Coinbase Defends Its Token Listings in Court Against SEC Lawsuit

Coinbase, the largest cryptocurrency exchange in the U.S., faced a tough grilling from a federal judge on Wednesday over whether the tokens it lists on its platform are securities subject to regulation by the Securities and Exchange Commission (SEC).

The SEC sued Coinbase in June 2023, accusing it of operating as an unregistered exchange, broker and clearing agency for digital assets that are securities. The SEC also alleged that Coinbase failed to comply with anti-money laundering and investor protection rules.

Coinbase has denied the allegations and filed a motion to dismiss the case, arguing that the SEC is taking a “regulation by enforcement” approach that creates uncertainty and confusion for the crypto industry. Coinbase also claimed that the SEC has not provided clear guidance on how it determines which tokens are securities and which are not.

In a hearing before New York District Judge Katherine Polk Failla, Coinbase’s lawyer William Savitt tried to explain the difference between “investing in Beanie Baby Inc. and buying Beanie Babies,” referring to the popular stuffed toys that were once a craze among collectors.

Savitt said that Coinbase does not dispute that some token transactions can be considered investment contracts, which are a type of security under the federal securities laws. However, he said that the SEC has not shown any evidence that the tokens listed on Coinbase’s website, such as SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, DASH and NEXO, meet the criteria for being investment contracts.

He said that the SEC’s lawsuit relies on a broad and vague definition of investment contracts that does not take into account the specific features and functions of each token. He also said that the SEC’s theory that token buyers are entering into investment contracts simply by reading the white papers and other information provided by the token projects is flawed and unsupported by the law.

“There has to be a statement that is meant to convey an enforceable promise. That’s the irreducible minimum of what can be conceived to be an investment contract,” Savitt said.

He also argued that tokens are fundamentally different from securities, because token buyers do not acquire the same rights and benefits that securities holders do, such as voting rights, dividends, or claims on the issuer’s assets. He said that tokens are more like commodities or currencies that can be used for various purposes on the blockchain, such as accessing services, verifying transactions, or rewarding users.

Judge Failla questioned Coinbase’s lawyer about how the exchange decides which tokens to list and whether it conducts any due diligence on the token projects. She also asked him about the relevance of some recent court decisions that have addressed the issue of whether cryptocurrencies are securities or not.

One of those decisions was made by New York District Judge Jed Rakoff, who ruled last month that Terraform Labs and its former CEO Do Kwon violated the securities laws by offering and selling unregistered securities in the form of UST tokens, which are pegged to the U.S. dollar. Savitt said that Coinbase disagreed with some of Rakoff’s analysis, but that it could “live with” his conclusion that there has to be a contract or a contractual agreement to establish an investment contract.

Another decision was made by New York District Judge Analisa Torres, who ruled in July that some of Ripple’s sales of XRP tokens did not constitute securities offerings, because they were done through a blind bid process that did not involve any promises or expectations from the buyers. However, she also ruled that other direct sales of XRP to institutional investors were securities offerings, because they involved explicit or implicit representations of future profits or returns. Savitt said that Coinbase agreed with Torres’ reasoning and that it was consistent with its position.

The hearing ended without a ruling from Judge Failla, who said she would take the matter under advisement and issue a decision in due course. The outcome of the case could have significant implications for the crypto industry, as it could set a precedent for how the SEC regulates and enforces the securities laws on digital assets.

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