The SEC just flipped on crypto, they’re threatening Coinbase with a lawsuit over their lend product. This is a huge deal because Coinbase sets the standard for all the other platforms in crypto. Whatever happens to Coinbase will inevitably happen to everybody else in this space because it’s like a domino effect.
If you’re somebody who likes to keep their coins on an exchange and you like to earn interest then this will affect all of us because this could be the beginning of the end of earning that passive income. In today’s article, I want to go over exactly everything that’s going on and what’s about to happen because it’s important.
Their latest product is something called lend and it’s exactly what it sounds like. We lend our stable coins namely USDC, in which remember one coin equals one dollar, to other people to earn 4% interest.
At the bottom of that product page on Coinbase’s website, there are two things; the first is the boring interest rates are subject to change but the second one is much more important and it’s directly referencing the SEC. It says Lend is not a high-yield USD savings account and Coinbase is not a bank. Your loan crypto is not protected by FDIC or SIPC insurance and this is where the real story begins.
The SEC enters the scene and sends Coinbase something called a wells notice tells Coinbase they’re about to get sued. So the CEO of Coinbase Brian Armstrong started a tweetstorm and it got a ton of attention, and for good reason.
Here’s what Brian himself had to say about the situation, in a tweet 21-part tweet story:
This is the main gist of it, you can read the rest here, on Brian’s Twitter feed: https://twitter.com/brian_armstrong/status/1435439291715358721
So we asked the SEC to help us understand and share their view because we always make an effort to work proactively with regulators and keep an open mind. They refuse to tell us why they think it’s a security with zero explanation. On the surface it does seem like Brian has a really good point, why would the SEC try to sue Coinbase over stable coins? If the SEC has never clearly labelled stable coins as securities.
Securities are things like stocks, bonds, treasury notes and that’s what they are when we think about them but there’s a plot twist, there are two important things we need to understand. The first one is something called the Howey test. This is the brainchild of the Supreme Court and they created it to figure out if something is a security and it does this by asking one really easy question.
Is it an investment contract?
There are four ways to figure out if it is.
- Is it an investment of money? In this case, holding USDC is not an investment so I would say this does not apply.
- It asks is it in a common enterprise? Yes, it is. Coinbase is a common enterprise. No. 2 is a check.
- Is there an expectation of profit? we expect to earn interest on our money so absolutely there is an expectation of profit.
- Is it derived from the efforts of others? in this case other people take the effort of borrowing our money which we then earn interest on.
This right here means that we fail three out of four of the Howey questions. The Howey test means that more than likely, we are a security and unfortunately this is just an outdated really old test that the SEC uses to figure out whether something is or isn’t a security.
Let’s say you disagree with me on all of this and you have your own opinion. But there’s something even more bulletproof as an argument against us and that is the securities act of 1933. It’s sneaky and this is why crypto’s really in trouble. This is directly from the document “The term security means any note stock treasury, stock security, future security-based swap, bond, debenture…”
It goes on to say something really interesting, and this is the most important part evidence of indebtedness, certificate of interest or participation in the profit-sharing agreement. So clearly the securities act of 1933 on literally page one has the words indebtedness and interest in it. That means technically because someone is going into debt by borrowing our USDC and we are then earning interest on it this can be argued in court that this is indeed a security.
Although this is a digital currency and that’s not going to stand up in court. That’s like saying well this is different because it’s got 1’s and 0’s and it’s on a computer screen.
It makes perfect sense because in 2008 when we had the collapse that happened as a result of greedy lending of debt securities. That is why debt and lending can be classified as a security even though when we think of securities, we think of them as things like stocks and bonds.
They’re nouns whereas lending is more of a verb, but again we lent debt securities in 2008 and we had that collapse. It was the SEC’s job to make sure that 2008 didn’t happen but it did and that’s how we can classify these USDC coins.
This should not be a surprise because Block5.io has been dealing with this same problem, their interest rates were in the mid 5% range. It was going well but then they dropped the rates which was weird because now bitcoin and crypto have recovered but their rates never did.
The statistics show that interest rates have stayed flat despite the prices increasing. This means there’s some external factor that’s affecting these interest rates and I could be wrong but I think it’s because states have started to issue cease and desist letters.
States like New Jersey, Vermont, Kentucky and Texas. But these states have told BlockFi that they violated the securities act. It looks as though states have started to crack down on Crypto and they’re making BlockFi an example and maybe they’re going after Coinbase now too.
The SEC has a close working relationship with the banks and they have an incentive to protect the legacy banking system. Allow me to pose a question, what would happen if the SEC allowed these platforms to exist and to continue paying us 5%+ on stable coins currencies that are arguably just as good as the dollar?
They’re stable and they’re not volatile, they don’t fluctuate in value and at that point, you’d have no incentive to keep your money in the bank when the national average is 0.6% on your savings account.
The average person would just transfer it over to these platforms where it’s equally as safe and you’d earn 10x more instead of having your money eroded by inflation. So if you follow the money logic it makes perfect sense why the SEC has this newfound pressure to regulate what’s going on. This kind of narrative is also helped by people like Brian Armstrong, the CEO, he’s like who are they trying to protect and what’s the harm?. Maybe they’re protecting the banks here, so that’s the first theory.
The second theory is regulators have no idea what they’re dealing with, they don’t understand crypto. The SEC has a responsibility; on one hand, they need to make sure that 2008 doesn’t happen again but on the other hand, they can’t blanket ban crypto and stable coins because that would limit innovation.
If we did that, people would create those jobs that technology and those opportunities somewhere else. We don’t want to do that but we want to make sure things don’t spiral out of control as they did during the credit crunch.
How do we do that?
Enter Gary Gensler, he’s like the good guy and the bad guy in this story but he’s the bad guy because his job is to regulate this stuff. He’s the head guy in charge of the SEC that regulates things; very hands-on. He looks at every platform and every coin on a case-by-case basis and to the outsiders, it looks as though he’s playing favourites for CEO’s like Brian Armstrong, who feels singled out.
Why is Coinbase not allowed to do this?
When BlockFi and Celsius and other platforms can pay interest to customers. Gary’s like the parent who’s bad at explaining. Allow me to explain Gary’s perspective in a way that’s a little bit more eloquent and makes sense. Every institution makes money in different ways. Voyager for example, pays interest based on the profit it makes from the bid and ask spread on their customers. For example if you were to buy $1,000 worth of Bitcoin on Voyager they would find that Bitcoin for $999 and they get to keep that $1, and with that $1 of profit that’s what they would use to pay us interest.
That is not the same as Coinbase’s interest model which lends our stable coins to their clients. That is perceived as a much riskier model than what Voyager is doing so even though the end result looks the same clients or customers earn interest it is mechanically very different.
The SEC is more interested in paying attention to the mechanics of how this interest rate model works and the sheer size of it. Coinbase is exponentially bigger than voyager it has a lot more influence over the Crypto industry that Gary feels like he needs to keep a closer eye on.
That is why some platforms are less regulated and why some coins are less important to the SEC because of size and the interest rate model, not necessarily because they’re trying to protect the legacy banking system.
What does all this mean and where are we going?
Interest rates this year and the next will most likely fall substantially as Crypto companies will probably want to play it safe and just wait it out so it looks as though the SEC has chosen to do regulation through litigation.
They don’t want to talk anymore they just want to sue companies and send them cease and desist orders, and the reason for that is not because they’re necessarily malicious or evil, it’s just because that’s how they like to play catch-up. One thing about innovation is that it has no patience especially in the space of Crypto and Crypto does not need permission.