The SEC is wrong about crypto exchanges

Good morning. Stock selection is hard. As of this morning, four out of five of Unhedged’s picks in the FT’s 2023 stockpicking contest are going badly (badly!) awry. In that limited sense, it is good news that the SEC is suing one of the companies we are short in the contest, Coinbase, and that its stock fell hard yesterday. It is with a heavy heart, therefore, that I argue below that the SEC should just leave Coinbase alone. I recognise that this view puts me in a distinct minority. Even Ethan says I’m wrong, and he works for me. If you happen to agree with me, then, please send me an email: [email protected].

Coinbase, Binance and the SEC

It is a shame that Ethan, Unhedged’s token young person and ace cryptocurrency writer, has taken a holiday at the very moment that the SEC has brought lawsuits against Coinbase and Binance, alleging (among other things) that the companies operate unregistered securities exchanges in the US. He would have had a nuanced comment to make.

I, on the other hand, can only die on the hill where I planted my flag back in November: cryptocurrencies are not securities, and so the SEC should leave them alone. This is not based on a view that crypto has a special, non-security value that needs preserving. On the contrary: cryptocurrencies are a dangerous nonsense — but one the market can be trusted to kill before long. If this does not happen, cryptocurrencies should be regulated like smoking, gambling or pyramid schemes. In either case, this stuff should not be granted the dignity of regulation under securities law.

In my view, then, the two companies are innocent of at least some of what the SEC accuses them of: operating unlicensed securities exchanges. Awkwardly, therefore, my argument has to address the little matter of what looks a lot like a confession. “We are operating as a fking unlicensed securities exchange in the USA bro,” the SEC complaint quotes the Binance chief compliance officer as saying to another exec (buy the T-shirt here).

But this comment, while hilarious, is not decisive, bro. A person who is hired into, and promoted within, a given industry is selected for their belief in that industry’s nonsense. Within crypto, that means people who believe cryptos is a legitimate asset class, and therefore something awfully close to a security, or at least a security in the eyes of the SEC. So the fact that a person who had the job of preventing Binance from breaking the law appears to have thought that Binance was breaking the law is not, in this case, persuasive evidence that Binance was breaking the law. It is evidence that that person was breathing a lot of the crypto industry’s exhaust.

But cryptocurrencies not securities; they are, to borrow a term from Bloomberg’s Matt Levine, magic beans. What I mean by this is that the only cogent theory of their value is the greater fool theory. And magic beans are not the sort of thing the SEC should be regulating.

What counts as a security is defined in US law by the Howey test, which says that an investment contract is anything that involves (a) a person investing (b) in a common enterprise (c) with the expectation of profits (d) based on the efforts of others. This is a hopelessly broad set of criteria, and my argument is that if it applies to crypto it applies to trading cards or sports betting, things everyone can agree the SEC should not fiddle with.

The worry underlying the lawsuits is not, of course, just that cryptocurrencies are securities and that therefore Coinbase and Binance should have registered with the SEC. The worry is that they operate not just as exchanges in this market, but as brokers, clearers, custodians and in some cases investment funds too, and that having all those functions performed by a single entity sets up terrible conflicts of interest. So it does! But that is only the SEC’s problem if cryptocurrencies are investments, which they aren’t. They are magic beans.

For fans of cryptocurrencies there is, of course, an irony in my view. If I’m wrong, and cryptocurrencies are more than just magic beans, then the SEC is within its remit and the lawsuit makes sense. Coinbase argues that it “does not list securities or offer products to our customers that are securities” and that as such the SEC’s core accusation is misguided. But it does not think this is so because cryptocurrency is just bullshit. It thinks, as it must, that the cryptocurrencies they list are legitimate assets, part of a “new financial system”, as the company says in its, ahem, SEC filings.

And if this is so, the argument about assets which are not securities absolutely needs to be had. Coinbase just wants to have that argument in Congress, or at least in a regulator’s office, rather than in a courtroom. I agree that this would be a better idea (even though, in my view, the right regulators’ office would be that of a state gambling commissioner). But the American political/regulatory system being what it is, it’s off to court we go.

The SEC complaint against Coinbase (the more straightforward of the two suits) makes pretty dull reading. The big accusation: “Coinbase’s failure to register has deprived investors of significant protections, including inspection by the SEC, record-keeping requirements, and safeguards against conflicts of interest, among others.” To which I respond: magic bean buyers are probably beyond protection, even the protection of the mighty SEC.

It is too bad, from my libertarian point of view, that the lawsuit is happening now. As far as I can tell, the industry has been slipping towards deserved obsolescence all by itself. Yes, the price of bitcoin is up this year, helped by the liquidity pushed into the US financial system after the collapse of Silicon Valley Bank. But the rally looks thin, especially as monetary policy tightens up again. As my colleagues over at Lex have pointed out, crypto trading volumes are falling fast. Had it been given the time, crypto is a problem that the market, with help from a little non-financial regulation and higher interest rates, could have handled.

One good read

A good idea from Jonathan Haidt: phones out of schools now.