But recently cracks have been appearing in their façade of respectability, big enough that even the New York Times has noticed. The Humbling of Coinbase by David Yaffe-Bellany and Mike Isaac summarizes the situation:
Coinbase rose to prominence as one of the first major crypto companies, a gateway to the chaotic world of digital assets for amateur investors. But as it has grown from plucky start-up to publicly traded company, its status as an industry leader has been threatened by a series of missteps and a steep decline in the crypto market over the last six months.Below the fold I probe into some of these cracks.
Trying To Sell Unregistered SecuritiesLast September David Gerard described the Coinbase Lend fiasco:
Encouraged by BlockFi and now Celsuis’s complete lack of any issues with the authorities, popular crypto exchange Coinbase decided it would get into the crypto lending game too — with Coinbase Lend! Coinbase would make loans, and you could buy a share in the loans. [Coinbase, archive]
As it happens, this is a type of security called a “bond”, and it’s listed in the first page of the Securities Act of 1933.
The SEC sent Coinbase a Wells Notice — the letter they send before prosecuting. Coinbase haven’t put the letter up, but they did say it was the SEC threatening them with prosecution if they went ahead with Lend.
Coinbase’s CEO, Brian Armstrong, posted a Twitter thread about the SEC’s “really sketchy behavior,” and Chief Legal Officer Paul Grewal blogged about how “We don’t know why.” [Twitter; Medium]
The responses divided roughly into:
crypto people: darn that SEC and their vicious lack of regulatory clarity!The SEC tweeted a helpful thirty-second video explaining what a bond was. [Twitter]
non-crypto people: it’s clearly a bond, Coinbase can’t possibly be this stupid in real life.
Doomberg wondered how the Wells Notice could be about Lend, because it hadn’t launched yet — “you don’t get a Wells Notice for something you are considering doing, you get one for deeds you’ve already done.” But Coinbase filed an 8-K about the Wells Notice, saying it was for Lend. [Substack; SEC]
Coinbase insiders dumped a pile of stock the day they received the Wells Notice. Coinbase pointed out that the sale was scheduled in the proper manner — but you’d think a Wells Notice was a sufficiently material event to cancel such a dump. [Twitter; Medium]
Eventually, Coinbase realised that a public company blatantly violating the Securities Act after an SEC warning is probably not a winning move — even if it gets you clout on crypto Twitter. Lend is no longer being offered. The company plans to still argue the point, though. [Coinbase, archive; Twitter]
Fiasco In IndiaThe same week that Coinbase announced their launch in India:
Coinbase got some bad news. A government-backed group issued a statement suggesting that the company would be unable to use a crucial payments platform — a system that was supposed to allow Coinbase customers to convert their rupees into virtual currencies like Bitcoin and Ether. Not long after its grand opening, Coinbase halted much of its trading service in India.
Despite its early start, Coinbase has never had a strong hold over the international market, which is dominated by Binance. The company went into India despite widespread uncertainty about how the government would react, an approach that industry experts considered unwise.
Misleading Customers About Their Funds And KeysIn April David Gerard reported on panic among Coinbase's customers:
In April, the SEC put forward new accounting rules for holding cryptocurrencies on behalf of a customer: you should account these as liabilities. [SEC]It was clearly news to many Coinbase customers that they were not protected by SIPC, like customers of a real exchange, or FDIC, like customers of a real bank.
So Coinbase duly stated in their quarterly 10-Q SEC filing that: [SEC]
because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.Not just cryptos on deposit for trading — but cryptographic private keys that customers gave Coinbase to look after, because keeping your keys safe turns out to be super-hard.
Proper banks cannot rifle through the safe deposit boxes to pay their bills — but Coinbase isn’t a bank, it just wants to pretend it’s as safe as one, when it absolutely isn’t.
Coinbase put on its “no risk of bankruptcy” shirt, which promptly raised a lot of questions answered by the shirt. [FT, paywalled; Twitter]
"Losing Money Running A Casino"In the same post Gerard added the wry note:
The 10-Q filing also revealed that Coinbase had somehow managed to lose buckets of money running a casino. Shares in Coinbase fell 23%. [Bloomberg]Coinbase Sinks After Warning the Slide in Volume to Worsen by Olga Kharif and Yueqi Yang provided more datils:
Coinbase Global Inc. shares tumbled after first-quarter revenue missed estimates and the largest U.S. cryptocurrency exchange warned that total trading volume in the current quarter will be lower than in the first.Note that when the story came out, BTC was trading at $31.5K, a month before Terra/Luna would start the slide to below $20K.
The company’s shares fell about 16% after the close of regular trading. Monthly transacting users fell to 9.2 million, below an estimate of 9.5 million. First-quarter revenue slumped to $1.17 billion, while analysts were expecting revenue of $1.48 billion, according to Bloomberg data.
