since then, everything has been so, so predictable. And the frustrating thing is that even if you don't believe that there is some big Operation chokepoint 2.0 conspiracy, the effective result of a few loud people in positions of power being left unchecked because no one wants to defend our industry right now is effectively the same. But wherever it all came from, clear we're in some sort of culmination phase of the SEC's antagonism towards the crypto space. In the first two days of this week, we got not one, but two marquee lawsuits. One was, of course, against Binance, and the other is against Coinbase. Coinbase was announced just before I was recording yesterday.

Today, we're going to hone in on the reaction and the response from the community, and we're going to start with the logistics, but first, we have to cover one more detail from the Binance story. One of the more shocking parts of the Binance lawsuit is just how, severe the requested penalties are. Alongside suing CZ personally, the SEC foreshadowed a heavy-handed emergency injunction which would freeze assets. On Tuesday, the SEC filed those precise orders, and indeed they called for a freeze of assets for Binance U.S. The major concern seems to be that assets held with Binance U.S. would be transferred offshore or to CZ personally, as was

alleged to have occurred previously. The big and unusual order the SEC is requesting is that Binance International and CZ personally, return funds that have been taken from Binance U.S. This is so far only supported by fairly undetailed allegations in the complaint that funds were taken from Binance U.S. accounts, so we might have to wait and see if the SEC has more solid evidence to present. Now, these are only draft orders representing what the SEC is asking for, so of course they'll need to be argued in front of a judge before they have any effect. And, as this is an emergency injunction, that hearing could happen relatively soon. Investor Adam Cochran writes,

To really spell it out for people, the Binance Freeze Order is expressly asking the courts to freeze funds from CZ. In other words, they believe he had been accessing and using user funds and were concerned that he would do so again. We've not seen something like this before. Other people were more cynical. Dysopia Breaker wrote, Investor protection is when you steal all their assets and cause bank runs.

Reflexivity research founder Will Clemente said something similar. SEC trying to freeze Binance U.S. assets feels like they're almost trying to orchestrate a run on its reserves. Steady lads, deploying more investor protection. Now, though, let's move to the logistics of the SEC's lawsuit against Coinbase. The lawsuit alleges that the exchange operated as an unregistered securities exchange, broker, and clearing agency. Those are the same core allegations as the Binance lawsuit. However, the Coinbase suit contains no serious allegations of improper conduct by management, like the commingling of customer funds, so it doesn't rope in executives as co-defendants,

as we saw with CZ being personally sued on Monday. For that reason, the complaint sticks much more closely to the technical arguments that the SEC is making around which crypto tokens and products should be classified as securities. The SEC lists 13 independent tokens, including large caps like Solana, Cardano, Maddoch, and Filecoin, which, as you can tell, means there's a lot of overlap between the tokens named in the Coinbase suit and the Binance suit. However, some additional tokens have been dragged into this filing with no obvious logic to the choice of targets.

The SEC has also alleged that Coinbase's staking program is a securities offering. In a similar fashion to the Binance allegations, the SEC claims that Coinbase's staking offering involves the skill and discretion of management to provide the staking yield. Interestingly, however, when introducing staking, Coinbase was very particular to set up the service in a way that they believe complied with securities law. So the big difference between Coinbase's staking model versus that employed by Cracken or Binance is that the Cracken slash Binance model took in customer funds, aggregated them, and then used some amount of discretion in deploying them to maximize yield. That obviously fluctuates based on the platform's

ability to generate that yield. Coinbase has always claimed that their product is structured as a completely vanilla pass-through service. Basically, they stake assets, and the staker gets whatever yield the protocol is offering with no managerial input from Coinbase other than a set service fee. Still, the SEC alleged that, quote, investors understand that Coinbase will expend efforts and leverage its experience and expertise to generate returns. Now, if successful, that line of legal argument basically puts all staking as a service offerings at risk of being labeled securities. Now, when it comes to those staking services, in a coordinated effort, 10 state regulators, including agencies from Alabama and California, also piled on top of the SEC lawsuit.

Those orders do not yet prohibit Coinbase from offering their staking services, but the exchange will be required to explain why they should not be directed to cease and desist from selling them on a fairly brisk timeline. Now, moving back to the SEC complaint, the most ambitious legal theory advanced was that Coinbase's non-custodial wallet service, counts as a brokerage and is therefore operated without the appropriate registration. Now, Coinbase's wallet provides a user interface to allow customers to access DeFi protocols to perform basic functions like swaps for which Coinbase charges a small fee. Coinbase has no control over the tokens offered on the DeFi protocols that's wallets connect to,

but regardless of that fact, the SEC claimed that being able to access some tokens via the wallet was enough to allege that Coinbase themselves were offering those tokens for sale. This obviously has huge implications for all providers of self-hosted wallets. if software that can connect to DeFi Protocol, who now might be considered to be operating unregistered brokerages merely by providing software that can connect to DeFi protocols. Meet TC, an anonymous crypto lawyer pointed out just how big of a problem this allegation could be in a Twitter threat. They write, basically, extrapolating this line of reasoning, the SEC is arguing

