The Defiant

Coinbase Wallet Catches SEC’s Attention In Industry-Defining Lawsuit

Regulator Claims Non-Custodial Wallet Is 'Unregistered Broker'

By: Owen Fernau Loading...

Coinbase Wallet Catches SEC’s Attention In Industry-Defining Lawsuit

U.S. regulators have charged against crypto’s biggest centralized platforms this week, but decentralized finance wasn’t left unscathed. Deep into the 100-plus-page Coinbase lawsuit, the SEC took aim at the exchange’s non-custodial wallet.

The Securities and Exchange Commission’s treatment of Coinbase’s non-custodial wallet may have the biggest implications for DeFi because, according to multiple sources, the agency may view Coinbase’s non-custodial wallet as a broker, an entity which must register with the government agency.

Coinbase operated an “unregistered broker,” through its Coinbase Wallet, “which routes orders through third-party crypto asset trading platforms to access liquidity outside the Coinbase Platform,” the SEC said in its complaint.

“The SEC seems to be arguing that Coinbase Wallet allows Coinbase to offer brokerage services and that the Wallet acts like a broker-dealer,” said Cathy Yoon, chief legal officer at MPCH, a company which develops Multi-Party Computation (MPC) technologies, which is a way for multiple entities to collaborate while retaining privacy.

Fees are Key

Yoon said the SEC’s framing of Coinbase Wallet as a protocol dealer stems from the fees Coinbase charges when users access DeFi protocols.

Chris Martin, who worked as a data scientist at Coinbase for four years before transitioning to work at the analytics company Amberdata, had a similar understanding of the SEC’s position.

“They're not alleging that you are not allowed to use a [decentralized exchange],” he told The Defiant. “What they're alleging is that the platform takes a fee and is therefore [a] platform for trading securities.”

Martin added that the SEC wasn’t targeting DeFi protocols, but it’s targeting the platforms that interact with them, in this case, Coinbase Wallet.

Evan Marshall, CTO at Demox Labs, which develops a wallet called Leo, put a finer point on the SEC’s filing.

“The SEC alleges that Coinbase, as the developer and maintainer of the non-custodial software, is responsible for the unregistered securities purchased in their non-custodial wallet that routes orders to third-party crypto asset trading platforms,” he said in a statement shared with The Defiant.

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Looming Legal War

With the SEC filing complaints against both Binance and Coinbase this week, crypto has formally begun a looming legal war where key questions around the industry will be decided. Front and center are what assets constitute securities, which are regulated by the SEC.

The issue of how to regulate DeFi protocols lurks in the background. Protocols are, in theory, “non-custodial,” meaning that users have control over their private keys and assets, and can therefore withdraw their funds at any time. Transactions are automated, which also brings up questions of how to regulate software runnings on decentralized networks.

No Impending DeFi Investigation

Kristin Smith, CEO of the Blockchain Association, a leading crypto trade association, told The Defiant that people at the companies behind major DeFi protocols had not indicated any impending action from the SEC.

“If you talk to the foundation and the entities that helped launch tokens, they're not being investigated by the SEC,” she said in an interview.

Smith added the caveat that just because her conversations with companies supporting DeFi protocols didn’t unearth any pending enforcement action from the SEC, that didn’t mean it wouldn’t happen. The SEC typically serves firms with a Wells Notice, as it did with Coinbase, before charging them with violating securities laws.

Path to Commodity

Two American Congress members, Patrick McHenry and Glenn Thompson, proposed legislation last week which would offer a clear path for a digital asset to transition from a security to a commodity. This would shift the assets from the purview of the SEC to the sister agency, the CFTC.

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The Blockchain Association’s Smith was encouraged by last week’s proposed legislation.

“On the legislative side, the debate is splitting CeFi and DeFi,” she said.

PoolTogether Win

The sector also scored a win this week when a judge dismissed a case against PoolTogether, a DeFi project which bills itself as a no-loss savings protocol.

The case centered on a key distinction in DeFi, and whether the company which launched a protocol, or runs an interface for one, is liable for the software itself, which may be non-upgradable when launched on a decentralized network.

To be sure, while it appears that DeFi is not directly in the SEC’s sights, there’s no guarantee that the sector won’t have another groundbreaking legal battle on its hands.

“Where does Gary Gensler go from here, and what is his next enforcement action?” Smith mused. “He seems to escalate every time.”

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