Coinbase earns the bulk of its revenue from trading fees, and its shares have fallen to all-time lows -- down more than 70% from where they traded when the company went public a year ago.
NFT Marketplace FiascoCoinbase was late to the NFT bubble:
Coinbase hoped to unveil the marketplace in the first quarter of 2022, Mr. Saxena said in an interview. But it was delayed until late April. By that point, the broader NFT market had cratered: Sales were down more than 80 percent from the fall.
After its release, the marketplace got scathing reviews. In the last week of July, it generated about $24,000 a day in trades; its main competitor, OpenSea, which serves as a kind of eBay for NFTs, generated 600 times that amount.
Tolerating Insider TradingThe next issue arrived with Coinbase Insider Trading Arrest Highlights “Altcoin” Problem by Max Chafkin, who started by explaining Coinbase's notorious "pivot to shitcoins":
Shortly after taking his company public, Armstrong announced that Coinbase would expand the number of coins listed on its service to keep up with investor demand. ... Over the next year, the company would add more than 100 new tokens.How did the pivot work out?
This made a certain amount of sense. Up to that point, Coinbase had been more cautious than competitors, listing only Bitcoin, Ether, and a handful of other well-established tokens. These restrictions had mostly kept its customers from getting wrapped up in the scams, hacks, rug-pulls, and pump-and-dump schemes that have dogged crypto for years. But Coinbase’s restraint created an opportunity for competitors—especially Binance, which offered hundreds of tokens—to gain market share.
At first, the pivot to shitcoin seemed to work out for Coinbase, which saw its stock price climb in the months that followed as digital asset speculation approached its peak. But in hindsight, one could be forgiven for seeing the move as reckless. Last week, federal prosecutors arrested a former Coinbase product manager, Ishan Wahi, accusing him of insider trading.In "You Don't Own Web3": A Coinbase Curse and How VCs Sell Crypto to Retail, Fais Khan explained the opportunity for insider trading at Coinbase:
For years, being listed for trading on Coinbase has been the holy grail of crypto - the equivalent of an IPO on Wall Street. And like an IPO, that seems to come up with a “pop” - Messari, a crypto research firm, documented in a report that the average Coinbase listing leads to a 91% gain in 5 days, on average.
And in The Unstoppable Grift: How Coinbase and Binance Helped Turned Web3 into Venture3, Fais Khan explains how these price spikes led Coinbase to list shitcoins:
the average returns on Binance blew Coinbase out of the water - although the difference in the returns was staggering.Doubling in four days is quite the ROI, and thus quite the temptation. Not just for A16Z and the other VCs to run List And Dump Schemes, but also insiders:
And the thing is, I think Coinbase knows that. Because if you look at the direction they took in 2021, they made a sharp turn to not only add a lot more assets, but being first to list coins, even some on the first day.
That seems risky to me. These are coins with tiny floats that may have only been founded as little as a year prior, and now they’re in the hands of tens of millions of retail investors - who the data shows are often less sophisticated than investors in stocks.
Why else does it matter? It’s also clearly the direction all of the industry is going in: exchanges creating huge venture funds and then aggressively listing coins (often that they’ve invested in) faster and faster. All while they shovel tens of billions of dollars into web3 startups to create an “ecosystem” of more coins that they can use to generate trading revenues.
Prosecutors said that starting last June, Wahi tipped off his brother and a friend about new listings, which allowed them to make about $1.5 million in profit by buying lightly traded cryptocurrencies ahead of new listings.Chafkin points out that the insider trading wasn't exactly secret:
The incident hardly suggests rigor on Coinbase’s part, however. The alleged insider trading seems to have been first spotted by a crypto influencer, Jordan Fish, who tweets under the pseudonym Cobie (short for Crypto Cobain) and who said he’d been complaining publicly for months about insider trading on Coinbase. That Coinbase investigated his Twitter tip is to the company’s credit. On the other hand, as Cobie put it, “surely Coinbase should have found this before randoms on Twitter did?”Coffeezilla interviewed Cobie, who pointed out that it was even worse (my transcript):
Cobie: Coinbase has had listings front-running issues for a while. Originally they only listed like Bitcoin and they had this policy like they were only going to list the best of the best. And then as time passed and they got to like the last couple of years, meme stocks became a thing and obviously they went public, they started losing market share. They sort of changed their policy and started listing like real, real, real garbage but at the same time they started having a lot of issues around people buying the garbage they were listing beforehand. Then they published this blog post about how they're going to change all their listing processes so that this stuff cannot happen in the future and they can get better controls around it. And the very next listing, every single coin got front-run once again.How did Cobie know?:
Cobie: I'm in a little group of like crypto people who like look at interesting blockchain stuff and one sent this Etherscan link and said "hey, has anyone looked into this, I think these things are going to get listed on Coinbase because they all got bought again by a person who front-run successfully last time. Does anyone know what any of these are? Some of them seem like really, really garbage". I think one of them was called "The Food" or something. I looked at the link, I waited for the coins to get added, about 80% of the ones that were bought on this day were added. So then I tweeted the screenshot of everything he purchased and the blog post like a few weeks ago saying we're tightening up our controls just to say like Coinbase is clearly incompetent at these issues, they're unable to stop it. They've just done this whole song and dance about how much they're going to improve the ecosystem and how much they care about like getting these things right and the very next coin listing has been front-run.Wahi was a Coinbase employee. He was part of the team responsible for listing new coins. He had been front-running for 18 months. Coinbase didn't notice this until Cobie tweeted about it. He was arrested at the airport as he tried to flee to India.
