Interview With Coinbase Chief Legal Officer Paul Grewald + Bullish Inflation Reading

Dear Subscribers,

Thank you again to those of you who joined me for our June webinar. We covered a lot of important information regarding market volatility, the SEC enforcement actions against Binance and Coinbase, as well as the outlook for a recent piece of market structure legislation that came out of two house committees (Finance and Agriculture), that could solve a lot of the questions raised in both SEC suits. If you have not yet had a chance to watch it, or would just like to see it again, please click on this link.

Now, I wanted to send you a quick note this morning to touch on some of the recent downtrends in the market and share some exclusive insights that I got yesterday when I spoke 1:1 with Coinbase’s Chief Legal Officer Paul Grewal.

First, regarding the market I would imagine that a lot of you saw a relatively large drop especially over the weekend for assets mentioned in both suits. I’ve illustrated the fall in the image below.

A couple of things are at play here. Yes, there is a fear that enforcement actions against these tokens–even though those teams were not mentioned in the suits–could lead to de-listings and less demand for the tokens. While all that may not, and perhaps should not, directly correlate to demand for the platforms themselves, that also fits into the equation. It does not help that regulated platforms with the SEC that trade crypto such as Robinhood and eToro have announced the delisting of tokens mentioned in the suits such as Cardano, Polygon and Solana and then Algorand and Dash, respectively. Neither platform accounts for a major degree of liquidity for any of these assets, but Robinhood in particular is a name brand so its actions carry some weight outside of its market muscle.

For what it is worth Binance.US is undergoing some major changes right now as tries to fight off a temporary restraining order that it said in a legal brief could put the entity out of business. If you use Binance.US, though I do not get the sense that many of you do not, I would switch to another platform. Coinbase has said that there will be no changes to its operating model and that right now none of the tokens mentioned in its suit will be de-listed.

PayPal has not made any announcement, but I am not expecting any delistings from them given that none of the four tokens currently supported by the company–bitcoin, ether, litecoin and bitcoin cash–were mentioned in any suit. In fact, a video has been circulating in the last day or so of Gary Gensler giving a speech a few years ago where he said that none of these tokens are securities. Of course that is at odds today with some of his recent commentary, where he’s argued that every digital asset outside of bitcoin is a security, but at least for now his agency is not taking this step.

A natural question to ask in light of these recent developments is whether it makes sense to reintroduce litecoin or bitcoin cash into either of our portfolios. That is something that I will look into over the next week or so as I put together the June issue of our newsletter. For some reference bitcoin cash has never been in a portfolio and I removed litecoin years ago because of concerns of its product market fit. There are of course important differences between these tokens and their communities, but at a high level I saw them as relatively weak competitors to bitcoin and potential targets for Layer 2 payment rails on top of bitcoin such as Lightning and Liquid. But I will give them another look. I’d love to hear any thoughts or questions that you may have.

Speaking of bitcoin and ether, it should be no surprise to anyone that they are the strongest performers of all these tokens given that neither was mentioned. Even though they are both slightly down over the past five days, they have proven relatively resilient through all this, and I’m encouraged that ether was excluded. Right now the SEC has bitten off a lot to chew, and I don’t think the agency has the stomach to target ether right now. In addition, I know that the community is excited that the SEC was finally required to release internal communications related to a now famous speech years ago when Bill Hinman, the agency’s former director of corporation finance, gave where he made the argument that ether is not a security. This release came as part of the discovery process for the agency’s suit against Ripple. I have not had a chance to go through everything yet, but if you would like, all the documents can be found here. If nothing else they will complicate the agency’s efforts to argue that ether is a security. There is no requirement that Gensler’s SEC has to respect a precedent set by his predecessor Jay Clayton. But it does muck things up a bit.

Finally, we got a bit of good inflation news. Even though the numbers are still elevated, inflation rose at a 4% annual rate in May, its lowest in two years. Odds are growing that the FOMC is going to finally pause this rate hiking cycle, leaving the federal funds rate at 500-525 bps tomorrow at its June meeting. Remember, this may have happened even sooner were it not for the regional banking crisis, but better late than never.

Now onto my conversation with Paul Grewal.

The timing yesterday was advantageous because it gave me the chance to ask for responses for a few of the charges that Gary Gensler made against Coinbase in prepared comments on Thursday at a financial conference. For example, Gensler made arguments that there are actually ways for companies to come in and register with the SEC through exemptions such as Reg A and Reg D. Regulation D is a common exemption used to issue securities to accredited investors that does not require the same disclosures as an offering to the broader retail market. Reg A is a newer exemption that increases the cap of securities that can be sold to the retail market to $75 million.

Grewal told me that neither one of these solutions were appropriate for crypto for a few reasons. For instance, either exemption would be antithetical to crypto’s decentralized ethos, a pretty common talking point right now and regardless neither is really scalable in his opinion. Speaking about Reg A in particular, the only notable project that I’m aware of to complete the process is Blockstack (original team behind portfolio member STX), which raised about $25 million in 2019. As a bit of a canary in the coal mine, former Blockstack CEO Muneeb Ali told me that the process, although valuable, was arduous, expensive, and long.

But to be honest, all of this seemed like a lot of minutiae when compared to the bigger questions at play here, which is how everyone in DC is going to demarcate the line between a security and commodity. Grewal perked up and was very optimistic about the recently-introduced piece of market structure legislation in the House of Representatives by Republicans in the Financial Services and Agricultural Committees. Specifically he pointed out how this law would provide market oversight responsibility to the CFTC for spot commodities for the first time and provide a roadmap for how an asset could transition from a security to a commodity or vice versa. If such a law went into place, the logical solution would be a trading platform that offers both commodities and securities.

Regarding the structure of the platform, he also had some interesting things to say. For instance, he was hopeful that an ATS model could be adopted that lets the firm act as both a broker-dealer and exchange. He said to me and other times in the past that the current national securities exchange model does not quite apply to crypto because in that case the blockchain is the settlement layer. I actually pushed back on this to him a little bit because at least with regards to retail trades, a lot of that activity is actually settled on internal ledgers, not blockchains, so perhaps there is a bit more nuance than he laid on at least in that case. Perhaps a solution would be creating a set of rules to make sure that every trader is treated equally on the platform and that potential conflicts of interest are minimized. On that note, and as I said before, it is very important to point out that while Coinbase and Binance’s suits came out in successive days, Coinbase is only be accused of operating as an unregistered exchange (where well-intentioned minds can differ on interpretations of the law), while Binance faces those charges and a host of other allegations implying fraudulent, manipulative, and improper behavior.

Regardless, I got the sense that he would be open to any solution that provides clarity, and when I asked if Coinbase would be prepared to spin off or separate parts of the business if that became necessary to register as a national securities exchange in order to come into compliance depending on the ultimate outcome of the legal proceedings or legislation he said that the company was able to profitably operate in many different scenarios.

Regarding what is coming next, there is going to be a lot of pre-trial activity, but Grewal made it clear that Coinbase was digging in for a long and protracted fight.