QUESTION 17: “Coinbase plays the role of both broker, executing trades on behalf of clients, as well as an exchange, matching buyers and sellers. This is a unique situation. In other markets, i.e. equities, a broker would be required to be legally independent of an exchange. Could you talk about how Coinbase operates as both a broker and an exchange? It seems like there are some conflicts of interest in the current situation." -- TidewaterVirginia
Alesia:
All right. Question 17. "Coinbase plays the role of both broker, executing trades on behalf of clients, as well as an exchange, matching buyers and sellers. This is a unique situation. In other markets, i.e. equities, a broker would be required to be legally independent of an exchange. Could you talk about how Coinbase operates as both a broker and an exchange? It seems like there are some conflicts of interest in the current situation." This is from TidewaterVirginia. Thank you so much for this question.
Alesia:
So it's true. On our retail side, we operate a full broker that includes the retail brokerage piece, as well as custody embedded in that retail trading experience. On the institutional side, we operate an exchange, a broker, and then a custodian. What I think is important about the Coinbase business model is that we have set up our business such that there's not a conflict. We do not proprietarily trade against our clients. What this means is that we're only executing orders on our customer's behalf and seeking for the best execution on those customer's’ orders.
Alesia:
So when an institutional customer engages with our broker, for example, we're routing that order across multiple liquidity venues; many trades on our own exchange, but oftentimes it trades outside of Coinbase as well, wherever the best price may be for that customer. In doing this, it is an agents-only model. There's no conflict of interest for us operating both the exchange and the broker, because we are ensuring that we're acting in our client's best interest at every point in the transaction.
---
The issue isn't so much that they're doing this, but what the corresponding implications of it when related to unregistered securities.
> The Coinbase Platform merges three functions that are typically separated in traditional securities markets—those of brokers, exchanges, and clearing agencies. Yet, Coinbase has never registered with the SEC as a broker, national securities exchange, or clearing agency, thus evading the disclosure regime that Congress has established for our securities markets. All the while, Coinbase has earned billions of dollars in revenues by, among other things, collecting transaction fees from investors whom Coinbase has deprived of the disclosures and protections that registration entails and thus exposed to significant risk.
It's that they are unregistered as any of those things.
> 8. By engaging in the conduct set forth in this Complaint, Coinbase has acted as an exchange, a broker, and a clearing agency, without registering as an exchange, broker, or clearing agency, in violation of Sections 5, 15(a), and 17A(b) of the Exchange Act [15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)(1)], and for purposes of Coinbase’s violations of the Exchange Act, CGI was a control person of Coinbase under Exchange Act Section 20(a) [15 U.S.C. § 78t(a)]. In addition, through its Staking Program, Coinbase has offered and sold securities without registering its offers and sales, in violation of Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. §§ 77e(a) and 77e(c)].
The SEC apparently won't decide if Ethereum is a security so it seems pretty complicated to me. I'm not going to insist the answers are obvious in such a legal minefield.
> It's being sued because it's trading a lot of things that aren't BTC or Eth.
Which the SEC was also refusing to rule on, even though it would have been easy and consumer-protective to get that done within a month or two of the coins gaining popularity.
If I don't treat that as uncertainty, I guess I have to assign significantly worse motivations...
When Coinbase did its S-1 it said that it was trading digital assets - not securities and not unregistered securities. It did say that those assets may be considered securities under future regulatory inspection.
The SEC doesn't rule on things. They make rules (not laws), but they don't decide those things. That is the domain of the judicial branch - not the SEC.
The SEC can say "I consider X to be a security" but it's the judges that apply those rules and decide if the proper regulations are followed.
The SEC, as part of the legislative branch makes the rules to follow under its creation as part of the Securities and Exchange Act of 1934. It can bring things to be enforced or decided to the judicial branch - it isn't the judge or jury.
It would be improper for the SEC to make claims that haven't been decided by judicial branch. The SEC can say "we consider digital assets that can gain value by actions of others to be securities" but its consider - saying "yes, ETH is a security" is something for a judge to decide, not the SEC. The way that is done is for the SEC to take a company that is trading what it considers to be an unregistered security to retail customers to court.
Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
QUESTION 17: “Coinbase plays the role of both broker, executing trades on behalf of clients, as well as an exchange, matching buyers and sellers. This is a unique situation. In other markets, i.e. equities, a broker would be required to be legally independent of an exchange. Could you talk about how Coinbase operates as both a broker and an exchange? It seems like there are some conflicts of interest in the current situation." -- TidewaterVirginia
Alesia: All right. Question 17. "Coinbase plays the role of both broker, executing trades on behalf of clients, as well as an exchange, matching buyers and sellers. This is a unique situation. In other markets, i.e. equities, a broker would be required to be legally independent of an exchange. Could you talk about how Coinbase operates as both a broker and an exchange? It seems like there are some conflicts of interest in the current situation." This is from TidewaterVirginia. Thank you so much for this question.
Alesia: So it's true. On our retail side, we operate a full broker that includes the retail brokerage piece, as well as custody embedded in that retail trading experience. On the institutional side, we operate an exchange, a broker, and then a custodian. What I think is important about the Coinbase business model is that we have set up our business such that there's not a conflict. We do not proprietarily trade against our clients. What this means is that we're only executing orders on our customer's behalf and seeking for the best execution on those customer's’ orders.
Alesia: So when an institutional customer engages with our broker, for example, we're routing that order across multiple liquidity venues; many trades on our own exchange, but oftentimes it trades outside of Coinbase as well, wherever the best price may be for that customer. In doing this, it is an agents-only model. There's no conflict of interest for us operating both the exchange and the broker, because we are ensuring that we're acting in our client's best interest at every point in the transaction.
---
The issue isn't so much that they're doing this, but what the corresponding implications of it when related to unregistered securities.
https://www.sec.gov/litigation/complaints/2023/comp-pr2023-1...
> The Coinbase Platform merges three functions that are typically separated in traditional securities markets—those of brokers, exchanges, and clearing agencies. Yet, Coinbase has never registered with the SEC as a broker, national securities exchange, or clearing agency, thus evading the disclosure regime that Congress has established for our securities markets. All the while, Coinbase has earned billions of dollars in revenues by, among other things, collecting transaction fees from investors whom Coinbase has deprived of the disclosures and protections that registration entails and thus exposed to significant risk.
It's that they are unregistered as any of those things.
> 8. By engaging in the conduct set forth in this Complaint, Coinbase has acted as an exchange, a broker, and a clearing agency, without registering as an exchange, broker, or clearing agency, in violation of Sections 5, 15(a), and 17A(b) of the Exchange Act [15 U.S.C. §§ 78e, 78o(a), and 78q-1(b)(1)], and for purposes of Coinbase’s violations of the Exchange Act, CGI was a control person of Coinbase under Exchange Act Section 20(a) [15 U.S.C. § 78t(a)]. In addition, through its Staking Program, Coinbase has offered and sold securities without registering its offers and sales, in violation of Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. §§ 77e(a) and 77e(c)].