Coinbase Global Inc. (COIN, Financial), a U.S. crypto exchange, has yet again found itself facing regulatory scrutiny.
The Securities and Exchange Commission, just a day after filing a lawsuit against Binance, sued Coinbase on June 6, alleging that it is operating as an unregistered securities broker. Over the past several quarters, the company has made steady progress to diversify its revenue streams and reduce its dependence on trading revenue.
This massive blow comes at a time when it is trying to strike a balance between trading and subscription revenue. In response, the stock crashed more than 15% at the start of trading on June 6, highlighting a notable deterioration in investor sentiment. Although Coinbase enjoys a long runway for growth as the adoption of digital assets continues for many years to come, it will face substantial earnings volatility in the short run, which will result in volatile stock prices.
The lawsuit
In a comprehensive 101-page complaint, the SEC alleged that Coinbase allowed its users to trade crypto tokens that can be classified as unregistered securities. In a statement, SEC Chairman Gary Gensler said, "We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions."
Given these alleged violations, the regulator is requesting Coinbase to give up the gains earned from these trades and discontinue the trading practices being flagged.
On June 5, the SEC also filed a lawsuit against Binance. After taking into consideration the impact of the lawsuit, Berenberg analyst Mark Palmer, in a note to clients sent on the same day, claimed that 37% of Coinbase’s revenue will be impacted if the SEC files charges against it as well. Palmer wrote:
"We believe investors should be focusing on whether Coinbase would have the ability to successfully pivot its business model and geographic focus if it were forced to curtail or cease a large portion of its business activities in the U.S. as a result of an SEC enforcement action. We estimate that at least 37% of Coinbase net revenue would be at risk if the SEC were to target the company’s crypto token trading and staking operations."
Further, Mizuho Securities analyst Dan Dolev also claimed on June 5 that at least 30% of Coinbase’s revenue will be at risk if targeted in the same fashion. Now that this risk has materialized, the market is likely to punish Coinbase in anticipation of the expected hit to revenue.
The impact of regulatory actions
Most of the SEC’s allegations against Coinbase revolve around its crypto trading business. According to the watchdog’s complaint, the company has carried out the functions of a broker, exchange and clearing agency without registering as a broker. This allegation directly targets the core business of Coinbase as the SEC said it made 13 crypto assets that are deemed as securities to its users without proper registration. These crypto assets are listed below:
- SOL, the native token of the Solana blockchain.
- ADA, the native token of the Cardano blockchain.
- MATIC, the native token of the Polygon blockchain.
- FIL, the native token of the Filecoin network.
- SAND, the native token of the Sandbox platform.
- AXS, the native token of the Axie Infinity game.
- CHZ, the native token of the Chiliz sports & entertainment ecosystem.
- FLOW, the native token of the Flow blockchain.
- ICP, the native token of the Internet Computer Protocol blockchain.
- NEAR, the native token of the NEAR blockchain.
- VGX, the native token of the Voyager platform.
- DASH, the native token of the Dash blockchain.
- NEXO, the native token of the Nexo platform.
Coinbase is very likely to be forced to ban these crypto assets from its platform in the future if they are still available to be traded, but the biggest impact on the company would be if it is forced to pay millions of dollars to settle the lawsuit filed by the SEC.
The other impact on Coinbase will come from a possible ban on its staking business. Crypto staking is the practice of investors locking up some of their crypto assets in exchange for a percentage-rate return. Crypto staking enables validation of new transactions into the blockchain (for cryptos that use a Proof of Stake mechanism, which includes the likes of Ethereum, Cardano and Solana). Back in 2020, staking accounted for less than 1% of Coinbase’s revenue. Today, this business represents more than 10% of total revenue. According to the SEC, the staking business should be registered as it represents an investment contract with users who agree to lock up their assets in exchange for an interest-like return. Since Coinbase has not registered this program with the SEC, the company is allegedly in violation of registration provisions of the Securities Act of 1933.
The staking business of Coinbase has already been praised by many analysts as it allows the company to diversify its revenue streams beyond transactional revenue. However, with the SEC focused on penalizing the company’s staking program, it might be in for a challenging period where it will have to defend its business practices to offer these services in the future.
Takeaway
Coinbase is headed toward rough waters. With U.S. regulators tightening their grip on the crypto industry, it is reasonable to expect Coinbase's stock to remain under pressure for the foreseeable future. There is light at the end of the tunnel if Coinbase survives this onslaught, however, as digital assets are likely to survive and thrive in the long term in one form or another.
Investing in Coinbase to make the most of its dominant position in the U.S. market may only be suitable for investors with above-average risk tolerance and an extensive investment time horizon.
