You Won’t Believe How the SEC is Failing Cryptocurrency Exchanges!

Good day. Stock selection is difficult. As of this morning, four out of five Unhedged picks in the FT’s 2023 stock pick contest are going wrong (really wrong!). In that narrow sense, it’s good news that the SEC is suing one of the companies we came up short in the contest, Coinbase, and that its shares fell sharply yesterday. Therefore, it is with a heavy heart that I argue below that the SEC should leave Coinbase alone. I recognize that this point of view places me in a clear minority. Even Ethan says I’m wrong and works for me. If he agrees with me then please email me: robert.armstrong@ft.com.

Coinbase, Binance and the SEC

It’s a shame that Ethan, the token young man from Unhedged and cryptocurrency writer, has taken a vacation at the same time that the SEC has filed lawsuits against coin base and Binancealleging (among other things) that the companies operate unregistered stock exchanges in the US would have had a nuanced comment to make.

I, on the other hand, can only die on the hill where I planted my flag in November: Cryptocurrencies are not securities, so the SEC should leave them only. This is not based on the view that cryptocurrencies have a special non-security value that should be preserved. On the contrary: cryptocurrencies are dangerous nonsense, but the market can be trusted to kill in no time. If this does not happen, cryptocurrencies should be regulated like smoking, gambling, or pyramid schemes. In any event, this material should not be granted regulatory status under securities law.

In my opinion, then, the two companies are innocent of at least one thing the SEC accuses them of: operating stock exchanges without a license. Awkwardly, therefore, my argument has to address the small issue of what looks a lot like a confession. “We are operating like a fucking unlicensed stock exchange in the US bro,” the SEC denounces. quotes Binance’s chief compliance officer as saying to another executive (buy the t-shirt here).

But this comment, while hilarious, is not decisive, brother. A person who is hired and promoted within a certain industry is selected because of her belief in the nonsense of that industry. Within cryptocurrency, that means people who believe that cryptocurrency is a legitimate asset class and therefore something very 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 stopping Binance from breaking the law appears to have thought that Binance was breaking the law is not, in this case, convincing evidence that Binance was breaking the law. It is evidence that that person breathed a lot of exhaust from the crypto industry.

But cryptocurrencies are not securities; they are, to borrow a term from Bloomberg’s Matt Levine, magic beans. What I mean by this is that the only the convincing theory of its value is the theory of the greatest fool. And magic beans aren’t the kind 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 profit (d) based on the efforts of others. This is an hopelessly broad set of criteria, and my argument is that if it applies to cryptocurrency, it applies to trading cards or sports betting, things everyone can agree the SEC shouldn’t be messing with.

The concern underlying the lawsuits is, of course, not just that cryptocurrencies are securities and that therefore Coinbase and Binance should have registered with the SEC. The concern is that they operate not only as exchange houses in this market, but also as intermediaries, liquidators, custodians and, in some cases, investment funds, and that having all those functions performed by a single entity creates terrible conflicts of interest. That’s how it is! But that’s only the SEC’s problem if cryptocurrencies are investments, which they’re not. They are magic beans.

For cryptocurrency fans, of course, there is an irony in my opinion. If I’m wrong and cryptocurrencies are more than magic beans, then the SEC is within its purview and the lawsuit makes sense. coin base argues that “does not list securities or offer products to our clients that are securities” and that, as such, the SEC’s central charge is wrong. But you don’t think this is so because cryptocurrency is just crap. He thinks, as he should, that the cryptocurrencies they list are legitimate assets, part of a “new financial system,” as the company says in its, ahem, filings with the SEC.

And if this is so, it is absolutely necessary to have the argument about assets that are not securities. Coinbase just wants to have that argument in Congress, or at least in a regulator’s office, rather than in court. I agree that this would be a better idea (although the proper regulatory office would be a state gambling commissioner in my opinion). But the US political/regulatory system being what it is, we go to court.

The SEC’s complaint against Coinbase (the easier of the two lawsuits) makes for pretty boring reading. The big indictment: “Coinbase’s lack of registration has deprived investors of significant protections, including scrutiny by the SEC, record-keeping requirements, and safeguards against conflicts of interest, among others.” To which I reply: buyers of magic beans are probably beyond protection, even from the powerful SEC.

It’s too bad, from my libertarian point of view, that the lawsuit is happening now. From what I can tell, the industry has slipped into obsolescence on its own. Yes, the bitcoin price has risen this year, helped by liquidity pouring into the US financial system after the Silicon Valley Bank collapsed. But the rally seems slim, especially now that monetary policy is tightening again. As my colleagues at Lex have pointed out, cryptocurrency trading volumes they are falling fast. Had it had time, crypto is a problem that the market, with the help of a bit of non-financial regulation and higher interest rates, could have handled.

a good read

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