Coinbase Strikes Back: Chief Legal Officer Explains Its SEC Fight

0:00Your favorite neighborhood spot grows with Square. Indeed, my favorite neighborhood spot has quickly become Todd Snyder in Williamsburg. Todd Snyder is one of my favorite menswear shops and has supplied me with all the clothes I have needed this quite hot summer. Every business has different goals, but Square is the business platform that supports them all. From opening a new location, selling something new, or just expanding their reach. Indeed, I've seen it with Todd Snyder. In Square, also, you can get real-time insights, so don't wait for end-of-day reports. Go to square.com forward slash go forward slash realvision to learn more about how your business can grow with Square.

0:43That's S-Q-U-A-R-E dot com slash G-O slash R-E-A-L-V-I-S-I-O-N. Today's Crypto Daily Briefing is sponsored by OriginDollar. With inflation still over 6 % and CeFi lending platforms going bankrupt, DeFi protocols that earn interest on stablecoins are once again back on crypto investors' minds. APYs on Aave, Compound and Curve are currently around 2%. By the time you pay gas to stake and unstake, it's a question of if it's even worth it for most people. If you want to earn yield on your stablecoins without needing to pay gas, check out Origin Protocol's Origin Dollar stablecoin. OUSD's average APY over the past 30 days is 5%, twice the rate you get lending directly on blue chip protocols.

1:29The best part is the boosted yield isn't from leverage or extra risk, it's from extra collateral and is rigorously audited. This is because smart contracts on Curve and other DAPs don't support rebasing, so their collateral is working for you. The way Origin describes it, for every$1 of OUSD, there's more than$1 in DeFi working for you. Origin wants you to know the collateral earns yield through these DAPs, the protocol routes rewards to your wallet on a daily basis. Do nothing and your OUSD balance grows daily. If you want to put your stablecoins to work, check out Origin Dollar's website. You can mint OUSD from the DAP or swap your stablecoins for it on Uniswap to start earning today.

2:07For those holding ETH, Origin Protocol is teasing the release of OETH, which does everything OUSD does, but for Ether. It holds liquid staking derivatives to optimize yield. Follow along on Origin Protocol's Twitter and Discord channels. Visit realvision.com slash origin dollar to learn more.

2:31Paul Graywall, Chief Legal Officer at Coinbase. Fantastic to have you on the show. We've waited to have you on a long time. Thanks for joining us. Thanks for having me on, Ash. I'm really looking forward to our conversation. Me too. You know, Paul, your shop, Coinbase, is at the very center of everything that's happening in the U.S. crypto space. In the last six to 12 months, let's say, the legal, regulatory, and compliance aspect of crypto has become very much the center of that conversation. And you're very well positioned to talk about all of this. Big picture, what's happening? Why is it important?

3:05And how do we understand it? Well, there's a lot happening right now when it comes to crypto and digital asset policy and regulation. I think the most important thing to understand is that first and foremost, in the United States, we're seeing a turf battle, a fight over jurisdiction that is driving a lot of behavior at the Securities and Exchange Commission, the Commodities Futures Trading Commission, and other federal agencies that really is first and foremost about who has the first line of sight and oversight over digital assets and crypto. That's why you're seeing, for example, different agencies claim that different types of digital assets are either securities on the one hand or commodities or virtual currencies on the other.

3:52At the same time as we're seeing this turf battle, I think it's fair to say we're seeing a real fight over what types of disclosures investors and others need, what types of market structures ought to apply to digital assets so that people can have confidence in what they're investing in. And at the same time, innovation is protected. So that fight is happening as well. The last thing I'll just say that's going on, again, at the highest level is that I think we're having a fundamental conversation right now in the United States over how does the rule of law actually work? Because while there are all sorts of good nature debates and disagreements we can have and are having over the right types of disclosures, whether to think about project groups as common enterprises and all those sorts of issues.

