Coinbase, Tarred as an Illicit Exchange by the SEC, Quietly Got Regulated Elsewhere in the U.S.

• Coinbase Inc. is the first crypto firm to get the gold-standard registration as a futures commission merchant, even as it remains in a legal battle for its life.
• The Commodity Futures Trading Commission granted Coinbase the ability to handle bitcoin and ether futures, which is another argument that ether is a commodity.

As Coinbase Inc. (COIN) scraps with the U.S. Securities and Exchange Commission (SEC) on its right to exist as an exchange, the company has achieved an unprecedented milestone in U.S. oversight by winning approval to handle customers’ buying and selling of crypto futures.

In an industry desperate for U.S. regulation, Coinbase is now registered as a futures commission merchant, or FCM, with the Commodity Futures Trading Commission (CFTC), akin to an SEC-registered broker-dealer and a club that plays a key role at the core of U.S. derivatives trading. As the first crypto-native company to win that designation, it’s potentially blazing a path to U.S. oversight – at least in the world of commodities.

And because the U.S. regulator of commodities markets is effectively saying Coinbase can do business in bitcoin (BTC) and ether (ETH) contracts, that permission could reinforce industry arguments that ether belongs in the commodities bucket – meaning it could face a less onerous U.S. regulatory regime. Ether fans are likely to welcome such news if it signals the SEC may not have a say in their asset.

“This is just one further nudge -- a little bit of extra confidence, a little bit of extra comfort that ether is – in fact – not a security,” said Dan Davis, a former general counsel at the CFTC.

Coinbase’s FCM registration may sound esoteric, but it’s a core part of the machinery in the financial sector, and there’s a high bar to winning that label.

“It's not an easy registration to get,” said Davis, who is now co-chair of the financial-markets practice at Katten Muchin Rosenman. “It's significant to get a registration like this,” he said, because a firm has to demonstrate strong systems for capital, disclosures, record keeping and segregating customer funds.

“It’s clear that in this instance, Coinbase was able to satisfy the regulatory requirements," he said.

While the approval for Coinbase Financial Markets technically came from the National Futures Association (NFA) – the industry-funded group that reviews registrations and enforces standards under CFTC authority – the derivatives agency has a direct hand in complex, novel or controversial applications. Coinbase checked all of those boxes with its 2021 application.

“You really see the branching paths that the CFTC has taken versus the SEC,” said Justin Slaughter, who has worked at both agencies and is now the policy director at Paradigm, which has an investment stake in Coinbase. The CFTC focused on getting a major crypto player registered, he said, while the SEC “is going to court to sue everybody.”

Black mark for SEC?

FCMs, which are held to exacting rules and pave the way for customers to trade on margin, represent an exclusive financial club populated by old-school firms such as Cboe Digital, the crypto unit of stock and options exchange operator Cboe Global Markets. And the CFTC’s welcome could represent a black mark for the SEC as it presses its legal clash with Coinbase.

“This is a setback to the SEC,” said Brent Xu, CEO and co-founder of Umee. “The CFTC has essentially said that Coinbase is a fully legitimate actor in the United States at a time when the SEC is saying that the exchange is not.”

In the same week in June, the regulator aimed massive enforcement actions at both Binance and Coinbase, declaring their fundamental business models violated U.S. securities law. Now, the SEC is fighting a multifront court battle with crypto firms about how to define unregistered crypto securities and illegal exchanges.

Coinbase denied the SEC’s allegations, arguing that they shouldn’t even apply. The new CFTC status doesn’t offer any new legal defense for the company in that dispute.

But the derivatives agency allowing a crypto-native company to join the ranks of traditional firms is a sign that the SEC is “out of step,” said Zachary Townsend, co-founder and CEO of Meanwhile, arguing that the CFTC is “moving in the exact opposite direction” as its sister regulator.

Still, crypto skeptics in Congress and consumer groups welcome SEC scrutiny on the industry. Todd Phillips, a former government lawyer and consumer advocate who teaches at Georgia State University, said the CFTC allowing major crypto exchange Coinbase to also be an FCM is illustrating a danger common across the industry.

“There are big concerns when firms control transactions from soup to nuts,” Phillips said. “That applies to Coinbase as well as traditional firms like NYSE. Owning brokers, exchanges and clearinghouses can raise costs for traders and makes market manipulation more possible.”

Whether welcome or not, this week’s development could be momentous.

Big deal

“It's a pretty darn big deal,” said Anthony Michael Sabino, a lawyer and professor at St. John's University. “It's like having a new Major League Baseball franchise.”

“It’s great for investors,” he said. “It’s good for market predictability and stability.”

“The ability to trade using margin gives customers leverage and access to the crypto market with less upfront investment than traditional spot trading,” Coinbase wrote in a blog entry on its announcement, which said the company will inform U.S. customers about how to access the service “in the coming months.”

The new status proves a crypto company can clear the regulatory hurdles and that the CFTC is willing to allow it to.

“The CFTC had the courage and Coinbase had the drive to answer those questions, and now the pathway is open,” Slaughter said.

While the SEC has so far approved one special-purpose broker-dealer for digital assets, Prometheum Inc., that obscure startup hasn’t yet tested its business model with trading. Coinbase, a publicly traded U.S. company that’s among the industry’s leading exchanges, has been doing it for years.

“The first is always the hardest,” Slaughter said. “You have to assume there'll be other applications coming.”

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