Attorneys for Coinbase (NASDAQ: COIN) have admitted that the speculative tokens on the digital asset exchange are little more than digital Beanie Babies.
On January 17, Coinbase and the Securities and Exchange Commission (SEC) delivered oral arguments before U.S. District Judge Katherine Polk Failla in a Manhattan federal court. The five-hour hearing was based on Coinbase’s motion to dismiss the SEC’s June 2023 complaint accusing the exchange of offering unregistered securities to the public.
Failla isn’t expected to deliver her verdict on the motion for several weeks or possibly longer, but Coinbase supporters are already claiming victory based on what they perceived was Failla’s slightly more skeptical view of the SEC’s arguments than those put forward by the exchange’s lawyers.
Instead of quizzing both parties simultaneously, Failla opted to proceed on an individual basis, first putting the SEC’s Patrick Costello under her spotlight then lobbing questions at Coinbase’s hired gun William Savitt. We won’t recap the entire marathon, but here’s a few highlights.
Early on, Failla told the participants that she had “decided nothing.” She suggested that she might end up deciding that some of the four services cited in the SEC’s complaint—general token sales, Coinbase Prime for institutional customers, the Coinbase Wallet, and the exchange’s staking service—are permissible, while others are not.
One of the day’s more surprising areas of agreement was when both sides stated that none of the 13 tokens cited in the SEC’s complaint were securities on their own. When Costello admitted as much, Failla indicated the Coinbase attorneys, saying: “That’s what the folks in the back table think. And they are wondering why we are here.”
Costello clarified that while the tokens weren’t securities on their own, transactions involving these tokens can be investment contracts (a key plank of the Howey test). A customer buying a token on Coinbase is “investing into the networks behind it. One cannot be separated from the other. When the value of the network of the ecosystem increases, so does the value of the token.”
Failla appeared skeptical that token purchases triggered all the planks of Howey, including whether buyers automatically expect profits due to actions of the developers of those tokens or that they are buying into a “common enterprise.”
When Savitt got a chance to speak, he countered that tokens weren’t securities because purchasing them didn’t give the buyer the right to receive dividends or other perks associated with traditional stock or bond purchases. Moreover, token buyers sign no contracts and receive no “statement that is meant to convey an enforceable promise” of profits derived from others’ efforts.
Utility, baby
In questioning how broadly the SEC was prepared to extend its definition of ‘security,’ Failla expressed her “real fear” that the SEC’s wide-ranging views could “implicate either collectibles or commodities.” Failla mused about having to adjudicate a future class action brought by the purchasers of Beanie Babies—stuffed toys that briefly caused a frenzy of speculation in the 1980s due to the perceived scarcity of certain models—against their issuer.
Powell rejected this possibility, saying the value of collectibles was independent of any actions by their issuers. “There’s no way for somebody to make a baseball card more valuable.”
Savitt later reconnected this argument to the distinctions between buying stocks and buying tokens, which he equated to “the difference between buying Beanie Babies Inc. and buying Beanie Babies.”
At one point, Failla asked Savitt why one buys a token at all. Savitt said he wasn’t going to try to rebut the SEC’s contention that people buy tokens on Coinbase believing they’ll increase in value but suggested that was only one of the reasons customers bought any of the 13 tokens specifically cited in the SEC complaint.
Other reasons Savitt cited include investment (without an increase in value?), a desire to ‘swap and trade’ (for funsies?), and utility (ahem). With respect, the ‘utility’ of the 13 tokens named in the complaint is transferring the buyer’s fiat currency to the issuer, after which identifying the token’s utility becomes the buyer’s problem.
Savitt’s ‘yes, tokens are Beanie Babies’ argument was meant to support his client but unwittingly exposed the rot behind Coinbase’s entire ‘crypto casino’ model. To wit: the tokens on offer are good only for placing another bet on which function-free token might ‘moon’ when the roulette wheel comes to a stop.
To be fair, that’s in line with Coinbase marketing. Consider their recent Update The System videos, which appear to equate trading on Coinbase with empowering young adults to somehow escape debt and build, er, something better. Call us crazy, but it almost sounds like some kind of expectation of future profits has been established, provided one were to join some kind of common enterprise.