4:46The fact of the matter is Congress sets the law in this country. Regulatory agencies are charged with writing rules to execute that law. But we all operate fundamentally under a constitution which requires due process, which requires fair notice, which requires a number of other fundamental rights be respected, even as we try to get to the right set of rules that apply to protect this important industry and this important community. Yeah, and this all begins with the fact that the laws that regulators are interpreting are 90 years old. Clearly, cryptocurrency digital assets was not in the mind of the folks who drafted those laws in the 1930s.

5:26Where are we now? You began with this notion of the turf battle that seems to be forming in Washington between the CFTC on one hand and the SEC on the other. This is a fundamental question of the nature of what cryptocurrencies are. Are they commodities? Are they securities? Are they some other type of property or asset? How do you guys think about that at Coinbase? Well, what we're seeing is quite remarkable. You're absolutely right that the laws that are applicable to crypto and digital assets were certainly drafted in a very different time with a very different set of concerns. The 1933 and 1934 Securities and Securities Exchange Act obviously did not contemplate that one day we would be talking about tokens, that we would be talking about distributed ledgers, that we would be talking about credits that are protected by blockchains and consensus mechanisms.

6:22These things, of course, didn't exist in the 30s. They didn't even exist in large part 10 or 20 years ago. Nevertheless, laws that were written in a different time can apply and often do apply to new technologies, new circumstances. But it's important that they be applied and updated in ways that make sense for the present time and our present economy. Last July, Coinbase filed something called a petition for formal rulemaking. And this was a formal request that we submitted to the Securities Exchange Commission in which we asked something like 50 different questions that we thought needed to be answered in order for there to be a regulatory framework that could apply to digital assets that would make sense, that would protect investors, protect consumers, but also promote innovation and reflect the realities that digital assets fundamentally work differently.

7:18Unfortunately, Ash, nine months or more have passed since we filed that petition. And unfortunately, we have not received even a response to it. So we remain committed to pursuing rules that will apply, not just to Coinbase, but the entire industry. Unfortunately, we don't yet have a willing partner in the SEC to fulfill that objective. And let's talk about the goals of that petition. It's important to point out that Coinbase also filed suit to get an answer to some of those questions. What is it that you guys are seeking in terms of clarity and guidance? You know, in a quite striking video that you guys posted a few weeks ago, you said, we will show up in your offices any day, any time to discuss a workable path forward for our industry.

8:02Talk a little bit about what you need in terms of a workable path, what you feel you need in terms of clarity to make the kinds of business decisions for Coinbase and for the space more generally. Well, I think for the space more generally, what we need are standards, for example, around issuer disclosures. What is the set of information that any reasonable investor is entitled to and needs in order to make a sound investment decision when it comes to digital assets? We think there are standards that could and should work for digital assets, including cryptocurrencies, but they need to account for the unique nature of digital assets.

8:39The fact that project groups operate differently than corporations, the fact that the nature of tokens and assets often does change over time. And so we'd like to see basic reasonable rules adopted so that everyone can understand what it is they're getting into when they elect to participate in a project or invest in digital tokens. Another big issue, Ash, is market structure. We'd like to see the current rules for digital asset exchanges reflect the reality that when it comes to crypto, when it comes to digital assets, the networks operate differently than more traditional asset classes. So, for example, with traditional asset classes, it makes sense that you have separate intermediate functions like trading – sorry, clearance and settlement and things like that, and agents operating to perform those functions that are different and separate from one another.

9:37But of course, when it comes to crypto, settlement is essentially instant. And so to impose archaic structures on this asset class that just increase the cost, increase the delay, and offer no benefit doesn't make sense. Those are the kinds of questions that we think could and should be answered by the SEC in order to allow for digital asset registration to take place. Up until this point, unfortunately, we don't have any answers to those questions. And so we're all operating in a very uncertain, very unsettled circumstance. Yeah, you know, in many ways, it's sort of second verse, same as the first.

10:10It's the same point we were talking about earlier. If you attempt to apply laws, if you've worked in the traditional banking sector, you know that you have execution, clearing and settlement execution. You do the trading clearing. You make sure that everything matches up settling. You have the actual back end payment architecture go into place in crypto and digital assets, It's all completely different. Very hard to understand how you could apply that framework, that paradigm to a digital asset space. Well, you can't. And of course, that's why when it's suggested that somehow cryptocurrency exchanges and issuers just come in and register, the suggestion really is unfortunately disingenuous.

