Will the SEC kill Coinbase (COIN)?

Many people think the SEC is trying to kill Coinbase (COIN) and other cryptocurrency exchanges. SEC attorneys allege Coinbase is trading 13 crypto assets without registering them as securities.

Two federal laws, the Securities Act of 1933, and the Securities Exchange Act of 1934, require all securities sold in the USA to be registered with the Securities and Exchange Commission (SEC). A lawsuit called Securities and Exchange Commission vs. Coinbase, Inc. and Coinbase Global Inc. alleges Coinbase is violating those laws.

Specifically, SEC attorneys allege 13 assets Coinbase sells violate the Howey Test, Quartz reports. To explain, the Howey Test refers to SEC vs. W.J. Howey Company, a 1946 US Supreme Court ruling.

How the Howey Test could Devastate the Cryptocurrency Markets

In Howey, the Supremes defined a security as an investment of money in a common enterprise with the exception of profit. To elaborate, the Howey company was selling ownership shares in Florida citrus groves an investment. The Supremes declared those shares securities.

The SEC’s Coinbase case could devastate the crypto markets applying the Howey Test to cryptocurrencies. In particular, SEC attorneys claim several popular cryptocurrencies meet the Howey criteria for securities.

Those cryptocurrencies include: Solana (SOL), Cardano (ADA), Polygon (MATIC), Filecoin (FIL), Sandbox (SAND), Axie Infinity (AXS), Chiliz, Flow (FLOW), Internet Computer (ICP), Near (NEAR), Voyager (VGX), Dash (DASH), and Nexo (NEXO). Notably, Cardano was the seventh-largest cryptocurrency with a $452.410 billion Market Cap. Solana was the ninth-largest cryptocurrency with a $425.399 million Market Capitalization, and Polygon was the 10th-largest cryptocurrency, with a $396.910 billion Market Cap on 9 June 2023

How the SEC could devastate the Cryptocurrency Markets

Notably, the SEC is alleging the world’s largest cryptocurrency exchange Binance is violating the Howey Test in another lawsuit. Binance (BNB) was the second largest cryptocurrency, with a $496.60 billion Market Cap on 9 June 2023.

If federal courts rule in the SEC’s favor. The agency will have the power to regulate and ban those cryptocurrencies in the United States. This could kill those cryptos because the US is the world’s largest economy. Authorities in the second largest economy, China, have banned private cryptocurrencies.

Hence, the SEC’s action could devastate the cryptocurrency industry by cutting off crypto’s access to the world’s largest economy. I think the cryptocurrency market could collapse without the USA’s $23.215 trillion economy.

Is the SEC trying to kill Cryptocurrency?

Dramatically, Coinbase’s chief legal officer, Paul Grewal, charges that the SEC refuses to let his company register and comply with federal law.

“When Coinbase has attempted to do just that, to talk about how we could register as a broker-dealer or an [alternative trading system] or even as a [national securities exchange] after months and months of discussion, we’re simply dismissed with no response or any counter proposal or ideas coming back from the SEC,” Paul Grewal charges. Grewal made the statement to the US House Agriculture Committee on 6 June 2023.

Attorney and former SEC commissioner, Dan Gallagher, charges that SEC staff refused to register Robinhood Markets Inc. (HOOD) as a special purpose broker dealer, CoinDesk reports. Gallagher alleges that SEC Chair Gary Gensler is hostile to crypto.

“Look, we don’t need more digital currency,” Gensler said during an appearance on CNBC’s Squawk on the Street. “We already have digital currency. It’s called the U.S. dollar. It’s called the euro, or it’s called the yen; they’re all digital right now. We already have digital investments.”

Hence, Gensler is hostile to non-government currencies. I think Gensler could be correct if the US had a Central Bank Digital Currency (CBDC). Unfortunately, politicians’ hostility to CBDC could block the Federal Reserve’s CBDC efforts while the People’s Bank of China deploys a Digital Yuan (e-CNY).

Is the SEC putting the Economy at Risk?

I think Gensler’s anti-cryptocurrency crusade shows the SEC is not doing its job. You can also charge that SEC’s actions are the real threat to the markets.

The first problem is that the SEC’s refusal to register Coinbase and Robinhood as broker-dealers favors the traditional financial industry (Wall Street) over new entrants in the business. Essentially, Gensler is saying that only traditional brokers and investment banks can sell securities in the US. This benefits politically connected institutions such as Goldman Sachs (GS) over decentralized finance.

Gensler’s stand is disingenuous because there is no evidence new platform such as Coinbase, Robinhood, and Binance create any more risk than the traditional securities markets. For example, the Great Financial Meltdown of 2008 began with the collapse of the 161-year-old investment bank Lehman Brothers.

Many critics blame the SEC’s failure to regulate derivatives for the 2008 financial crisis. Now, Gallagher and Grewal charge the SEC is refusing to regulate one of the fastest segments of the securities market. Hence, the SEC is failing to do its job and putting the economy at risk.

Is the SEC waging Class Warfare?

I think the Securities and Exchange Commission’s stand on crypto is on shaky moral and philosophical ground. To explain, the SEC is taking sides in the market, which most Americans will view as wrong and a violation of the free market. 

Cynics will wonder if SEC members and staff are more interested in high-paying jobs on Wall Street than doing their duty. Hence, there could be regulatory capture and conflicts of interest at the SEC.

