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Coinbase insider trading case highlights SEC, CFTC crypto turf war

cryptocurrency regulation

Yesterday a former Coinbase employee and two others were charged in two lawsuits relating to insider trading. The ex-employee, Ishan Wahi, allegedly tipped a relative and friend with advanced knowledge that tokens were to be listed on the cryptocurrency exchange. They made between $1.1 million and $1.5 million on the information. One of the lawsuits is a criminal one, but the other is a civil one brought by the SEC that includes claims that nine tokens involved in the alleged insider trading are securities. 

There’s much debate about whether the CFTC or SEC should have jurisdiction over spot cryptocurrency transactions. In a statement, CFTC Commissioner Caroline Pham says the SEC lawsuit is a ‘striking example of regulation by enforcement.’ Fellow Commissioner Kristin Johnson took a more conciliatory approach, saying that regulators and law enforcement stand united and “prepared to enforce against such predatory and abusive behavior.”

However, the newly appointed Commissioner raised concerns that differences between regulators could be exploited. “We must continue to work collaboratively to adopt a whole-of-government approach to prevent bad actors from taking advantage of important policy and regulatory debates,” she said.

Within roughly six weeks, President Biden’s executive order requires a combined report from the Treasury and agencies suggesting legislative and regulatory steps. Perhaps that’s not going swimmingly.

The SEC has long taken the stance that most cryptocurrencies are securities, including before Gary Gensler became SEC Chair. The lawsuit against Ripple, alleging XRP is a security, was not initiated under Gensler’s watch.

On the one hand, XRP, for a long time, was a special case with a close association with Ripple, including its influence over which nodes could write data. 

At the same time, it’s not clear why Ethereum should be treated as a commodity and other tokens not. The sufficiently decentralized test seems a little loose. For example, large volumes of Ethereum transactions pass through Infura and the Metamask wallet, products developed by an Ethereum co-founder’s company. 

So requests for clarity appear valid. But that lack of clarity doesn’t mean the SEC is wrong on everything.

Coinbase pushback

For more than a year, Gensler has been banging the drum that crypto exchanges and lenders need to register with the SEC.

If the SEC wins the insider trading lawsuit, then by definition, Coinbase is an unregistered securities trading venue. Hence it’s no surprise that Coinbase is pushing back. 

Its Chief Legal Officer Paul Grewal said on Twitter last night, “Coinbase doesn’t list securities. Period.” He continued, “We have cooperated with both the DOJ and the SEC on this investigation. The DOJ reviewed the same facts and chose not to file securities fraud charges against those involved.”

Coinbase Chief Policy Officer Farya Shirzad penned a blog post on the topic and filed a petition asking the SEC to begin rulemaking on digital asset securities, stating the “existing rules for securities just do not work for digital assets.” The post distinguishes between digital assets that are commodities versus those that would be considered securities.

This isn’t the first run-in between Coinbase and the SEC. Last September, the SEC warned Coinbase not to launch a lending offer, stating that crypto lending would be considered a security. It also reached a $100 million settlement deal with lender BlockFi, which agreed to launch lending offerings as securities in the future. BlockFi suffered significant losses during the crypto crash.

It makes one think: What would have happened if Coinbase had proceeded with a crypto lending product? Would its strong risk management have protected clients’ funds? Or, in a race to keep up with competitors that were offering high deposit rates, would it have taken similar risks? Because any lending fallout would have impacted all its clients, not just Lend clients. If the SEC hadn’t dissuaded Coinbase, there’s a possibility the crypto crash might have had a far more damaging effect on the entire crypto ecosystem. 

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