10:49Because the fact of the matter is, if you go to the website and download the form, as has been suggested on at least one occasion, you can't register today. You can't comply with the rules that are set out. And so effectively, what's being suggested is digital assets operate outside of the regular perimeter and without any oversight by the SEC. see. Ironically, it's Coinbase and it's many others in the industry who support what we're trying to do, who are asking for that oversight, who are asking to be allowed to come into the perimeter. We just need rules to be able to do that, which is why we filed our petition in the first place.

11:28Yeah. So let's talk a little bit about those rules. And one of the challenges with the digital asset space is that it's just so vast. It's not just a particular asset class. It's an entirely new paradigm for thinking about the way that assets work. I've heard you speak before about digital assets that clearly seem to be securities. Then you have things like stable coins, which may be better regulated like a money market. Then you have things that might be commodities. I mean, it's a really complex, rich, and ramified architecture out there. How do you begin to think about the categories that these digital assets fall into?

12:03Well, the way we think about it, Ash, is actually pretty simple, which is we would like to be able to offer as many assets in the United States as we are legally able to do so. That's first and foremost. Unfortunately, today there is no way to be able to offer digital asset securities in the United States because, as I've described, the SEC doesn't provide a path to registration that would allow that. And so we undertake a very rigorous analysis of any project that we evaluate, any asset that we're considering for listing. And if we conclude that based on our best read of the current law that an asset may be a security, we don't list it, period, end stop.

12:47Now, we'd like to be able to list it. Right now, our review process eliminates something like 90 % or more of assets because there may be a digital asset security risk or other legal issues with the project. But we'd like to be able to offer that in the future. That's one of the reasons why we've pushed so hard for a registration path for issuers and for exchanges like Coinbase. And at the same time, there are many projects, many assets which are clearly not securities, which are commodities or currencies. And so if we otherwise are satisfied that they don't pose unnecessary or unacceptable risk for our customers in terms of cybersecurity or our ability to make sure that compliance issues are properly monitored, we list them.

13:39That's the way that we kind of go about this. But make no mistake, what this means in real terms, Ash, is that 90 plus percent or more of assets are off limits to most U.S. customers. And we'd like to be able to address that, but we need regulatory clarity in order to be able to do that. So in your view, all the digital assets that Coinbase currently lists are not securities. By the way, I should say in full disclosure, I have a Coinbase account or retail account myself with an embarrassingly small amount of funds in it. But the assets that you guys list in your view are not securities. They're not.

14:12They're not. And I say that with confidence because of this review process that we undertake. And this is not just a matter of asking our issuers to download a form and submit it to Coinbase in the way that the SEC has suggested that all of us download its form and submit it to the SEC. We undertake a rigorous process that involves analysts here at the company, lawyers and others at Coinbase, outside counsel that we bring in to vet and evaluate our process. And if we weren't confident in that process in and of itself, the fact is we submitted this process and described it when, of course, two years ago, Coinbase became a public company.

14:54And who did we submit that process to? Of course, we submitted it to the SEC because they were the agency which reviewed our application to List as a public company here in the United States. And throughout that S-1 process, Ash, where our draft registration statement and other materials were submitted to the SEC, Coinbase underwent a very rigorous vetting and evaluation by the commission of our asset review process. They asked lots of hard questions. They wanted lots of details. And we provided thorough answers and all the details that were requested. And after that entire process two years ago that we went through, at the end of the day, we were allowed to list as a public company.

15:35That certainly should give others, and it certainly gave Coinbase confidence that our process was sound. And, of course, we always update it, and we always are amending it in order to reflect new information and a new understanding of these markets. But this is not something new. This is something that's been battle-tested over many years across many, many different assets and submitted to the SEC as part of our own public listing process nearly two years ago. Indeed, to that very point, you posted on the Coinbase website just last week, quote, Coinbase is the same company that we were when the SEC allowed us to become a public company two years ago after detailed discussions with us about the very aspect of our businesses that are now the subject of the Wells Notice.