that if you provide a wallet that can be used to acquire any token available on chain, you are offering and selling those tokens to users of that wallet, regardless of whether you actually handle any of the tokens in question. This is a much bigger deal than anything else in here, in my opinion. Feels like they'll extend this to creators and all other software in the ecosystem, like other wallets, autonomous protocols, and front ends. That's a potentially huge problem and fight. It also seems entirely insane to me, but here we are. Now, unlike the Binance lawsuit, the penalties requested against Coinbase were much more in line with run-of-the-mill securities litigation. The SEC is not asking that either the company nor its executives be banned

from operating in securities markets or obtaining legislation. Instead, the penalty if the SEC is successful would be a large fine, along with the requirement to either register or delist the products that are found to be unregistered securities. That, however, is likely cold comfort to Coinbase. A shock I.R., counsel at Ashbury Legal, painted a picture of just how grave the situation is. For Coinbase, this case is life or death, since it is more concentrated on the U.S. market. Expect Coinbase to litigate this vigorously. It is alleged that virtually their entire U.S. business is illegal. All told, the Coinbase lawsuit looks like the SEC firing all of its guns at once.

We have a wide-ranging attempt to label most crypto tokens as securities. We have allegations that staking services generally are securities. We have the claim that wallet software providers are operating on licensed brokerage services. We even have the concept that beyond simply being unregistered securities exchanges, some companies in the industry are operating in a way that is completely incompatible with the law by rolling exchange, brokerage custody, and clearing all into one firm. Now, Coinbase, for their part, responded in a way that made it pretty clear that they knew or at least believed this to be coming. Brian Armstrong tweeted,

regarding the SEC complaint against us today, we're proud to represent the industry in court to finally get some clarity around crypto rules. Remember, one, the SEC reviewed our business and allowed us to become a public company in 2021. Two, there is no path to come in and register. We tried repeatedly, so we don't list securities. We reject the vast majority of assets we review. Three, the SEC and CFTC have made conflicting statements and don't even agree on what is a security and what is a commodity. Four, this is why the U.S. Congress is introducing new legislation to fix this situation, and the rest of the world is moving to put clear rules in place to support this technology. Instead of publishing a clear rulebook, the SEC has taken a regulation by enforcement

approach that is harming America. So if we need to avail ourselves of the courts to get clarity, so be it. Coinbase also dropped a response video, which again leads me to the conclusion that they thought this was coming, including noting that they mentioned staking in their public S1 report 57 times and met with the SEC in 2022 30 times asking for guidance. Former CFTC Commissioner and now head of policy at A16Z, Brian Quintens, did not mince words. He wrote, The SEC's actions today continue the pattern of an irresponsible regulation by enforcement approach that hurts entrepreneurs, investors, and consumers, while threatening to stifle innovation and drive responsible companies away from the U.S. Enforcement is not a substitute for guidance.

investigating whether specific tokens are securities through enforcement actions against third parties like these exchanges is inappropriate and does little to protect consumers or provide markets with clarity. Note the point that he's making here is that they're not suing the Salana Foundation for Solana being a security. They're suing Coinbase. That means that Salana doesn't have a chance to defend itself to say, no, we're not a security. Quintens concludes, it has been four years since the last meaningful crypto-related guidance from the SEC. Ironically, today's actions come on the heels of Congress putting forward a proposal that would give clear rules, to protect Americans and root out bad actors in the industry. The SEC should be working with Congress and

responsible U.S.-based crypto companies to provide clarity, not deepen the confusion. Now, in case you had any doubt of the media and PR goal here, Gary Gensler scheduled all of the morning talk shows and wasted no time in taking a victory lap. On CNBC, he made the unequivocal statement that, quote, we don't need more digital currency, we already have digital currency. It's called the U.S. dollar. It's called the euro or it's called the yen. They're all digital right now. We already have digital investments. Now, old timers might say, hey, that sounds familiar. Remember on July 11th, 2019, after saying that he was no fan of Bitcoin or other cryptocurrencies, Donald Trump tweeted, we have only one real currency in the U.S. and it is stronger than ever.

It is by far the most dominant currency anywhere in the world, and it will always stay that way. It is called the United States dollar. Good to see that even though they're from different parties, Gensler and Trump agree on this point. Now, the industry piled on to these statements. Chris Black writes, well, there you have it. Gensler blurts the truth out right on national TV. It's not about protecting retail at all.

It's about protecting fiat. Twang V. Lai, the head of policy at Bain Capital, writes, does anyone else think it's a problem that the head of the agency that has declared regulatory authority overall crypto just said he doesn't believe digital currency should exist? Orlando Cosmey writes, I'm so glad that the SEC is technologically neutral.

