Coinbase, one of the largest cryptocurrency exchanges in the world, is facing a lawsuit from the US Securities and Exchange Commission (SEC) over its alleged violation of securities laws. The case revolves around whether some of the digital tokens traded on Coinbase’s platform are considered investment contracts and thus subject to SEC regulation. Coinbase’s chief legal officer (CLO) Paul Grewal has recently called out the SEC for its lack of clarity and consistency in defining what constitutes an investment contract and urged Congress to intervene and provide a clear framework for the crypto industry.
The legal dispute between Coinbase and the SEC started in September 2023, when Coinbase announced its plan to launch a new service called Coinbase Lend, which would allow users to earn interest on their crypto holdings by lending them to other users. The SEC claimed that this service would involve the offering of securities, namely the tokens that would be used for lending, and demanded that Coinbase register them with the agency or stop the launch. Coinbase argued that the tokens were not securities, but rather utility tokens that facilitated transactions on its platform, and that the SEC had not provided any clear guidance or rules on how to determine whether a token is a security or not.
Coinbase decided to sue the SEC in October 2023, seeking a declaratory judgment that the tokens in question were not securities and that the SEC had no authority to regulate them. Coinbase also accused the SEC of engaging in “regulation by litigation”, meaning that the agency was trying to impose its views on the crypto industry through lawsuits rather than through rulemaking or legislation. Coinbase claimed that the SEC’s actions were harming innovation and competition in the crypto space and creating uncertainty and confusion for investors and developers.
SEC’s Broad and Vague Definition of Investment Contract
The key issue in the case is how to apply the so-called Howey test, which is a four-part test derived from a 1946 Supreme Court case that defines what constitutes an investment contract and thus a security under federal law. According to the Howey test, an investment contract is a contract, transaction, or scheme whereby a person invests money in a common enterprise and expects profits solely from the efforts of a third party. The SEC has argued that the Howey test is flexible and adaptable to different contexts and that many of the tokens traded on Coinbase’s platform meet the criteria of an investment contract.
However, Coinbase has challenged the SEC’s interpretation and application of the Howey test, arguing that the agency has failed to provide a clear and consistent definition of what constitutes an investment contract in the crypto context. Coinbase has also pointed out that the SEC has not issued any formal rules or guidance on how to apply the Howey test to crypto tokens, but rather has relied on enforcement actions and public statements that are often contradictory and confusing. Coinbase has cited several examples of the SEC’s inconsistent and arbitrary approach, such as:
- The SEC has not taken any action against other crypto platforms that offer similar lending services as Coinbase, such as BlockFi and Celsius.
- The SEC has not explained why some tokens, such as Bitcoin and Ethereum, are not considered securities, while others, such as Ripple’s XRP, are.
- The SEC has not clarified how the Howey test applies to tokens that have multiple functions and uses, such as governance, utility, or payment.
- The SEC has not distinguished between primary and secondary markets for tokens, meaning that the agency could potentially regulate any token transaction, regardless of whether it involves the issuer or not.
Coinbase CLO Calls for Congressional Oversight Over SEC
In a recent post on X, Coinbase’s CLO Paul Grewal has called for Congress to step in and provide a clear and comprehensive regulatory framework for the crypto industry, rather than leaving it to the SEC to define and enforce its own rules. Grewal has stated that the SEC cannot “unilaterally expand and redefine its own regulatory ambit” and that this should be left up to Congress and the ongoing legislative discussions about regulatory frameworks that are currently taking place. Grewal has also expressed confidence in Coinbase’s legal arguments and hoped for a decision that will bring clarity and certainty to the industry. He has said:
Today we made arguments in our motion to bounce the @SECgov suit against @Coinbase. After hours and hours, this much remain clear: the SEC continues to claim broad authority over all investments while offering no limiting principle to its definition of investment contract. 1/4
The SEC cannot unilaterally expand and redefine its own regulatory ambit. This should be left up to Congress and the ongoing legislative discussions about regulatory frameworks that are currently taking place. 2/4
Coinbase does not offer securities. We are confident in our legal arguments and look forward to a decision that will bring much needed clarity to our industry. 3/4
We are grateful to the court for the opportunity to present our case and hope for a favorable outcome at the end of this lawsuit. 4/4
The outcome of the case between Coinbase and the SEC is expected to have significant implications for the crypto industry, as it could set a precedent for how crypto tokens, especially those involving lending, staking, or other forms of interest-earning, are regulated in the United States. The case could also influence the future of innovation and competition in the crypto space, as well as the protection and empowerment of investors and consumers.
