Coinbase at Center of Court Crypto Security Dispute

Key Insights:

• Investors claiming Coinbase is selling securities want compensation for losses.
• U.S. regulators have not determined the status of crypto assets yet. 
• The regulatory uncertainty is becoming a problem for exchanges.

With no clear regulatory framework for the industry in the U.S., cryptocurrencies are still in a grey area when it comes to investment status. Investors are increasingly asking courts whether digital assets are treated as commodities such as gold or securities such as stocks and shares.

Earlier this month, a group of Coinbase users took the company to court demanding compensation for losses on crypto assets they claimed were securities.

Coinbase [COIN] responded with a motion to dismiss the class-action lawsuit, claiming that 79 of the tokens listed on its platform were unregistered securities. On May 26, the WSJ took a deeper look into the thorny issue surrounding the classification of crypto.

Crypto: Security or Commodity?

Former Securities and Exchange Commission (SEC) commissioner Joseph Grundfest told the outlet it was to do with the amount invested and the recent downturn:

“The more money at stake, the higher the probability of litigation, and with the sharp downturn in crypto values, the incentives to litigate have turned up as sharply,”

Crypto-related lawsuits are up this year, with eight being filed already compared to 11 in 2021. SEC Chair Gary Gensler is convinced that cryptos are securities and wants to impose the same restrictive regulations on exchanges that stock brokerages face.

Coinbase lawyers argue that crypto trading is often peer-to-peer, and the users (that the SEC is claiming to protect) will suffer.

“If successful, plaintiffs would have this court effectively freeze the accounts of innocent [Coinbase] users who, by their own choice, transact with one another in these tokens,”

The ongoing battle between Ripple and the SEC highlights the issue’s complexities. The regulator claims that XRP is a security because the company sold the tokens to investors. However, Ripple strongly refutes this claim. A win for the SEC could be catastrophic for the entire crypto sector in the United States.

SEC Wants Full Control

Earlier this month, Gensler reiterated his stance, stating, “Most crypto tokens involve a group of entrepreneurs raising money from the public in anticipation of profits.” On May 18, he took another swing at crypto exchanges, stating:

“They should move towards getting registered, or we’re going to be the cop on the beat, and we’re going to bring the enforcement actions.”

The Howey Test is used to define whether an asset is a security. It refers to a 1946 U.S. Supreme Court case for determining whether a transaction qualifies as an investment contract. Under U.S. law, an investment contract exists if there is an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Coinbase wants more clarity from financial regulators; a spokesperson told the WSJ:

“We want to constructively engage on this issue but believe the SEC needs to make their thinking public so a meaningful debate can occur. Clarity is critical.”

Meanwhile, regulators continue to drag their collective feet regarding clarifying the asset class and rolling out a productive framework. Hopefully, it will be one that isn’t designed to crush the fledgling industry.