Coinbase Chief Legal Officer responds to concerns about Crypto Rating Council

Crypto firms are coming together to flesh out which tokens are more likely to be deemed securities by U.S. regulatory bodies in the Coinbase-led Crypto Rating Council. The member-operated coalition plans to elucidate legal characterizations of tokens with its sliding scale, but some aren’t sold on the value of a business-operated rating council. Coinbase's legal counsel responded to concerns about conflicts of interest and legal analysis by a coalition with interests in listing compliant assets.

Founding members of the Council include Anchorage, Bittrex, Circle, Coinbase and Kraken among other parties. Coinbase heads up the organization as the driving force, having brought industry players and securities law experts together to formulate what it calls a “scalable, points-based rating system” based on yes or no responses. The questions are formulated from Securities Exchange Commission (SEC) guidance and case law detailing whether an asset is a security, according to a statement from Coinbase. The score is intended to inform other token dealings for companies, according to the statement.

“The result of the analysis is a score which makes it easy for members to synthesize the analysis across many tokens and make their own, independent business decisions about whether or how to support an asset," said the statement.

Scores range between one and five, with five being clearly a security. However, the council doesn’t plan to disclose five ratings, according to CoinDesk, since member exchanges wouldn’t carry them anyway.

Published ratings are compiled by legal experts in partnership with experts at member firms, according to the statement. Those member firms deliberate with their own lawyers and vote whether to adopt the rating. Despite the strong legal analysis, Coinbase insists that the ratings are not to be taken as legal advice. 

“We make clear on the website that we're not providing legal advice and people should consult their own legal advisers,” said Brian Brooks, Chief Legal Counsel for Coinbase. “This is essentially an automated compliance tool, of which there are many in the financial services world. Think Hummingbird for AML compliance, or Fair Lending Wiz for fair lending compliance. No one thinks those tools represent the practice of law. And this certainly doesn't constitute investment advice – we're not rating the quality or value of assets, only their status as a security or not.”

Still, despite abounding disclaimers, Tyler Gellasch, executive director at Healthy Markets and previous counsel to SEC Commissioner Kara M. Stein, said it can be murky. The Council may be leaving itself open to considerable risk.

“There's a lot of complex rules around those types of things, but yet I don't think it's clear how they intend to address those rules and risks,” he said. “For example, what if they determine that something is very much not a security, but the SEC then makes a determination that the product is, in fact, a security?  What if an investor relied on their opinion when making its investment decision?”

Furthermore, Gellasch said he sees a lack of clarity on the purpose of the ratings. Brooks referred to the ratings as a compliance tool for industry players, providing them with further information to help them adhere to U.S. regulations. However, the Council notes that it is an independent body not endorsed by the SEC, CFTC, or any government agency, developer team or other third party.

Since it's a tool for legal compliance that specifically states it's not to be taken as legal advice, Gellasch said it’s unclear what the goal is. Additionally, regardless of its legal standing, there are questions of how useful the tool will be.

“I see a very limited utility of this thing,” said Gellasch. “I don't see it as being particularly relevant for the legal counsel or investment professionals at an investment firm, nor do I see regulators giving it any extra value. So the only value of this is to provide the sort of sales pitch of this is an adult asset class that you [investors] should consider.”

In terms of that sales pitch, Gellasch said it isn’t very persuasive to have members of the council involved with rating assets that they have stake in.

“A group of private companies jointly declaring how they think things that directly impact their bottom lines should be regulated isn't likely to be all that persuasive to regulators or investors.”

However, Brooks said the self-interest in maximizing the number of assets member exchanges can list, custody, or invest in doesn’t necessarily outweigh the self-interest in avoiding SEC fines and other penalties. He also pointed to a number of the assets being rated a five, or strongly resembling a security, which he said dispels suggestions that the scorecard is an attempt to justify listing any asset.

“The point is to get clarity, not justify listing assets that wind up being deemed unregistered securities,” he said.

Indeed, Richard Johnson, an analyst at capital markets consultancy Greenwich Associates, said he sees the Council as more of an informational tool, but he too had questions of how it’ll be used by industry members.

“My biggest question is what's next? Where do you go when you get these rating numbers? Obviously it's not going to be like a Moody's that's going to be used for investors. It seems to be like more of a regulatory risk type rating. So who's going to use it?”

Still, Johnson said the Council represents considerable collaboration in the space by reputable firms, which could grow the asset class. 

Of those firms, Paxos was initially reported to be a member by the Wall Street Journal before the organization corrected its coverage. Coinbase said it initially anticipated Paxos and ItBit to be among the founding members, but no contracts were ever signed nor agreements made.