Coinbase Exec Says Its ‘Catch 22’ for Crypto Firms Seeking SEC Registration

ETH tokens are essential for executing smart contracts on the Ethereum network, unlike Apple’s stock which is not necessary for operating an iPhone, Paul Grewal argues

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Source: Shutterstock / Brandon Bourdages, modified by Blockworks

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Coinbase’s Chief Legal Officer will testify before Congress on Thursday to advocate for the adoption of clearer rules in the US crypto market, including the ways in which policymakers should approach the industry’s age-old question of what constitutes digital asset securities.

In a written testimony, published Wednesday ahead of his appearance in Washington, D.C., Coinbase’s Paul Grewal argues for fresh legislation, “necessary to address the novel features and benefits of blockchain technology.”

“The current rules never contemplated transactions that could move at the speed of the Internet,” Grewal writes. “Even today, ‘digital’ securities transactions settle in an analog world, typically two days later.”

Grewal said it’s because of these archaic rules that crypto firms now find themselves in regulatory hot water with the US Securities and Exchange Commission (SEC). The agency’s chair, Gary Gensler, contends otherwise, claiming that the “path to compliance is clear.”

The Coinbase executive is expected to tell Congress that applying the existing registration and disclosure frameworks for securities offerings to digital assets poses real challenges.

That’s because digital assets are often designed to be directly used in exchange for goods and services on a given protocol or network, unlike traditional securities.

Digital assets’ utility makes them an integral part of the operation of the network which neither looks like a securities transaction nor should be treated as one, according to Grewal’s testimony.

Unlike a typical SEC reporting company, whose securities are tied to the viability of ongoing operations and control, a digital asset token can exist and flourish independently of its issuer. 

Ethereum tokens, for example, are essential for executing smart contracts on the Ethereum network, unlike Apple stocks which are not necessary for operating an iPhone, Grewal notes.

While these digital assets play a crucial role in the network’s operation, they do not resemble securities transactions and should not be treated as such. As the tokens’ value can only be fully realized when used for their intended purpose, investors can only profit if the tokens function as intended.

That also means that in order for digital assets to operate as designed, holding them outside the control of centralized entities such as securities dealers, banks or other custodians is crucial to their success, proponents argue.

Therefore, establishing a clear framework to resolve which tokens are securities and which are not, while recognizing that tokens issued through an investment contract may change over time is essential, Grewal contends.

Exchange registration for digital assets, a winding path

There currently exists no path for crypto firms looking to register as a National Securities Exchange (NSE) while the Exchange Act generally requires securities to be traded via an SEC-registered exchange, according to the Coinbase executive.

NSE’s are SEC-registered entities that meet regulatory standards, including having a minimum number of listed companies and meeting certain financial reporting requirements. 

The Exchange Act, meanwhile, requires companies with securities listed on US stock exchanges to register with the SEC and disclose certain financial and business information to the public. It also regulates the activities of securities brokers, dealers and exchanges while putting the SEC in charge of policing the sector.

Digital asset trading platforms, including the likes of Coinbase, wanting to register as an NSE cannot satisfy the Exchange Act’s requirements and have no legal path to do so, Grewal said.

Importantly, the SEC has never determined that facilitating the trading of non-security digital assets, such as bitcoin, furthers the purposes of the Exchange Act.

“This creates a catch-22 for digital asset trading platforms,” Grewal said. 

Crypto firms are unable to satisfy the purpose of the Act, as interpreted by the SEC because they facilitate trades in assets not considered securities outside the scope of the regulator and the Act itself, according to Grewal.

“Because the SEC has rejected the registration of digital asset exchange-traded products, citing the lack of a significant regulated market, no such market can form,” he said.

Multiple companies have attempted to register various versions of a bitcoin exchange-traded fund over the years to no avail with the SEC often citing a lack of demand for such a product while raising concerns centered on market manipulation and thin liquidity.

Prominent crypto firms have taken the SEC to court over the issue for what they’ve deemed as an unfair interpretation of the law. 

In 2018, the SEC rejected a proposal by Cameron and Typer Winklevoss, co-founders of the Gemini exchange, citing a lack of investor protections. The Winklevoss twins argued the regulator’s decision was based on a bad reading of the law and was therefore treating bitcoin unfairly to that of other asset classes.

While the case was appealed, a US court eventually upheld the SEC’s decision.

In 2021, Valkyrie Digital Assets filed a lawsuit against the SEC after its application for a bitcoin ETF was delayed. Valkyrie argued that the SEC had failed to provide a reason for the delay and that the delay was causing harm to its business.

More recently, Grayscale Investments has sued the agency for blocking its own attempts to convert its flagship product into a bitcoin ETF. 

Desired outcomes

As part of all future digital asset policymaking decisions, legislation should contain strong consumer and investor protection standards for intermediaries and service providers to safeguard customer assets at all times, Grewal noted.

There also must be a path for offerings involving tokens to list as securities on SEC-registered trading platforms and Congress needs to provide a way for builders to succeed, he said.

As such, Grewal wants Congress to direct the SEC to permit existing digital asset trading platforms to register as an Alternative Trading System, which is currently permitted for trading securities under existing rules.

“A key inhibitor to a functioning primary market for digital asset securities, including investment contracts, is the lack of a workable set of registration and reporting requirements,” Grewal said. “Existing disclosure requirements are not tailored to digital assets or designed to protect investors in this distinct marketplace.”

Centralized trading platforms and custodians should also hold customer assets 1:1, proving their reserves through independent audits, he added. Proof of Reserves, as they’ve come to be known, refer to independent audits demonstrating asset held on centralized crypto exchanges.

Binance, Kraken, Crypto.com, and others have all come under fire from market participants over the way in which they report users’ holdings on their platforms — sparking a debate over the veracity of what’s reported.

They’ve been a vocal point of contention within the industry ever since the collapse of FTX in November. Until then, those audits had been an afterthought. Grewal wants policymakers to enshrine the practice into law.

The subcommittee on Digital Assets, Financial Technology And Inclusion is scheduled to meet at 2:00 pm ET on Thursday.


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