Coinbase Says SEC has threatened to sue it over plan to pay interest

Coinbase, the largest cryptocurrency exchange in the United States, said on Wednesday that federal securities regulators were threatening to sue it over a proposed financial product that would let customers earn interest on digital asset deposits.

In a regulatory filing, the company said the Securities and Exchange Commission notified it Sept. 1 that its Lend product could violate securities laws. Regulators, the company said, might respond to Lend’s release by seeking a civil injunction.

The issue raised by Lend — an interest-generating service that somewhat resembles accounts traditionally offered by banks — is whether it will be engaged in trading or offering products to consumers that are considered securities, which the SEC has the power to regulate.

The warning to Coinbase, which listed on the public market in April, is an indication that the SEC is closely watching cryptocurrency companies — especially as they move into the territory of heavily regulated industries such as banking. SEC Chair Gary Gensler has said he is worried about the effects that unregulated crypto exchanges and products could have on the markets and investors.

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Lend, which Coinbase announced in June, would allow customers to earn interest on cryptocurrency deposits. Specifically, customers would be able to earn interest on USD Coin, a so-called stablecoin whose value is tied to the dollar. Yields would be higher than those offered on classic bank accounts, and Coinbase would be among numerous cryptocurrency businesses entering this sector.

In online postings, Coinbase executives pushed back against the SEC, saying that the Lend program doesn’t qualify as a security and that the commission’s notice caught them off guard.

“The SEC has repeatedly asked our industry to ‘talk to us, come in.’ We did that here,” Coinbase’s chief legal officer, Paul Grewal, said in a blog post. “But today all we know is that we can either keep Lend off the market indefinitely without knowing why or we can be sued.”

In an extensive thread on Twitter, Coinbase CEO Brian Armstrong called the SEC “sketchy” and said he went to Washington in May to meet with financial regulators at many agencies. “The SEC was the only regulator that refused to meet with me,” he said.

By seeking permission to act, Armstrong said, Coinbase is facing more resistance from regulators than other cryptocurrency companies that have introduced similar products.

Securities lawyers were divided over the SEC’s tactics in going after Coinbase. Daniel Hawke, an attorney with Arnold & Porter and a former chief of the SEC’s market abuse division, said the agency’s trying to stop a product launch “sounds aggressive.”

But some legal experts said securities regulators appeared to be taking a somewhat cautious approach in giving Coinbase a fair warning of its thoughts as opposed to simply letting the company go forward with the lending product and suing it later.

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Tyler Gellasch, a former SEC official who leads the nonprofit Healthy Markets Association, said the commission recognized the importance of carefully handling a new kind of product entering the market.

“This is a very large player in the cryptocurrency place, and they are extremely cautious in bringing down a hammer,” he said.

Coinbase is not the only company running into trouble with securities regulators over crypto-based interest-generating services. Officials in five states have targeted BlockFi, a cryptocurrency business that offers high yields on holdings. BlockFi CEO Zac Prince said that the company was complying with the law but that regulators did not fully understand its offerings.

“Ultimately, we see this as an opportunity for BlockFi to help define the regulatory environment for our ecosystem,” he wrote in a note to customers.

Shares of Coinbase fell a little more than 3% by the close of trading Wednesday.