Cryptofinance: Coinbase invokes national security concerns in SEC fight

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Hello and welcome to the latest edition of the FT’s Cryptofinance newsletter. This week, Coinbase invokes national security concerns.

I’m coming to you this week from New York, where I attended The State of Crypto Summit, an event hosted by Coinbase in partnership with the Financial Times. 

The crypto exchange has a long-running and deep difference of opinion with the Securities and Exchange Commission over crypto regulation. That relationship hit a new low this month when the SEC said Coinbase was in violation of several federal securities laws, most notably operating an unregistered securities exchange. Coinbase disagrees with the SEC’s interpretation and has said it will fight the lawsuit.

For some, the SEC case — which is similar to charges the agency laid against both Binance and Bittrex — represents an existential risk for both Coinbase and the US crypto industry. If the SEC wins, that will hit the majority of Coinbase’s revenue. There has been speculation Coinbase and others will be pushed offshore, unable to operate in the US.

After all, if a San Francisco company with an American chief executive that trades on the Nasdaq can’t survive the SEC’s attack, what hope do smaller companies have? 

But Brian Armstrong, Coinbase’s chief executive, thinks there’s another reason people should care deeply about where the US and its regulators are going.

“I do think it’s a national security risk for the US . . . this is the most important technology to update the financial system,” Armstrong told me during a brief sit-down interview between panels. 

“If other countries seize that opportunity, long term, it puts at risk the US dollar as a reserve currency, it puts at risk the ability for the US to do sanctions, it puts at risk the ability for the US to have soft power with technology companies,” he added. 

It’s a lofty self-assessment to see yourself in the vanguard of America’s future security. Especially when one considers that the US has repeatedly shown it will go after actors perceived to be a national security threat, regardless of whether they exist onshore or offshore. 

This year the US arrested the Russian founder of crypto exchange Bitzlato, described as a “crucial financial resource” to the dark net. It used a powerful new section of the Combating Russian Money Laundering Act, highlighting the seriousness with which the US is treating crypto-related activity. 

Authorities have also gone after crypto mixing service Tornado Cash, which served as a tool for North Korea-backed criminal groups to wash illicit funds by disguising the audit trail of crypto payments.

There’s also little evidence as yet that crypto is anywhere near updating the financial system. Probably the most high-profile attempt to date was the effort by ASX, the Australian stock exchange, to use a distributed ledger as the backbone for trade settlement. It failed after seven years of trying. Right now, the only thing that looks like being improved is the inefficiency of the crypto system.

So I asked the Coinbase chief to expand on his rationale: why would a departing American crypto industry hamstring the government’s efforts to keep the country safe?

“The biggest tech companies got built in the US, and they should make sure the biggest crypto companies get built in the US, otherwise it’s going to be like 5G or semiconductors, where there is going to be some major initiative in five years that [creates] an emergency,” he said. 

Possibly, although owning the intellectual property and manufacturing capability for a microchip is hardly the same as ownership of a market that styles itself as highly decentralised.

But Coinbase’s pushback against the SEC does raise an issue that will need to be addressed at some point. Will there be a way for a US consumer to trade crypto and not worry that they’re indirectly contributing to terrorism financing, the drug trade or nuclear weapons building?

“The best step that we could take as a country to protect consumers, protect the industry, and to protect the United States, would be to ensure that there is compliance with US anti money laundering and counter-terrorism financing standards,” said Courtney Simmons Elwood, who served at the CIA before becoming a regulatory adviser for Coinbase Asset Management. 

What’s your take on the national security angle to crypto? As always, email me your thoughts at [email protected]. 

Weekly highlights

• Read about how the Matt Damon-endorsed and Singapore-based crypto exchange, Crypto.com, deploys internal teams to trade cryptocurrencies for profit, in this great scoop by my colleague Nikou Asgari. Crypto.com said its practice was not controversial. 

• A total of $200mn in fees has been racked up by lawyers and others working on the FTX bankruptcy, according to independent auditor Katherine Stadler. Law firm Sullivan & Cromwell pocketed more than $40mn within the first three months of FTX’s bankruptcy filing, while management consultants Alvarez & Marsal — acting as financial advisers to FTX debtors — have invoiced almost $28mn. Check out the story here. 

• Bitcoin, the industry’s flagship cryptocurrency, suddenly surged higher and broke through the $30,000 level, which many crypto-punters consider to be an important psychological milestone for the coin. It’s only the second time bitcoin has reached the figure this year.

• Also during the week BitGo, the digital asset custodian, called off its proposed purchase of Prime Trust. The latter is one of the few “crypto-friendly” US financial institutions with some regulatory approvals to operate in the traditional US banking and payments system. Others, like Silicon Valley Bank, Silvergate and Signature Bank, collapsed this year. Hours after the deal was called off on Thursday Nevada regulators ordered Prime Trust to halt its operations in the state, saying Prime was unable to satisfy customer withdrawal requests because of a shortfall of customer funds.

Soundbite of the week: Stablecoins and the Fed 

Jay Powell, chair of the US Federal Reserve, appeared at a House financial services committee hearing this week and was asked about stablecoins. He said stablecoins were a form of money but caveated:

We believe that it would be appropriate to have quite a robust federal role in what happens in stablecoins going forward . . . leaving us with a weak role and allowing a lot of private money creation at the state level would be a mistake.”

Data mining: Coinbase fortunes defy expectations 

You may have thought the SEC’s lawsuit against Coinbase might have frightened away customers. Not quite.

Numbers from CCData show Coinbase’s share of the US market has increased for four consecutive months, moving up to 57 per cent in June. How much of that is down to customers deserting rivals and the overall market shrinking in the face of the SEC’s broad crackdown is another matter. Still, it does suggest US crypto punters are unfazed by the lawsuits for now.

Cryptofinance is edited by Philip Stafford. Please send any thoughts and feedback to [email protected].