16:17We should probably talk about the Wells Notice, what it means more generally, and how you feel it impacts your operations at Coinbase. Yeah, so a Wells Notice is just a legal term of art that refers to a formal notification by the SEC that it believes one or more violations of federal securities laws has taken place. Once a Wells notice has issued, a company has the opportunity to come in to lay out its side of the case and to attempt to persuade either the staff or the commissioners themselves that no enforcement action should be pursued. Now, Coinbase has taken advantage of that opportunity.

17:02And of course, we have now shared publicly the very detailed brief we submitted to the SEC, as well as a video that it allowed us to present as well. And following those submissions, we have met with the SEC to try to make our case that enforcement action of the type that's been suggested by the SEC just doesn't make sense and frankly would be contrary to law. We were very keen, Ash, to be as public about all of this as we could be. We shared the Wells notice, of course, immediately after we received it. And we've now shared, as I mentioned, our response as well as the video. We're sharing all this so that people can assess the facts for themselves.

17:41They don't have to rely upon Coinbase's characterization or, frankly, the SEC's characterization of that dialogue. People can review it for themselves and draw their own conclusions. I think if your listeners and viewers do that, what they will see is that we have laid out a very compelling case that an enforcement action against Coinbase, at least as has been suggested by the SEC, would be a very serious mistake. So let's dig in and talk about what that review process is, because I think it's so important for folks like me who are non-lawyers to understand exactly what you guys do when you do this review process.

18:19And even more generally, how you think about the intellectual framework for determining what is and is not a security. So Coinbase released a letter to SEC in July, and there's an extensive appendix in this that defines two principal tests that you guys use to determine whether or not something is security and whether it's used more broadly in the industry. Of course, the first is the Howey test from the 1940s, and the second is the Reeves test from the 1990s. Can you describe what those tests are and why they're so important to making this determination between what is and is not a security under U.S.

18:51law? Yeah, well, both tests ultimately are focused or aimed at that fundamental question of is the product or service or asset that you're looking at a security or not? Because if it is a security, then there are a series of requirements that follow. And of course, the Securities and Exchange Commission, as you might guess from the name, would have jurisdiction authority to supervise that. The fundamental question under these tests is whether or not the asset or product or service in question is either an investment contract on the one hand, if you're talking about tokens, or a note or a lending product on the other, if you're talking about things that fall outside of the investment contract analysis.

19:38Those are the two major categories of crypto products or services that have been the focus of the SEC's attention. And there's been a lot of criticism, Ash, or concerns raised about the Howey test and its application to digital assets, because the Howey case that it refers to took place in the 1940s. It's only slightly younger than the statutes that Congress passed a decade before. And so some have suggested that it really doesn't make sense to even apply the Howey test. We think there would be a good opportunity for Congress to step in and issue new legislation that made more sense for a digital age and that was, I think, more carefully tailored to the realities of how networks generally work in 2023 and beyond.

20:28But to be super clear, Howie remains good law. And we think it's very clear under Howie that the definition of investment contract, which requires that there be a transaction scheme or contract that involves an investment of money in a common enterprise, that there be an expectation of profits based upon the efforts of others, that that test, when you apply it to many digital assets, simply does not hold. Again, are there certain assets that are, in fact, investment contracts? Yes, we don't list them, but there are many others that are not. And for various reasons, it's important that you be very specific in applying that test to each individual asset.

21:17So that's what we do in this process that I described. We take the white papers that the issuers have drafted. We look at other information about the project that's been submitted as part of the application. And then we run all of that data, all that information through these legal standards and ask the fundamental question, are these different elements met? And if there's a close call, if there's an open question, we err on the side of caution because we don't want to list digital assets that qualify or might qualify as securities until we have a path to registration. But in many, many instances, the projects have become sufficiently decentralized.

21:57In many, many instances, there is no common enterprise. And in yet other instances, there is no contract at all that would even qualify under the Howey test. And so we have confidence that we can list the product or list the asset or provide the product or service. And so that's what we do. And just to review for folks who are not familiar with this, those four prongs of the Howey test needs to be an investment of money in a common enterprise made with a reasonable expectation of profit based predominantly on the entrepreneurial or managerial efforts of others. Those are the four principal tenets.

