Crypto: Coinbase fights back against the SEC

A few days ago the SEC succeeded in convincing Kraken to shut down its crypto staking service to US users, and now it is taking a shot at Coinbase.

Indeed, Coinbase itself had unveiled a couple of days earlier that the SEC was moving to try to ban it from offering its staking service to retail investors in the US.

However, while Kraken has caved in, agreeing to shut down the service in the US and pay a $30 million fine, Coinbase seems unwilling to budge.

Coinbase’s position versus the SEC’s position

The SEC, which is the US government agency that oversees security markets, argues that offering the crypto staking service is equivalent to an investment contract, i.e., a security, and for that it must be approved by the same agency.

Coinbase, on the other hand, argues that crypto staking is not a security.

In a post published a few days ago on the exchange’s official website blog, Coinbase Chief Legal Officer Paul Grewal wrote that crypto staking is not a security under either the US Securities Act or the Howey Test.

However, he also specifies that there are many financial products called “staking” on the market that actually work very differently from actual crypto staking.

Grewal claims that Coinbase only offers the real crypto staking service, which is not a security. By implication, he suggests instead that services called “staking” and offered by competitors might be.

True crypto staking

The term “staking” in crypto comes from what is known as Proof-of-Stake, or an alternative system to Proof-of-Work for validating blockchain blocks, and thus transactions.

The first cryptocurrency ever created, Bitcoin, was always based on Proof-of-Work, which, however, turns out to be very energy intensive. To reduce energy consumption and block validation time, Proof-of-Stake (PoS) was invented many years ago.

PoS involves locking tokens on validating nodes. In this way, the node can validate the blocks, receiving in return the fees paid by the users who made the transactions.

This is called staking, and it is a fundamental activity for PoS-based cryptocurrencies, without which they simply could not be traded.

Given that anyone can install a validator node and put their tokens in staking, it seems totally incorrect to call staking an “investment contract,” since there are not two parties agreeing to it, but only one that installs the node and puts their tokens in it.

The crypto staking service of exchanges: Coinbase, Kraken and Binance on the podius

The problem arises when users want to stake their tokens on others’ nodes.

Some cryptocurrencies allow this natively, that is, without the necessary intervention of an intermediary, but for example Ethereum does not. In other words, in order to be able to put one’s ETH on someone else’s node, it is necessary to go through an intermediary, which is usually the same owner of the node.

The largest brokers in the world offering ETH staking are Coinbase, Kraken and Binance, which are three exchanges, although the largest pool in the world in this respect is Lido DAO. Being a DAO, Lido is not a financial company offering an investment product, so again there is no real contract.

Instead, the problem is the staking services offered by companies such as exchange companies, because they look a lot like real investment contracts that promise earnings.

The problem with Coinbase and the service related to crypto staking

Coinbase claims that the service it makes available to its users is precisely the real crypto staking described above, whereas they assume that the service offered by competitors is not.

In other words, they claim that their service is not an investment contract, while admitting that the one offered by others might be.

The key issue seems to be the ownership of the crypto staked on Coinbase

Indeed, Grewal asserts that when customers stake part of their cryptocurrencies on Coinbase, they are not giving up one thing to get something else: they own exactly the same thing they owned before, because they retain full ownership of their assets at all times.

In other words, it is as if he is saying that Coinbase is not acting as an intermediary, and therefore there cannot be an investment contract.

At this point, however, some doubts about this claim arise, because while it is true that Coinbase Wallet is a non-custodial wallet, in which users therefore retain sole ownership of their tokens, this cannot apply to, for example, ETH staked on Coinbase Earn.

It is therefore possible that if Coinbase continues to support this position the SEC could take the matter to court so that a judge can decide who is right.

Grewal also claims that staking services would not meet the “reasonable expectation of profits” element of the Howey Test. Even this claim is open to doubt.

The assumption therefore is that if the SEC decides to go through with Coinbase, the matter may indeed end up in court.

Coinbase is a publicly traded company, and its share price in the last week has lost 17%.

Today on top of this loss in pre-market there is another -2%, probably because the markets are not so confident that in the end this tug-of-war with the SEC can end in victory for the exchange.

It is worth noting that the current value of Coinbase shares is 81% higher than last year’s lows.