Stake through the heart
When the discussion turned to Coinbase’s staking program, Powell argued that the exchange had established an investment contract by building its program on top of an established blockchain (Ethereum). Savitt countered by saying users retained ownership of the staked tokens, with Coinbase’s role limited to serving as a hired hand.
Failla may have tipped her hand on this front by repeatedly praising the DeFi Education Fund (DEF) amicus curiae brief from last August, which she described as “really fine” and “very interesting.” Failla particularly appreciated the DEF’s explanation of staking, which she said “makes more sense to me than the Commission’s description of it in the complaint.”
Major questions
Part of Coinbase’s defense involves the so-called ‘major questions’ doctrine, a theory that says areas not specifically delineated by legislation are best left to legislators, not government agencies, to resolve. Even before Wednesday’s hearing, Failla appeared sympathetic to this view, although that may not necessarily play in Coinbase’s favor here.
Last August, Failla dismissed a class action complaint brought by users of the Uniswap decentralized exchange, saying the protocol’s lack of centralized ownership structure meant that token issuers’ identities were “basically unknown and unknowable, leaving Plaintiffs with an identifiable injury but no identifiable defendant.” Failla also suggested that “the current state of cryptocurrency regulation leaves [plaintiffs] without recourse.”
On Wednesday, Failla expressed “concern” that the SEC was asking her to “broaden the definition of what constitutes a security.” However, she told the Coinbase team she was equally worried that she was “doing exactly the thing that you’re arguing the Commission is doing here, which is to take power I don’t have to stop activity I shouldn’t be stopping … The answer may be that I’m just out of luck until Congress acts.”
Sell the news… hell, sell everything
While Coinbase fans were quick to proclaim their side the winner of Wednesday’s debate, the markets don’t seem as enthused. Coinbase’s share price fell more than seven percent on Thursday, which may or may not reflect investors’ own view of Wednesday’s proceedings.
Coinbase’s shares were also dragged down by a JP Morgan analyst’s warning that the drastic competitive fee-cutting that preceded last week’s launch of 11 BTC spot-based exchange traded funds could erode Coinbase’s trading volume and already thin margins.
The potential reduction in trading fees is projected to be greater than the fees that Coinbase will earn from serving as the BTC custodian for eight of the 11 ETFs. Worse, those fees could one day vanish once the tradfi entities behind most of the ETFs grow more comfortable with (a) the concept of self-custody and (b) cutting out the middleman.
These concerns aren’t necessarily new, but given that Coinbase could post its eight consecutive loss-making quarter when its Q4/FY23 numbers are released next month, investors have a right to question the company’s ability to get back into the black.
That view may have convinced one of the exchange’s co-founders to dump another eight-figures’ worth of his shares while the dumping’s good. On January 12, Fred Ehrsam III sold $13.1 million in Coinbase stock, bringing his seven-week total to just under $80 million. Ehrsam is the lone Coinbase director to have actually bought any company shares over the past two years, but he’s been in sell-only mode since November. Think he knows something rank-and-file investors don’t?
This all could be unnecessary
The SEC v Coinbase suit could prove moot if the U.S. Supreme Court strikes down the longstanding legal precedent known as the Chevron deference. The Court heard arguments this week regarding a case involving the National Marine Fisheries Service charging fishing vessels a fee to fund data collection efforts that ensure proper conservation and management of the fishing industry.
The case could have a sweeping impact on all federal agencies by prohibiting them from enforcing edicts not explicitly granted to them by Congress. Since its adoption in the 1980s, the Chevron deference has been used in over 17,000 legal cases, a testament to the often vague language of legislation that emerges from Capitol Hill.
Obviously, the SEC would have its own wings clipped if, as expected, the Court sides with the plaintiffs seeking to overturn Chevron. With digital assets not explicitly referenced in the existing securities legislation that preceded their arrival by decades, the SEC would find its hands tied until Congress gets off its ass and actually approves bespoke digital asset legislation. Which, given the current dysfunction in the House of Representatives, could be never.
Attorney Paul Clement, a former U.S. Solicitor General who argued the plaintiffs’ case for the plaintiffs before the Supremes, specifically referenced the efforts by SEC chair Gary Gensler to address “the uniquely 21st century phenomena of cryptocurrency” using “a couple of statutes passed in the 1930s.” Given the political leanings of the current court, ‘crypto’ could well be heading into its second golden age of lawlessness.
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