Coinbase vs. the SEC: A gamble to take on a regulator undefeated on crypto

Coinbase started a legal and public relations battle with its government regulator by suing the Securities and Exchange Commission on Monday, preemptively acting before the agency advances in its own fight with the crypto giant.

The lawsuit, which seeks a clear answer surrounding crypto rulemaking, could be the company's best possible chance to take on the SEC, and speed up a lengthy court battle that it already faced. Or, it could just be a desperate ploy to grab headlines. Regardless of opinions on the lawsuit’s merit, stakeholders see the latest salvo fired by Coinbase at the U.S. government as aimed at the court of public opinion in addition to the actual courtroom. 

“This preemptive strike that Coinbase is doing with this writ of mandamus is just another attempt to rally the mob,” said John Reed Stark, former chief of the SEC’s Office of Internet Enforcement, a current compliance consultant and vocal crypto critic. “They make these arguments like a bunch of children, running around with silly ideas, and they rally the mob with silly ideas.”

The narrow suit brought by Coinbase against the SEC revolves around a petition to the agency for new rules around digital assets. While the company has said it "firmly believes that a new regulatory framework is needed to ensure that the SEC can fulfill its responsibility to oversee the digital asset securities markets," it has yet to receive a response to the request sent last July.

Coinbase didn't respond to a request for additional comment. 

Coinbase fighting on its own terms

“For whatever reason Coinbase loves to speak loudly about everything and antagonize the SEC,” Stark said.  

They may have good reason to do so, said Jennifer Schulp, a financial regulation expert at the Cato Institute and a former enforcement director at the Financial Industry Regulatory Authority, a self-regulatory organization for the securities industry.

“They want to be able to point out that the SEC is deficient here” by “not acting in good faith” with regards to digital assets, Schulp said. 

By filing a writ of mandamus, a specific type of lawsuit against the government described as an “extraordinary remedy," Coinbase may be giving itself its best chance of fighting on its own terms before the SEC can pursue legal action against the company. The U.S. crypto giant publicly disclosed last month that the SEC launched an investigation into Coinbase over its staking, wallet, institutional and exchange businesses. 

At the center of the unusual lawsuit is a petition for rulemaking specific to digital assets, which Coinbase first requested in July. The legal maneuver aims to force the SEC to provide a yes or no response to the petition, with the likely next step to be appealing a ‘no’ decision in court and beginning a legal fight with the SEC that Coinbase knows could come anyway. 

"If the SEC says no to our rulemaking petition, which it has the right to do, then Coinbase would be allowed to challenge that decision in court and explain in that formal setting why rulemaking is required," wrote Paul Grewal, Coinbase's chief legal officer, announcing the action this week. "From the SEC’s public statements and enforcement activity in the crypto industry, it seems like the SEC has already made up its mind to deny our petition. But they haven’t told the public yet."

Playing the long game

“The current writ of mandamus is an unusual move, it is aggressive, doesn’t mean it’s wrong, but it’s not the usual tack that people take when there’s a petition for a rulemaking and it’s been nine months,” Schulp said. 

Schulp, who used to work at Gibson Dunn, the law firm hired by Coinbase to argue its case against the SEC, saw a thin argument around the length of time that has passed since the petition for a rule was made, since most SEC rules take a substantial amount of time. But she saw a stronger case to be made that SEC leadership already made up its mind without giving a formal yes or no answer. 

“From a legal strategy standpoint this is about moving the ball forward,” while also getting “good optics” for the company, she said. She noted that Eugene Scalia, a former cabinet secretary and previous colleague of hers who is leading Coinbase’s case, has won cases against the SEC and other financial regulators.

“It’s playing a long game and it depends on what the SEC’s action looks like against Coinbase,” she said, adding that the move is providing "more color and evidence to the argument that Coinbase will make in defending itself against the SEC” in a way that at least builds more material for Coinbase's defense if the SEC comes after it.

Careful what you wish for

But even if Coinbase forced the SEC to make a rule specific to digital assets, it might not be a rule that the crypto industry would want. And if the process plays out as Coinbase seems to think it will, with the SEC refusing to make a specific rule, Coinbase could appeal in court but may not win. 

“The SEC has never lost a single one of those cases,” Stark said, referring to the over 100 cases brought against crypto projects. Every enforcement action has ended in an SEC win or settlement where the subject of an enforcement action ceases an activity or pays a fine, and often both. 

Stark, who said he leans libertarian, is a critic of the SEC in other areas of its jurisdiction and has authored Wall Street Journal op-eds critical of agency policies. But on crypto, he said he agrees with the SEC’s “regulatory onslaught” of enforcement actions, policy positions and speeches, and noted that the agency has never seen the success rate it has against crypto in any other area it polices. 

“They had no program area where they were undefeated, until crypto came along,” he said.

Courting disaster?

From a business perspective, a win might provide a short-term bump for Coinbase’s stock. In the meantime, major legal hurdles are hindering the stock’s performance, and recent moves being made haven't helped, according to a Mizuho analyst.

In March, the SEC issued Coinbase a Wells Notice regarding aspects of the company’s exchange, staking service Coinbase Earn, and Coinbase Wallet after a cursory investigation. That put “30-40% of revenue at risk” for Coinbase, according to Ryan Coyne, a research analyst at investment bank Mizuho.

“Over 80% of their business currently is done in the U.S.,” Coyne said, noting that most of that with retail investors. He highlighted how reliant the company is on U.S. customers and said that it's unlikely to follow through on hints that it could leave the U.S. altogether. 

A recent licensing in Bermuda, meanwhile, is only expected to attract more regulatory scrutiny given continued concern from regulators over offshore arbitrage, especially after the epic implosion of Bahamas-based FTX, the analyst said. 

“It’s not like they’re going to domicile in Bermuda and no longer serve the U.S. user,” Coyne said. “I’m not totally sure that Coinbase has the firmest of grounds to stand on in this battle.” 

Adam Morgan McCarthy contributed to this report.