Coinbase was planning to launch a cryptocurrency lending service, but the Securities and Exchange Commission (SEC) has threatened to take legal action if it proceeds. That’s according to a blog post by Coinbase’s Chief Legal Officer, Paul Grewal, and a Twitter thread by Coinbase’s CEO Brian Armstrong. The SEC is alleging that a crypto loan is an unregulated security. Coinbase claims that the SEC hasn’t clarified why crypto lending is considered a security. However, the blog post revealed a legal case upon which the SEC says it’s relying.
The United States legal system relies on case law, so by providing the case the SEC IS providing the reason.
Why crypto lending is considered risky
As context, crypto lending has been happening for some time but only took off in a big way last year. Without any supervision, there’s not a lot stopping crypto lenders from running massive Ponzi schemes. Just last week, the SEC started litigation against one that cost investors $2 billion, and that one had a lot of red flags.
Rates offered for deposits of Bitcoin, Ether and especially stablecoins can be pretty high. Currently, centralized crypto lender BlockFi is offering 7.5% and Nexo offers 12%. These are not entirely risk-free because BlockFi is “in part, funding its lending operations and proprietary trading through the sale of unregistered securities in the form of cryptocurrency interest-earning.” That’s according to the State of New Jersey, one of the multiple states to issue a cease and desist order to BlockFi.
In other words, the assets being ‘deposited’ aren’t just sitting around. They are being used for relatively risky activities. Arguably centralized lenders such as BlockFi, Celsius and Nexo are higher risk than decentralized or DeFi lenders like Compound and Aave. The reason is there is little oversight over the centralized lenders, and there is at least some transparency with Compound and Aave through blockchain explorers. The latter both offer around 3.2% on USDC stablecoin deposits. Higher interest rates offered by centralized lenders partly reinforce this risk differential.
And it’s a growing industry. BlockFi currently has around $10 billion in assets under management which we believe is down from $15 billion a few months ago. Nexo and Celsius each claim to have more than $15 billion.
The SEC’s case
The SEC put forward the old Howey case law test for a security, but also the 1990 Reves case. This clarifies which loan notes are considered securities and states that those redeemable on demand – as opposed to those longer than nine months – can also be considered securities in part because the redemption date is unclear (and hence could be far longer than nine months.)
All loan notes are considered securities unless they are within specific categories outlined in a previous case. The exceptions are:
- a note delivered in consumer financing
- a note secured by a mortgage on a home
- a short-term note secured by a lien on a small business or some of its assets
- a note evidencing a ‘character’ loan to a bank customer
- short-term notes secured by an assignment of accounts receivable
- a note which simply formalizes an open-account debt incurred in the ordinary course of business, particularly if collateralized
- notes evidencing loans by commercial banks for current operations.
While it’s perfectly understandable that Coinbase thinks it’s ‘unfair’ that it can’t do crypto lending while others can, the SEC has already made clear it considers crypto lending as a security. And by providing the case law, it arguably is giving the reasons, leaving Coinbase’s professional legal team to provide an interpretation.
That’s not to say that the courts will agree with the SEC’s interpretation of the case law.
There’s also the obvious point that if Coinbase started offering crypto lending services, the scale could be more significant than it has been so far. And not just for lending but also for stablecoins because crypto lending has been a major driver behind stablecoin growth in the past 18 months. And crypto lending fuels crypto prices.
The author is not a lawyer and this is not legal advice