Coinbase is in deep sh*tcoins—and so is the SEC

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Coinbase is in a world of regulatory pain right now. A report this week said the SEC is investigating the company for selling digital assets that should have been registered as securities—a development that triggered a 20% crash in its share price, and resulted in longtime Coinbase booster Cathie Wood finally dumping her position. All of this comes only a week after the Justice Department charged a Coinbase manager with insider trading.

The news is especially damaging to Coinbase since the company, from its founding, has styled itself as the “white knight of crypto”—a firm that stayed on the right side of regulators even as others in the industry played fast and loose. So what happened?

Bloomberg’s Max Chafkin places the blame on Coinbase’s ill-advised decision some years back to “pivot to shitcoins.” A familiar term in the crypto world, “shitcoins” typically refers to digital tokens that have no obvious utility beyond speculative hype. (The Chafkin piece is illustrated not so subtly with coins bubbling out of a toilet).

Chafkin’s broader point is that Coinbase spent years building its reputation, but then squandered all that embracing shitcoins. This included promoting the likes of novelty coin Dogecoin to small and unsophisticated investors, many of whom have taken losses of 80% or more. Meanwhile, the decision to add shitcoins also opened the door for the rogue Coinbase manager’s insider trading scheme.

None of this is a good look for Coinbase. But on the other hand, the company faced an impossible dilemma: It could have stuck to offering Bitcoin and Ethereum even as rivals enticed away its customers with hundreds of new assets or, to stay competitive, could have offered shitcoins too. It chose the latter and now it’s in trouble.

It’s easy to fault Coinbase’s executives for this situation, but the ultimate blame lies elsewhere—specifically with the Securities and Exchange Commission. For years, Coinbase and others in the industry have begged the agency to offer clear rules on how the law of securities applies to the crypto realm. And for years, the SEC has refused to do so, instead pursuing a “regulation by enforcement” approach that has forced companies to guess on what the agency will do. 

The situation has gotten much worse under the SEC’s current chairman, Gary Gensler. Unlike his predecessors, Gensler is not a lawyer and has used the post to engage in nakedly partisan behavior aimed at raising his own profile with Democratic party mandarins like Elizabeth Warren.

In doing so, Gensler has sought to bludgeon mainstream companies like Coinbase, which have (mostly) followed the rules all while letting the worst actors run amok. Two of the biggest crypto crackups this year—the collapse of the Ponzi-like stablecoin Terra and the bankruptcy of lender Celsius—happened on Gensler’s watch, and the SEC failed to intervene in time. As a result, small investors are out billions of dollars.

And then there’s the question of how the SEC’s Coinbase investigation—which like all such investigations are supposed to be secret until a charge is brought—ended up in the media in the first place. Some on Twitter have suggested Gensler leaked the investigation to Bloomberg to punish Coinbase, which has publicly complained about the SEC’s behavior. A veteran crypto lawyer familiar with the ways of Washington, DC told me this is almost certainly the case, and said Gensler’s fingerprints are on earlier leaks to the Wall Street Journal.

Meanwhile, the SEC has also come under fire for self-dealing by senior officials who leave the agency to cash in at private law firms. The most egregious example is set out in a new exposé that shows how a lack of oversight allowed former SEC lawyers to use their ties to the agency to game a whistle-blowing program and earn themselves tens of millions of dollars.

Mr. Gensler may thus want to get his own house in order before tormenting the likes of Coinbase. In particular, he should stop the political shenanigans and deliver a framework to help crypto and blockchain—one of the most important technologies of this century—thrive on America’s shores.

He is unlikely to do so but this may not matter. The debate over how to regulate crypto is moving outside the realm of SEC and towards other agencies, including the CFTC, that have recognized the importance of innovation as well as protecting consumers from harm. And come January, when the Republicans are expected to control the House of Representatives, we can expect Congress to use its subpoena power to force Gensler to explain just what he has been doing. 

The bottom line is that shitcoins landed Coinbase in trouble with the SEC but, in looking at the fallout from the shitcoin boom, it is the SEC that has the most explaining to do.

Jeff John Roberts
jeff.roberts@fortune.com
@jeffjohnroberts