It sure would be an issue of an unelected government official made policy judgments about the utility of a whole field of technology. Luckily, the U.S. doesn't have to deal with such things. Austin Campbell writes, this is a clear statement the SEC intends to ban crypto and decide for Americans what innovation they are allowed to participate in and what investments they are allowed to make. China would blush at this level of state control. Now, Miles Jennings General Counsel at A16D wrote a nice threat about this. The SEC's actions today make clear what many in the industry have long suspected. Under the direction of Chair Gensler, the SEC's endgame for crypto and Web 3 in the United

States is about one thing, banning the technology. In pursuit of this goal, the SEC has fostered uncertainty by refusing to engage the industry proactively, even though this approach has led to significant investor harm, royal markets, and hindered capital formation and contravention of the SEC's three-part mission. Crucially, this uncertainty gives the SEC leverage. If nobody knows the rules, the SEC gets to make them up as it goes. Neither good actors nor bad actors can defend themselves against such an approach. Show me the man and I'll show you the crime. But this leverage also appears to be slipping away. We're only a few days removed from an incredible effort in Congress to provide clarity, and the CFTC chair is even testifying today about his agency's authority and the benefits of decentralization.

Against this backdrop, today's action against Coinbase feels like a rushed attempt to force it into a registration regime that could enable the SEC to ban Web 3 in the U.S. before its leverage wanes. And indeed, many people right now are speculating that the timing of this has much to do with the release of the McHenry-Thompson Cryptomarkets Structure draft discussion bill last week. I talked about this on Monday, but the bill is a rare collaboration between the House Financial Services Committee and the House Ag Committee. This bill marks a turning point for Congress in demonstrating the most serious attempt to date at getting legislation on the books.

Now, on Tuesday, while news of the Coinbase lawsuit shook the industry, the House Ag Committee held a hearing to discuss the draft with CFTC Chairman Rosten Benham and a group of high-profile industry figures, including Coinbase chief legal officer Paul Gruel. Now, Democrats noted the complexity of the bill, complaining that they had been given less than a week to digest it. Numerous committee Democrats pointed out the lack of a funding mechanism and wrung their hands at the prospect of paying to expand the regulatory agencies tasked with overseeing the market. Benham's main critique as head of a regulatory agency was that the bill would create a provisional registration period to act as a safe harbor against enforcement while crypto firms come

into compliance. He argued that this would be quote-unquote handcuffing regulators. Justin Slaughter, the policy director at Paradigm, points out the politics of all of this. Strategically, he writes, the SEC really needs to keep House Dems away from the negotiating table on McHenry Thompson. Once Dems start suggesting there are specific changes to the legislation they'd need to support it, the bill's odds of passage go up. Traditionally, the number one way to prevent Congress from doing something on an issue is for there to be active litigation on the issue.

Kills oversight, letters, testimony, legislation. The more major cases the SEC has active against major crypto players, the harder it will be for Democrats in the House to sign on legislation on crypto. The danger is, what happens if the SEC starts losing? Or worse, if the SEC loses a big case at SCOTUS, with the court saying crypto products aren't securities, and the SEC needs legislation to regulate and enforce on crypto. If that happens, the McHenry-Thompson bill is off the table,

and any legislation on crypto is very light touch at best. So is there an upside? Well, Jim Bianco wrote, What is happening in crypto this week is bullish? The SEC and Gensler put their cards on the table. Now they can go to court and ask a judge about those cards. I don't think Gensler will like what the court will say. Indeed, related to that, in the lawsuit launched against the SEC by Coinbase in April, the court has made a fairly substantial ruling. Now you'll remember this case revolved around Coinbase's petition for rulemaking filed in July last year,

with Coinbase seeking a court order that the SEC must respond to that petition in a more timely manner. The SEC claimed they need to do nothing of the sort, citing precedent which they said meant they could drag their heels for a decade or more before making a decision on whether crypto rulemaking is necessary. Coinbase's argument was that the regulator had already made up its mind to deny the petition, but had not announced this to avoid that decision being challenged in court. On Tuesday evening, the judge overseeing the case issued an order specifically referencing Gensler's public comments and congressional testimony in which he stated that current regulations are sufficient for digital assets. In light of those comments, the SEC was ordered to present

a letter to the court explaining, quote, whether the SEC has now decided to deny Coinbase's petition for rulemaking. If not, how much additional time the SEC requires to decide whether to grant or deny that petition, and why the court should not impose a timeline for the SEC to make a decision. The SEC was given just seven days to explain themselves. Now, this order was widely viewed as the court essentially telling the SEC that they were ready to rule in Coinbase's favor, unless the regulator can come up with a good reason why they shouldn't. Attorney Collins-Belton writes,

Even circuit judges are trying to figure out if Gary Gensler's public statements on places like Squawk Box are supposed to be formal agency stances. So, friends, there you have it. I tweeted yesterday something to the effect of, isn't this all their shots? Do they have anything else? And the only one that some pointed out, which is true, is that they could come directly at the claim that Ethereum is a security as well.

Maybe it's all just building up to that, I don't know. But what's clear is that we're in some sort of endgame, and we're moving to the courts next. I'm no lawyer, but I got to think that's better for us than what we've had so far. So there is a bleary, chaotic sort of optimism that I feel as well. But in the meantime, yeah, man, it's weird to be in an industry that so many people seem to hate so much, and the powers that B want dead so badly.

But we are nothing, if not cockroaches and survivors, so good luck, Gary. Until next time, be safe and take care of each other. Peace.