Actually Selling Unregistered SecuritiesThe very same day Allyson Versprille and Lydia Beyoud reported that Coinbase Faces SEC Probe on Crypto Listings; Shares Tumble:
Coinbase Global Inc. is facing a US probe into whether it improperly let Americans trade digital assets that should have been registered as securities, according to three people familiar with the matter. The company’s shares dropped 21%.The "digital assets that should have been registered as securities" are the shitcoins to which Coinbase pivoted in an attempt to catch up to Binance.
The US Securities and Exchange Commission’s scrutiny of Coinbase has increased since the platform expanded the number of tokens in which it offers trading, said two of the people, who asked not to be named because the inquiry hasn’t been disclosed publicly. The probe by the SEC’s enforcement unit predates the agency’s investigation into an alleged insider trading scheme that led the regulator last week to sue a former Coinbase manager and two other people.
Forcing Arbitration On CustomersGreg Stohr's Coinbase Asks Supreme Court to Halt Account-Holder Suits shows how Coinbase thinks unhappy customers' disputes should be handled:
Coinbase Global Inc. asked the US Supreme Court to halt two lawsuits by users of the cryptocurrency exchange platform while the company presses appeals that seek to send the cases to arbitration.How likely is it that an arbitrator will rule for the little guy?
In one case, a man says Coinbase should compensate him for $31,000 he lost after he gave remote access to his account to a scammer. In the other, Coinbase is accused of violating California consumer law by holding a $1.2 million Dogecoin sweepstakes without adequately disclosing that entrants didn’t have to buy or sell the cryptocurrency. Both suits seek class action status.
Federal trial judges in both cases rejected Coinbase’s bid to send the disputes to arbitration, which the company says is required under its user agreements.
Staking Customer's CoinsYueqi Yang's Coinbase Under SEC Scrutiny Over Its Crypto-Staking Programs reveals:
Coinbase Global Inc. said it’s being probed by the US Securities and Exchange Commission over its staking programs, which allow users to earn rewards for holding certain cryptocurrencies.
The company “has received investigative subpoenas and requests from the SEC for documents and information about certain customer programs, operations and existing and intended future products,” according to a quarterly regulatory filing. The requests relate to Coinbase’s staking programs, asset-listing process, classification of assets and stablecoin products, the company said.
At Coinbase, blockchain-rewards revenue, primarily from staking, accounted for 8.5% of net revenue in the second quarter. It fell 16% sequentially to $68.4 million during the quarter, less than the decline in trading revenue.
And The Result IsCoinbase Falls After Second-Quarter Revenue Misses Estimates by Olga Kharif and Yueqi Yang reports on the outcome:
Shares of the company, which were first listed last April, dropped about 4% after the close of regular trading. Coinbase has slumped 65% so far this year
Revenue declined to $808.3 million, missing the $854.8 million estimate from analysts polled by Bloomberg. Monthly transacting users dropped to 9 million in the second quarter, a 2% decline from prior quarter.
Coinbase lost $1.1 billion in the three months ended June 30, including a $446 million non-cash impairment charges related to investments and ventures, making it the largest amount since it became a public company.
They're Not AloneAnother example of a supposedly trustworthy US exchange heavily into cryptocurrencies is Robinhood. Robinhood Crypto Unit Fined $30 Million by New York Regulator by Annie Massa reveals that:
Robinhood Markets Inc.’s cryptocurrency arm was fined $30 million by New York’s financial regulator after the brokerage was accused of violating anti-money-laundering and cybersecurity rules.
The unit must enlist an independent consultant to monitor compliance, according to an order filed Tuesday. The firm disclosed last year that it expected to pay the penalty.
The enforcement action by the New York State Department of Financial Services underscores the continued regulatory scrutiny Robinhood faces, even as it pushes a message to investors that it’s taking a “safety first” stance toward digital tokens.