Moreover, you argue that the SEC is taking sides in America’s class warfare. To explain, platforms such as Coinbase, Binance, and Robinhood provide middle and working-class people without Ivy League degrees direct access to financial markets.

Hence, Gensler is saying that it is alright for an Ivy-League educated cokehead at Goldman Sachs to make direct investments in securities. Yet it is wrong for a truck driver in Duluth, a schoolteacher in Tampa, or an insurance agent in Long Beach to make direct investments in securities. I think that’s hypocritical.

Historical debacles, such as Long-Term Capital Management (LTCM) and Lehman Brothers, show Ivy-League educated financial engineers, have no special knowledge or expertise that makes them better investors. Indeed, you can argue Gensler’s stand increases the risk to the economy by giving Wall Street more money and power.

Is the SEC trying to Destroy DeFi?

Moreover, banning decentralized finance (DeFi) by refusing to regulate it could help Wall Street make more money. I think DeFi platforms such as Coinbase, Robinhood, and Binance threaten traditional brokers, investment banks, and fund managers.

In particular, Gensler could want to preserve the monopoly America’s retirement system gives giant fund managers such as BlackRock, Fidelity Investments, and Vanguard Group. To explain, the current tax system forces most Americans to invest in those funds for retirement. Ordinary Americans are told “invest in an individual retirement account (IRA) or a 401K or spend your golden years eating cat food.

This gives fund managers enormous power and wealth. For example, America’s largest fund manager, BlackRock, has $9.090 trillion in assets under management (AUM), the Sovereign Wealth Fund Institute estimates. Similarly, Vanguard has $8.1 trillion in AUM and Fidelity has $3.88 trillion in AUM.

Hence, the current system creates enormous risk to America by concentrating wealth in a few large institutions. For example, what happens if BlackRock CEO Larry Fink calls the White House or the US Secretary of the Treasury and says, “I need a bailout now or tens of millions of Americans’ retirement savings will disappear!” Remember, that happened in 2008, and Wall Street got its $700 billion bailout.

Critics will say a decentralized system in which ordinary citizens control their own money will be more resilient. The cryptocurrency industry is trying to build such a system, yet the SEC is trying to destroy it.

This also gives Congress (which relies on Wall Street donations) a powerful incentive not to increase Social Security, which can serve as an alternative to retirement accounts. Cynics will say Gensler is trying to preserve Wall Street and the fund industry’s monopoly not protect investors.

Will the Courts Boost Coinbase (COIN)?

Strangely, Mr. Market thinks the courts could rule for Coinbase Global Inc. (NASDAQ: COIN). For example, he paid $53.28 for COIN on 9 June 2023.

I think Mr. Market overprices Coinbase because it loses money. For example, Coinbase reported a -$123.88 million quarterly operating loss on 31 March 2023. The quarterly operating loss fell from -$554.87 million on 31 December 2022 and -$554.56 million on 31 March 2022.

In contrast, Coinbase reported a quarterly gross profit of $676.16 million on 31 March 2023. The quarterly gross profit fell from $888.61 million on 31 March 2022. Coinbase is making less money, and it is shrinking.

For example, Coinbase’s quarterly revenue fell from $1.166 billion on 31 March 2022 to $772.53 million on 31 Mach 2023. Similarly, Stockrow estimates Coinbase’s revenues shrank by -33.77% in the quarter ending on 31 March 2023.

Coinbase suffered five straight quarters of double-digit revenue growth shrinkage, Stockrow reports. For example, Coinbase’s revenue growth fell by 74.82% in the quarter ending on 31 December 2022.

How Much Cash does Coinbase have?

Interestingly, Coinbase (COIN) can generate some cash. For example, Coinbase reported a quarterly ending cash flow of $10.338 billion on 31 March 2023.

The quarterly ending cash flow from $16.117 billion on 31 March 2022 but rose from $2.191 billion on 31 December 2022. In contrast, the quarterly operating cash flow fell from $3.232 billion on 31 December 2022 to $463.08 million on 31 March 2023. Yet the quarterly operating cash flow rose from -$91.36 million on 31 March 2022.

Coinbase borrows some money and pays it enormous debts. It reported a quarterly financing cash flow of -$5.610 billion on 31 December 2022. However, the quarterly financing cash flow rose to $460.13 million on 31 March 2022.

Coinbase’s total debt fell from $3.619 billion on 31 March 2022 to $3.42 billion on 31 March 2023.

What Value Does Coinbase (COIN) offer?

I think Coinbase (COIN) has some value characteristics because it had more cash than debt on 31 March 2023. Coinbase had $5.348 billion in cash and short-term investments on 31 March 2023. The cash and short-term investments fell from $6.323 billion on 31 March 2022.

Yet Coinbase is capable of enormous growth. Its total assets grew from $20.895 billion on 31 March 2022 to $139.302 billion on 31 March 2023. Hence, Coinbase added almost $119 billion in assets in a year, which is why Mr. Market loves it.

I think the assets make Coinbase an interesting growth stock. Thus, I think Mr. Market fairly priced Coinbase at $53.28 on 9 June 2023. I think Coinbase could experience enormous growth if federal courts rule in its favor in the SEC case. Unfortunately, such a ruling could be years away.

Conversely, Coinbase faces total collapse if the courts rule in the SEC’s favor. Coinbase is an interesting stock, but it is not for the faint of hear or anybody who cannot afford to lose money.