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Coinbase Fights Back: Files Motion to Dismiss SEC Lawsuit, Stresses Regulatory Clarity

The exchange contends that the SEC has "violated due process, abused its discretion, and abandoned its own earlier interpretations of the securities laws."

Coinbase Fights Back: Files Motion to Dismiss SEC Lawsuit, Stresses Regulatory Clarity

Coinbase, the prominent cryptocurrency exchange, is taking an assertive stance against the U.S. Securities and Exchange Commission (SEC) in its ongoing legal battle. On Friday, Coinbase filed a motion to dismiss the SEC's case against the company, citing several grounds for dismissal. The exchange contends that the SEC has "violated due process, abused its discretion, and abandoned its own earlier interpretations of the securities laws." Additionally, Coinbase argues that the subject matter of the case falls outside the SEC's delegated authority, stating that none of the relevant transactions involving digital assets and services are "investment contracts" or "securities" under the Securities Act of 1933 and the Securities Exchange Act of 1934.

The crux of Coinbase's argument revolves around the SEC's attempt to retroactively regulate digital asset exchanges. The exchange maintains that the SEC's current targeting of its services, including Prime, Wallet, staking, and the spot exchange, was previously overlooked when Coinbase sought to become a publicly traded company in 2021. Coinbase points out that SEC Chair Gary Gensler, at that time, deferred to Congress as the appropriate authority for regulating crypto exchanges.

Regarding staking services, Coinbase refutes any association with investment contracts, as they do not involve the relinquishment of property and the risk of loss, which are necessary elements of being deemed a security. The exchange argues that the SEC is trying to stretch the definition of an investment contract to encompass a standard fee-for-services arrangement.

Coinbase draws parallels to the recent Ripple ruling, where the judge found that institutional sales met the Howey requirements, while programmatic sales did not. According to Coinbase, the Ripple court's findings align with facts similar to those alleged in its case, strengthening its position.

Beyond seeking a dismissal of the SEC's claims, Coinbase invokes the Major Questions Doctrine, asserting that clear congressional authorization is needed for the SEC's actions, which it currently lacks under Gensler's leadership.

The SEC Lawsuit

The SEC filed its lawsuit against Coinbase on June 6, following a Wells notice received by the exchange roughly three months prior. The regulatory body is also actively pursuing legal actions against other prominent players in the crypto industry, including Binance and Hex founder Richard Heart amongst others.

The Coinbase lawsuit alleged that the exchange operated as an unregistered exchange and offered unregistered securities, and the ensuing legal battle has highlighted the tension between cryptocurrency firms and regulators as the industry seeks greater regulatory clarity.

SEC Chair Gary Gensler has been vocal about his stance that most cryptocurrencies should be classified as securities, thus falling under the purview of the SEC. However, he has made an exception for Bitcoin, considering it more appropriate to be classified as a commodity, overseen by the Commodity Futures Trading Commission (CFTC).

The legal battle with the SEC took a fiery turn when Coinbase's legal counsel accused the regulatory body of "violating due process" in suing the exchange. The accusations were put forth in a filing with a New York District Court on August 4. Coinbase's legal team asserted that the SEC abused its discretion and deviated from its own previous interpretations of securities laws while pursuing the case.

Coinbase's Troubled Financial Situation

The move comes as Coinbase expresses confidence in winning the court case, as revealed by Paul Grewal, the exchange's Chief Legal Officer, during its second-quarter 2023 earnings call. The company reported an impressive $663 million in net revenue for the quarter.

A noteworthy development in Coinbase's financials is the surge in non-trading revenue, surpassing its trading revenue for the quarter. Out of the $663 million in net revenue, $335.4 million came from subscriptions and services, while $327 million was from transaction revenue. Coinbase's CEO, Brian Armstrong, emphasized the company's focus on non-trading aspects of the business over the next three to five years, with priorities like scalability, regulatory clarity, and driving crypto utility. However, while Coinbase’s situation might seem bright and hopeful, the exchange might be in more troubled waters than it seems.

Although Coinbase’s earnings are much better than feared, considering Coinbase managed to maintain a positive adjusted EBITDA for the second consecutive quarter, analysts at Berenberg Capital Markets highlighted potential risks related to interest income from USDC and staking revenues, which together accounted for approximately 36% of Coinbase's net revenue in the quarter. USDC's continued market cap decline and increased scrutiny on staking by the SEC and various states put those sources at risk, posing a potentially large risk for the exchange in the near future.

Moreover, the National Defense Authorization Act (NDAA) introduces the possibility of new compliance requirements for USDC, further complicating the company's financial position. However, some analysts, like Owen Lau from Oppenheimer and Co., anticipate positive regulatory developments, such as the proposed Financial Innovation and Technology for the 21st Century Act, which could gradually reduce Coinbase's downside risk.

However, despite regulatory challenges and the expected headwinds facing the exchange, Coinbase's stock price remained relatively stable, indicating a wait-and-see approach from investors. The outcome of this high-profile lawsuit could have far-reaching implications for the cryptocurrency industry, shaping the future regulatory landscape for digital assets.

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