SEC lawsuit against Coinbase raises questions about crypto's market structure

Quick Take

  • The SEC case against Coinbase calls out commonplace crypto market structure.
  • Unlike exchanges in equities, crypto trading platforms have integrated platforms that span custody, trading and exchange.
  • It’s a model that opponents say raises the potential for conflicts of interest.

The U.S. Securities and Exchange Commission's lawsuit against Coinbase has raised fresh questions about the legal status of a wide angle of cryptocurrencies.

More broadly, it has also called out the overall market structure of the industry. In U.S. equity trading, exchanges operate more narrow businesses compared to their crypto market counterparts, which — in the case of Coinbase — serve as custodians, retail brokers, and over-the-counter traders as well as exchanges.

"The Coinbase Platform merges three functions that are typically separated in traditional securities markets—those of brokers, exchanges, and clearing agencies," the SEC said in its complaint. "Yet, Coinbase has never registered with the SEC as a broker, national securities exchange, or clearing agency, thus evading the disclosure regime that Congress has established for our securities markets."

This structural approach underpins most venues in crypto. Kraken, for instance, operates a retail brokerage in addition to its exchange, as well as an over-the-counter trading desk that allows larger trading firms to execute orders.

Gemini, founded by Cameron and Tyler Winklevoss, shares this model. It offers Gemini eOTC, a service similar to Kraken's OTC desk. That service is integrated with its settlement service, Gemini Settlement. Kraken, like Coinbase, also operates a custodial service. 

Traditional equities exchanges, like Nasdaq and the New York Stock Exchange, don't operate custodians, a job left to firms like BNYMellon or State Street. Nor do they operate trading desks.

The perceived benefits of the integrated crypto model are tied to the space's operating ethos: a smaller amount of middlemen is more cost-efficient and less expensive to run. 

The drawbacks, however, can lead to conflicts of interest between different business lines. That's also been an issue in equities; when high-frequency trading firm Virtu announced its deal to purchase ITG, a client-facing agency trading firm, it had to quell market anxieties about potential conflicts. 

CoinRoutes' Dave Weisberger has called for separating the crypto exchange business from over-the-counter trading since he entered the space six years ago. 

On custody, Weisberger said the separation would be good because "the information in knowing the identity of wallet movements is potentially market impacting."

"OTC separation is even more important as having the ability to trade against client orders is a clear conflict," he told The  Block. "It also creates risk and, since funds are comingled, could impact clients if the desk loses money."

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