Why the SEC cracking down on Coinbase could level the crypto playing field

The hands-off regulatory position the U.S. Securities and Exchange Commission (SEC) has long taken when it comes to managing cryptocurrencies appears to be coming to an abrupt end.

On Tuesday, Coinbase co-founder and CEO Brian Armstrong went public with the battle he says the SEC has now picked with his company's proposed lending product. In a long thread on Twitter, Armstrong chronicled his attempts to work with the SEC to explain how the company's customers would be able to earn interest on their crypto assets. After months of open dialogue, Armstrong claims the SEC shut talks down and threatened to sue Coinbase if they launched the service.

At the heart of Armstrong's issue is that other crypto platforms have already been offering interest on crypto assets, similar to the way banks pay interest on cash deposits. In his thread attacking the SEC for what he called "sketchy" and “intimidation tactics behind closed doors,” Armstrong also bemoaned that "plenty of other crypto companies continue to offer a lend feature, but Coinbase is somehow not allowed to."

6/ They refuse to tell us why they think it's a security, and instead subpoena a bunch of records from us (we comply), demand testimony from our employees (we comply), and then tell us they will be suing us if we proceed to launch, with zero explanation as to why.

— Brian Armstrong (@brian_armstrong) September 8, 2021

But the question around what exactly the SEC sees as above and below board in the crypto space has been boiling for years. The agency has punted on opportunities to more clearly define what might be a security in crypto — only going as far as saying that bitcoin and ether, the two largest cryptocurrencies by market cap, are most likely not securities. In regards to stablecoins, the cryptocurrencies that maintain a peg to the dollar or other base currencies, the SEC had not previously made them a priority. The Federal Reserve, however, had been sounding the alarm over the impact a run on stablecoins could have for the traditional financial sector.

Wall Street veteran Caitlin Long, now also the founder and CEO of Avanti Bank, one of the first crypto platforms to win a banking charter, told Yahoo Finance that even though the SEC hasn't taken issue with companies offering interest on crypto before doesn't mean they wouldn't want to make an example out of Coinbase.

"We’ve seen that before with the SEC. They will pick one or two 'problem children' if you will," she said on Yahoo Finance Live. "Typically it’s cases that are easy for them to win in court and that’s how they move the market from an enforcement action perspective."

Example setting

That could spell problems for companies like BlockFi and others, which have already offered interest-earning accounts to crypto holders for years. BlockFi, which offers interest rates at roughly 120-times the national savings rate at most banks, recently ran into problems with smaller regulators around claims those accounts also qualified as securities. New Jersey hit BlockFi with an enforcement action to stop offering interest accounts for new customers. More states followed suit this summer, all while the company defended its accounts as lawful.

What's perhaps more problematic, however, is the example it sets for trying to work with the SEC to follow the rules, Long says. To be met with the threat of a lawsuit after months of dialogue with the SEC doesn't exactly invite others in crypto to work to seek approval from the agency.

"If you take Brian Armstrong’s word for it — that they were engaging with the SEC for six months and then all of a sudden the door slammed shut — again, those of us in the industry, my company included, who are actively seeking regulatory permission before we do things are having more trouble than those who are just ignoring the law and going forward," she said. "And frankly, the joke is on the ones who are trying to get regulatory approval right now because that really has not been forthcoming."

Suddenly, the proverbial regulatory axe might be dropping. SEC Chair Gary Gensler has a few months under his belt since he was sworn in back in April. Whether he follows through on using litigation as his preferred form of regulation or not could set the tone for all of crypto — not just the giants like Coinbase.

Zack Guzman is an anchor for Yahoo Finance Live as well as a senior writer covering crypto, cannabis, startups, and breaking news at Yahoo Finance. Follow him on Twitter @zGuz.

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