Here’s Why Coinbase Is In Hot Water Over Crypto Lending And How The SEC Is Sending A Shot Over The Bow For DeFi

Crypto experts and financial specialists explained to MarketWatch that the legal dispute could be one that establishes clearer rules for the nascent segment of the digital asset market known as decentralized financing, or DeFi, where investors lend digital coins for additional fees. to earn.

Also read: What is Decentralized Finance? An expert on bitcoins and blockchains explains the risks and benefits of DeFi

Crypto professionals say DeFi has grown, and Coinbase currently offers a variety of services, including trading bitcoin BTCUSD,
+0.39%,
meme assets dogecoin DOGEUSD,
+2.12%
and Ether ETHUSD,
+1.14%
wants to expand its fee-generating offering as a publicly traded company.

As in the stock market, the coins lent by customers can facilitate speculation through crypto derivatives and other products.

However, in the eyes of the SEC, the lending program securitizes the crypto, passing the interest on to the customer, similar to how a bond pays interest to a holder or how a stock pays dividends.

Armstrong claimed in a series of tweets that the SEC, led by Gary Gensler, which took over the reins of the regulatory agency in mid-April, has not made its stance clear on what is and isn’t security.

However, at least one former regulator said the SEC has been crystal clear about its position on the matter.

When does a crypto asset become a security? When you start lending it, Amy Lynch, former SEC regulator and president of FrontLine Compliance, told MarketWatch in a phone interview Wednesday afternoon.

Coinbase planned to eventually expand its crypto lending program to other assets outside of USD Coin.

Lynch said she advises companies offering crypto lending services to register with the SEC or go through a broker/dealer to comply with regulatory rules.

For example, Gemini has partnered with cryptocurrency lender Genesis, a subsidiary of Digital Currency Group. In that case, Gemini, owned by twins Cameron and Tyler Winklevoss, collects a portion of the spread between the interest paid on the crypto and the interest Genesis charges on its loans to institutions.

Lynch said Coinbase may not be happy to make such an arrangement, as it would involve sharing costs.

If the SEC decides this is a concern, they will take a closer look at the companies that do this, she said.

Indeed, The Wall Street Journal recently reported that the SEC sent letters to companies seeking information about crypto lending platforms. MarketWatch’s sister publication reported that the regulator was seeking information, including on whether digital assets on offer are securities that must be registered.

RA Farrokhnia, a professor at Columbia Business School, said Coinbase stands for financial innovation and that regulation should not stifle the new.

What you see is the evolution of crypto, and specifically the next phase is decentralized finance, Farrokhnia said.

Unfortunately, despite crypto having been in our financial ecosystem for the past few years, there hasn’t been a clear regulatory framework outlining what is and isn’t allowed, he said.

So this lack of regulatory clarity on what exactly is considered a security in the existing framework[without the] creating brand new regulations, tailored for our new reality, is causing all sorts of confusion, Farrokhnia said, explaining that he believes the SEC should express more willingness to partner with the nascent crypto industry.

Gensler, who has trained the SECs to focus on investor protection, perhaps more than any other regulator to date, has openly said he wants to upgrade crypto regulations as well.

As far as anything is a security, the SEC has a lot of authority. And many crypto tokens that I will not call them cryptocurrencies at this point are indeed securities, Gensler told CNBC during an interview in May.

We need to update and refresh our rules to make sure that while private investors and any individual have the First Amendment right to speak, and so on, they don’t mislead the public, they don’t manipulate the public, and they don’t manipulate the markets, he said. he.

Lynch said the SEC’s stance on Coinbases lending could be influenced by a recent lawsuit against BitConnect, which in 2016 offered its own digital security in exchange for bitcoin and created an automated program that made money by trading the contributed bitcoin. Investors thought the profits were shared, but the SEC claims the program was an elaborate Ponzi scheme.

Coinbase shares finished 3.2% on Wednesday and are down 7.3% this week, compared to a weekly decline for the Dow Jones Industrial Average DJIA,
-0.20%
and the S&P 500 index SPX,
-0.13%
of 0.5% and 1% respectively.