The Empire Strikes Back – The SEC Versus Coinbase

  • The SEC has threatened Coinbase with legal action over its Lend programme.
  • This action is part of a broader regulatory offensive against the cryptocurrency industry.
  • The SEC’s opaque guidelines are causing regulatory uncertainty in the US.
  • The politicisation of regulatory enforcement is a danger to the rule of law.

Democratic societies have legal systems based on predictability, clarity, equal application and consistency. They start to crumble when political considerations trump fair legal processes.


Protecting the public from fraud, abuse and manipulation is a worthy cause. This was the reason behind the creation of the US Securities and Exchange Commission (SEC) in the wake of the Great Depression. The SEC has carried out plenty of important work, but it also has an impressive track record of failure under administrations from both parties. They missed the warning signs of the most consequential economic meltdown of recent times and the largest Ponzi scheme in the history of mankind.

Among other incidents, an Assistant Director of the Office of Compliance, Inspection and Examinations got engaged to Bernie Madoff’s niece and compliance officer, three months after he had closed down an investigation into Madoff’s activities. They had met as part of the proceedings, but, rest assured, the SEC later investigated this, internally, and found no wrongdoing.

The SEC was also caught destroying thousands of records, which hampered its investigations into numerous financial institutions. The whistleblower, who revealed this practice, warned of the dangers of the revolving door between the SEC and the financial actors it was meant to regulate. The prospect of lucrative jobs endangered regulatory objectivity. This was further flagged in the 2014 retirement speech of James Kidney, a trial attorney for the SEC. In his words, the “revolving door is a very serious problem” and the actions of senior people at the SEC were “tentative and fearful in many instances”.

The SEC’s latest move against Coinbase is anything but tentative and fearful. But who is it protecting?

The Rule of Law

In September, Coinbase received a Wells Notice out of the blue. A Wells Notice is a written warning, from the SEC, informing its recipient of impending legal action. Coinbase responded publicly, with an impassioned blog post by its chief legal officer, Paul Grewal, and a Twitter thread by its CEO, Brian Armstrong. They expressed surprise at this regulatory aggression. This surprise was made worse by the reverent approach the company had taken towards the SEC. They claim to have kept the agency informed of their progress and sought regular clarifications, in order to comply with unclear guidelines and decision-making processes. They also point out that other entities are performing similar services, but have not been subjected to similar measures. The action by the SEC thus seems arbitrary, inconsistent and inexplicable.

Despite some efforts to discredit the blog post, Paul Grewal is not a rookie in the legal tech sphere. Grewal was vice president and deputy general counsel at Facebook, after serving as a US Magistrate Judge for the District Court of the Northern District of California. Grewal’s core legal argument is that Coinbase’s lend programme, which was the target of the Wells Notice, is not a security. It is neither an investment contract nor a note he argues.


Participants in this programme lend their USDC in order to receive interest. Coinbase guarantees the payment of interest in the Lend programme, as well as the principal itself. USDC, short for USD Coin, is a stablecoin pegged to the US dollar. It is issued by regulated financial institutions and backed by assets, which make it directly redeemable for US dollars. Grant Thornton, one of the world’s largest auditors, periodically releases a report confirming that there are enough assets to back the total amount of USDC in circulation. It is therefore less volatile and, theoretically, safer than unbacked cryptocurrencies.

Instead of providing guidance on this technical disagreement, the SEC decided to send it directly to the courts. The courts will have to determine how the Howey and Reves tests apply, in this context, thus determining whether Lend is a security or not. It would be great to parse through the SEC’s own justifications and provide an in-depth legal analysis of their stance, but, unfortunately, there is nothing to analyse. It is, in effect, regulation through litigation. Without guidelines, the public and operators in the crypto industry are supposed to have blind faith in the SEC’s judgment, which materialises, sporadically, through cherry-picked litigation.

The irony of accusing an industry of shady practices while regulating them arbitrarily, through opaque guidelines, is, of course, beyond glaring.


The SEC chairman, Gary Gensler, used to teach a course on blockchain at MIT's Sloan School of Management. He understands the technology and its potential. In his lectures and writings, he took a broadly balanced stance towards the industry and described himself as a “centrist-minimalist”. This apparent objectivity seems to have gone out of the window ever since his confirmation.

Gensler now repeatedly calls the sector “rife with fraud, scams and abuse”. In a Senate Banking Committee hearing on 14 September, he, again, called the industry the “wild west” of finance. A fellow Democrat lawmaker later expressed surprise that he had only used one “wild” in the phrase.

This transformation may be a product of the political nature of the SEC’s leadership. Each incoming administration has the power to appoint a new chairman, as well as a majority of the SEC’s commissioners. Gensler has thus gone from academic commentator to political operator. The administration he serves and other leading figures from the party, have not hidden their desire to crack down on cryptocurrencies. The White House, Treasury, Federal Reserve, IRS, Congress, CFTC, Office of the Comptroller of the Currency and SEC are acting in unison towards this goal. The urge to do something, anything, to push forward this agenda may have spurred Gensler into action.

Beyond the party political, the Lend programme challenges the US government’s power in two important ways. Firstly, it undermines one of the major levers the government has over money - setting interest rates. The Lend programme enables investors to buy the digital equivalent of a dollar and earn eight times the average US interest rate. This risks freezing vast amounts of capital in the programme, thereby defeating the purpose of low interest rates, which encourage capital deployment. The prospect of anyone saving and earning interest is anathema to contemporary monetary policy.

Secondly, the USDC is a private alternative to a CBDC (central bank digital coin). Should it continue to grow, it could hamper the ability of the US government to create its own CBDC. The market would no longer have a need for it and the US government would be impeded in its ability to control future monetary supply.

Governments fight very hard to control money. Anything that stands in their way is at risk of being regulated to death or severely handicapped. As Ray Dalio recently said about Bitcoin, “if it’s really successful, they’ll kill it”. This is what they could be trying to do to Coinbase and stablecoins in general. The trillion-dollar question, however, is whether crypto is now too big to kill. If it is, then the tables have turned and the government’s action may just be a desperate attempt to rein in an industry that it can no longer control. This may well be a Goliath-versus-Goliath situation.

The political dimension of the SEC and the broader threat Lend represents to monetary control could explain why the agency is clutching its pearls over a relatively anodyne programme. Out of all the financial schemes that could endanger the public, be they crypto or not, the Lend programme is, surely, not top of the list. Questions remain as to whom the SEC is trying to protect.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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