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

The recent attainment of futures commission merchant (FCM) status by the firm at the CFTC has the potential to reshape the regulatory landscape in the United States, potentially undermining the authority of its counterpart, the U.S. Securities and Exchange Commission (SEC). In the midst of its legal tussle with the SEC over its legitimacy as an exchange, Coinbase Inc. has achieved an extraordinary feat – securing approval to oversee the trading of cryptocurrency futures, a monumental leap in U.S. regulatory oversight.

In a cryptocurrency industry that yearns for proper U.S. regulation, Coinbase's enrollment as an FCM with the Commodity Futures Trading Commission signifies an advancement akin to becoming an SEC-registered broker-dealer. This status places Coinbase at the heart of the intricate web of U.S. derivatives trading, marking it as the inaugural crypto-native entity to secure this esteemed designation, potentially paving the way for heightened U.S. regulatory involvement, primarily within the realm of commodities.

Furthermore, this landmark decision by the U.S. regulator responsible for commodities markets implicitly allows Coinbase to engage in activities involving bitcoin (BTC) and ether (ETH) contracts. This move could potentially lend further credence to the industry's assertion that ether should be categorized as a commodity rather than a security, potentially leading to a more lenient U.S. regulatory framework for the cryptocurrency. Advocates of ether would likely welcome this development, viewing it as a signal that the SEC's influence over their asset might be diminished.

Former CFTC general counsel Dan Davis remarked, "This is just one further nudge – a bit of extra assurance, a touch more confidence – that ether is, indeed, not a security." While the FCM registration for Coinbase might seem esoteric, it constitutes an integral facet of the financial sector's machinery, and achieving this designation is no mean feat.

"This isn't a straightforward registration to attain," asserted Davis, now co-chair of Katten Muchin Rosenman's financial markets practice. He emphasized that securing this type of registration holds substantial significance, as companies must demonstrate robust systems for capital management, disclosure, record keeping, and the segregation of customer funds.

Davis added, "It's evident that, in this particular instance, Coinbase managed to meet the stringent regulatory prerequisites." Even though the authorization for Coinbase Financial Markets was technically granted by the National Futures Association (NFA) – a group funded by the industry that evaluates registrations and upholds standards under the jurisdiction of the CFTC – the derivatives agency is directly involved in intricate, pioneering, and potentially contentious applications. Coinbase ticked all these boxes with its application in 2021.

Justin Slaughter, who has experience with both the CFTC and the SEC, noted, "The contrasting paths taken by the CFTC and the SEC are quite apparent." He observed that the CFTC concentrated on registering a significant crypto participant, while the SEC was increasingly embroiled in legal actions against various crypto firms.

The exclusive club of futures commission merchants (FCMs), characterized by rigorous regulations that facilitate margin trading, includes traditional firms such as Cboe Digital, the crypto wing of stock and options exchange operator Cboe Global Markets. The CFTC's endorsement of Coinbase could potentially be viewed as a dent in the SEC's credibility as it continues its legal confrontation with Coinbase.

Brent Xu, CEO and co-founder of Umee, asserted, "This poses a challenge for the SEC. At a time when the SEC is casting doubts on the legitimacy of the exchange, the CFTC has essentially proclaimed Coinbase a fully legitimate entity in the United States." Notably, the same week in June saw the SEC initiate sweeping enforcement actions against Binance and Coinbase, asserting that the fundamental business models of these platforms were in violation of U.S. securities law. Consequently, the SEC is currently entangled in a multifaceted legal battle with crypto firms, grappling with the question of how to classify unregistered crypto securities and illicit exchanges.

Coinbase has vehemently contested the SEC's allegations, contending that they do not apply to its operations. While the new FCM status granted by the CFTC does not offer additional legal defense to Coinbase in its dispute with the SEC, it does signal a significant shift. It underscores that the derivatives agency is moving in a direction counter to that of its sister regulator, the SEC, which is under scrutiny for its approach.

Nonetheless, despite differing opinions, this week's development holds the potential for transformative consequences. The sentiment is echoed by Anthony Michael Sabino, a lawyer and professor at St. John's University, who likened it to the inauguration of a new Major League Baseball franchise. Sabino lauded its positive impact on investor confidence, market stability, and predictability.

"The capability to engage in margin trading empowers customers, providing leverage and entry into the cryptocurrency market with a lower initial investment compared to traditional spot trading," emphasized Coinbase in a blog post, also highlighting plans to apprise U.S. customers of the new service in the upcoming months.

This newly conferred status not only serves as evidence that a crypto enterprise can surmount regulatory challenges but also underscores the CFTC's willingness to embrace this evolution. As Zachary Townsend, co-founder and CEO of Meanwhile, aptly observed, "The CFTC and Coinbase's willingness to confront these challenges head-on has paved the way for future possibilities." While the SEC has thus far sanctioned one specialized broker-dealer for digital assets – Prometheum Inc. – this fledgling startup has yet to validate its business model through trading. In contrast, Coinbase, a publicly traded U.S. firm and a leading player in the industry, has been actively engaged in these operations for several years.

As Slaughter pointed out, "The initial steps are often the most arduous. It's reasonable to expect a slew of subsequent applications."