(Bloomberg) – Coinbase Global Inc. knew all along that it could be in trouble with regulators.
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More than two years ago, when the crypto exchange filed with the U.S. Securities and Exchange Commission to begin publicly trading its shares, it said there was a "high degree of uncertainty." regarding the legality of its operations, warning that "regulators may disagree". with the company's view that this was not covered by their rules.
That possibility became a reality on Tuesday, when the SEC sued Coinbase for failing to register with the agency as a broker, exchange, or clearing house — all roles the company plays in a cryptocurrency market. currency where many tokens are, according to the agency, actually unregistered securities. The regulator also alleged that Coinbase's staking program, which allows customers to lock up their coins in exchange for a share of the rewards offered by various blockchains, also violates securities laws.
The charges came a day after the SEC filed a similar lawsuit against rival Binance Holdings Ltd., marking a sharp escalation in its efforts to rein in an obscure industry that has burned investors with outbursts like the FTX collapse l 'last year. The SEC's push is particularly heavy for Coinbase, which generated more than 80% of its revenue in the United States last year and now faces a near-existential threat to its business model.
“For Coinbase, this case is a matter of life and death because it is more focused on the US market,” said Ashok Ayyar, attorney at Ashbury Legal. “Expect Coinbase to argue vigorously – it is alleged that nearly all of their activity in the United States is illegal.”
Chairman and CEO Brian Armstrong responded to the lawsuit on Twitter, saying he was proud to represent the industry in court. He repeated his defense that the SEC had reviewed its business and allowed Coinbase to become a public company upon filing the action. Yet the regulator made it clear in its complaint that approving the company's proposed IPO did not amount to giving its business model the green light: "Declaring a Form S-1 registration statement effective does not constitute an opinion by the SEC or staff on, or endorsement of, the legality of an issuer's underlying business."
Legal experts are inclined to agree.
"Coinbase has publicly asserted that going public means the SEC has somehow endorsed their business or its legality - that's a mistake," Ayyar said. “Going public simply means that the SEC reviews the offering prospectus and that the document meets the filing requirements. It is not a stamp of approval for the company, its products or its activities.
Armstrong said the company plans to challenge the SEC to get more legal clarity for its industry. One of the main issues will be which of the thousands of cryptocurrencies on the market are considered securities. Altcoins — tokens other than Bitcoin and Ether — accounted for nearly half of Coinbase's trading revenue in the first quarter of this year, according to a letter to shareholders. In its lawsuit, the SEC said several of these exhibits are securities.
Oppenheimer & Co. analyst Owen Lau predicts a long-term legal battle. While the company may operate normally in the short term, he said, the potential reputational damage caused by the SEC's claims could cause users to withdraw their money from the platform. During the first quarter, Coinbase's revenue was already less than a third of its peak at the end of 2021. Over the past two days, its shares have fallen 20%.
Longer term, Coinbase faces a bigger hit if the SEC lawsuit prevails. The case could force the company to stop providing custody and trading of coins considered securities, threatening much of its business.
"If the SEC stops Coinbase from trading certain tokens it considers securities, it could have a huge impact on Coinbase's financial health," Lau said. “I would say revenue at risk could be over 50%.
But, he added, the SEC may not prevail on all charges: "The caveat is that the likelihood of losing it all could be very low."
The SEC may also seek to compensate customers who traded unregistered securities on Coinbase, according to John Reed Stark, consultant and former head of the SEC's Office of Internet Enforcement.
"The SEC would determine a penalty amount and a restitution amount and find a distribution agent to distribute the funds to the harmed investors," he said.
--With the help of Olga Kharif and Emily Nicolle.
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