22:32For what reasons do you think, for example, Ethereum does not meet those tests? Well, for example, Ethereum doesn't meet that test because, of course, when you're talking about a common enterprise, right, you're generally talking about a control group. You're generally talking about a centralized group of people who have authority over resource allocation, who have authority over managerial direction, who have authority over the long-term success or failure of the project. And Ethereum, whatever its history, certainly in 2023, is none of those things. And that's just not me or Coinbase talking.

23:15You don't have to accept my word for it. Take the words of the chair of the Commodity Futures Trading Commission, Roz Benham. Chair Benham, in testimony before Congress, was explicit that Ethereum is a commodity, not a security. And so you have other regulators validating this analysis, even as the chair of the SEC refused to answer that same basic question when it was put to him in his own testimony before Congress a week or two ago. Yeah, and to that very point, the CFTC makes the same points in their complaint against Binance. I'm just going to read this. Essentially, I'm just going to skip ahead here.

23:54leverage retail commodity transactions involving digital assets that are commodities, including Bitcoin, Ethereum, and Litecoin for persons in the US. This is a reading from a complaint CFTC filed against Binance. But again, that's the assertion that they're making, that these are in fact commodities. How do you think about operating in this environment when you have different regulators essentially taking different views about whether or not a security is a security or a commodity? I mean, that is a very difficult position for the business to be in, but also a very difficult position for the entire space, for people who want to be good actors, who want to have clarity around what they're doing.

24:30These are very challenging times. It is very challenging for people and for companies that are trying to do the right thing. You know, it's not just the regulators who are having these fundamental disagreements. You have the Department of Justice also making clear that it rejects the SEC's current approach. We had a recent case involving a former employee of Coinbase who was accused of front running. In fact, he ultimately pled guilty to that charge. And in that particular case, the assets at issue needed to be evaluated to establish whether or not the fraud that was taking place by this former employee was securities fraud on the one hand or non-securities fraud or what in the law we refer to as wire fraud.

25:13And the Department of Justice, who, by the way, are no softies. These are federal prosecutors who have every incentive to pursue the highest charges and, in fact, are directed internally to pursue the highest charges they can, looked at the same assets as the SEC evaluated in its own parallel case and concluded that the assets were not securities, and therefore the case needed to be charged not as a securities fraud case, but as a wire fraud case. And if that weren't enough, Ash, if it weren't enough that you have these different federal bodies reaching very different conclusions, you have the SEC chair himself reaching different conclusions at different points in time.

25:49For example, Professor Gensler, before he was even appointed as chair of the SEC, said without qualification that something like 75 % or more of the market is not even impacted by the Howey analysis because they are not securities. And even after Coinbase became a public company and Professor Gensler became Chair Gensler in May of 2021, the chair said in his own testimony before Congress that there is no market regulator applicable to cryptocurrency exchanges like Coinbase because the assets that they trade in are not securities. That's the necessary implication of what he said. So it's a mess.

26:33It's a challenge. It can be even frustrating at times. But, you know, there's still time to get this right. I think sometimes in crypto, we aren't optimistic enough that there are solutions to these problems. I am optimistic that we can draft reasonable rules that establish what is a security, what is not security. But we have to stop focusing on who has authority and whose turf we're encroaching upon. Those types of debates aren't helpful. What would be helpful are clear rules that define these things so that we can all focus on building great products and services instead of these legal fights.

27:08What do you think the best way to get there is? Obviously, everyone wants that clarity that you're talking about, but what do you think the best way to attain that goal is? Is it through new legislation? Is there some other type of action that you see us getting there? What are your thoughts about the direction? How do we get there, Paul? Well, you know, we would love to see new legislation. And that's why we've been very encouraged by what appears to be bipartisan support in the House Financial Services Committee for legislation that would address at least portions of these issues. It may not be comprehensive in the end, but we think we can make good progress on certain areas like stablecoins.