• Coinbase Pre-IPO contracts breached a market cap of $75 billion on FTX Friday
  • Recent proxies for institutional demand like Microstrategy point to a frothy open
  • Former CFTC Senior Trial Attorney Braden Perry says an “ever-changing regulatory environment” in the US hinders compliance.

Capitalizing on Bitcoin’s meteoric rise in 2020, Coinbase announced in December that it had filed preliminary private paperwork with the Securities and Exchange Commission to go public — a move that had been rumored to be in the works since the summer.

Within days of this announcement, derivatives exchange FTX created a synthetic Pre-IPO futures contract that went as high as $317. The contract surged over 140% in it the opening hours of trading, and is currently trading below its listing price at $279.

At the peak of its trading frenzy, the exchange’s implied market cap hit a valuation of over $75 billion. The contracts will convert to tokenized fractional shares upon Coinbase’s listing day. 

Despite this staggering valuation, one former attorney for the Commodity Futures Trading Commission warns that this valuation might not be reflective of the regulatory reality in the United States. 

“Due to the lack of regulatory structure in the United States, there are a number of challenges to exchanges like Coinbase,” Braden Perry, a former CFTC attorney, told Blockworks. 

Perry, now a regulatory attorney with Kansas City-based Kennyhertz Perry, points to the Financial Crimes Enforcement Network’s proposed rule on increased Know-Your-Customer thresholds for crypto wallets as an example of an “onerous” regulatory environment that discourages compliance. 

“This ongoing and ever-changing regulatory environment hinders well-designed compliance and regulatory plans.,” Perry said. “The last thing any industry wants is what the SEC and CFTC have done: regulation by enforcement, in which agencies decide that some practices should have been illegal, [and then] go back and prosecute the people who were doing it before”

Like many exchanges, Coinbase makes an extensive array of altcoins available to traders on its platform. Analysis of data from CoinMarketCap shows that altcoins make up between 10-12% of the bourse’s daily volume of $5.3 billion.

Perry points out that regulatory uncertainty surrounding the SEC’s definition of what constitutes a security — the SEC recently took action against Ripple for its XRP token which was first introduced nearly nine years ago — is going to have a chilling effect on what could be a lucrative business. 

“At this point, the lack of regulatory guidance creates uncertainty for these altcoins, the number, and utilization of which are only increasing. As a US Exchange, Coinbase is at a significant disadvantage, as the almost unlimited scope of enforcement powers by the SEC and CFTC stifles an exchanges’ appetite to associate with altcoins,” Perry said.

It should also be noted that as a US exchange Coinbase is unable to offer derivatives margin trading, something that the majority of its offshore-domiciled competitors offer to great enthusiasm from their users. In November Coinbase disabled margin trading on advice from the CFTC, according to reports, as it prepped for its IPO. 

And with this uncertainty might come hesitation from traditionally-conservative institutional money, according to Perry, that prefers regulatory clarity. “Until there is clear guidance from the federal and state level, gaining a broad institutional base will remain a difficult proposition,” he said. 

But does the market really care?

While on paper Coinbase is a company fraught with structural risks, as Perry points out, some of the boldest technology IPOs in recent memory also suffered from a similar predicament. 

Airbnb hit the NASDAQ in December and surged 112% giving it a market cap of $86.5 billion despite the fact the company is seemingly despised by regulators and city councils in every market it operates in — including most of the major cities in North America and holiday hot spots like Thailand and Indonesia. But despite all this, and the Covid-19 pandemic decimating the travel market, the stock still trades above its listing price. 

Uber, another tech darling, has also benefited from an investor base seemingly unconcerned with regulatory risk. The strategy appears to have worked, as despite a raging pandemic and plummeting travel demand the stock trades almost 30% over its listing price. Despite plummeting demand for travel thanks to Covid-19, Uber’s stock trades for almost 30% over its listing price; investors were happy to give it a long runway to sort out its regulatory issues. 

More recently in crypto, Morgan Stanley upped its stake in MicroStrategy, a business intelligence company that has effectively become a macro proxy for crypto given its Bitcoin holdings, reaffirming that big institutional money might be a bit less conservative than previously thought. 

Regulations are changing, and for the better

For all the talk of regulatory uncertainty and lack of clarity, it’s important to remember that regulators surrounding crypto in the US are on the move — for the better. Days into the new year the OCC, run by former Coinbase attorney Brian Brooks, issued an interpretive letter which moved crypto into the ‘stack’ of chartered financial institutions by saying that they may use blockchain technology and stablecoins to facilitate financial transactions for their customers. 

On the securities side, Hester Pierce, one of the five commissioners of the SEC, has consistently issued dissents against orders to penalize crypto projects for violating securities law. 

“I think that’s not only a problem with respect to digital assets, it’s actually a broader problem because we have this very open-ended category called an ‘investment contract,” Pierce said in a recent interview with Forkast.  “So something might be characterized as one thing by another agency, yet still be a security under our rules, and that can be frustrating for people.”

Working their way through the legislative process are two bills that would provide more clarity on if tokens are securities or not, using modern terminology and not precedent from a 1946 court case — a potential sigh of relief for Coinbase as it prepares for an IPO. 

Will institutional money support this valuation?

All things considered, it’s yet to be seen if the level of interest institutional money has in Coinbase also supports the valuation that traders on FTX are prescribing.

While traders on the crypto derivatives platform have pushed its pre-IPO contracts to $317, hitting a peak valuation of over $75 billion, the daily volume is only a little over $100,000, or just over $2.5 million since its first listing in December.

Given the FTX userbase’s familiarity and enthusiasm for crypto, there might be an inherent bias in place and it remains to be seen if the general market will support this valuation. 

While the pre-investment contracts will convert to respective amounts of tokenized fractions of Coinbase shares when the company eventually IPOs, FTX warns that the market for tokenized equities is still “highly illiquid” on the sell-side in its disclosure.

Traders are able to redeem the equities custodied by its brokerage provider, but that’s a process requiring the user to email its support team (they can, however, be used as collateral for margin trading at a weight of 0.80-0.85). FTX did not return a request for comment about Coinbase’s pre-IPO contracts by press time. 

A spokesperson for Sharespost, the largest secondary market for trading in pre-IPO contracts, told Blockworks that it could not comment on companies on its platform citing securities laws. However, they pointed to recently published research reports by the firm which shows an overall strong secondary market for technology and Fintech firms.  

  • Blockworks
    Reporter
    Sam Reynolds is a Taipei-based reporter, covering digital assets and regulation throughout Asia. Before joining Blockworks he was an editor at Forkast News and an analyst with IDC.