Coinbase vs. SEC discusses the difference between Beanie Babies and securities

Five hours in court and Coinbase’s fate as a going concern hangs in the balance. Coinbase and the U.S. Securities and Exchange Commission (SEC) spoke in the Southern District of New York on Wednesday, arguing over the validity of the major securities underwriter’s lawsuit against the largest U.S. cryptocurrency exchange.

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To the surprise of many, U.S. District Judge Katherine Polk Failla came prepared and seemed unusually open to hearing from Coinbase. It’s just one more piece of data that shows that even if Congress is unable to pass significant legislation and executive agencies continue to “regulate through law enforcement,” cryptocurrencies can at least get a fair hearing.

Coinbase is pushing to dismiss the case, and while no formal decision has been made, Failla reportedly expressed concern that the SEC is misinterpreting U.S. securities laws and overstepping its bounds. SEC case calls into question Coinbase’s business model.

If the agency wins, it could force Coinbase to delist tokens it believes are securities (13 tokens were named in the complaint, but SEC Chairman Gary Gensler said most cryptocurrencies resemble securities) and/or close some business operations. Investment bank Mizuho described this as turning altcoins into “haltcoins.”

But just as the SEC highlights a key aspect of Coinbase’s business, Judge Failla poked holes in one of the SEC’s central claims. Namely, Failla questioned the idea that when someone buys a token, they are purchasing a “joint enterprise” and “expecting profits” based on the developers’ work, which is the definition of security under the prevailing “Howey Test”.

See also: Gary Gensler’s Bitcoin ETF Clown Show

If that were the case, it would open up the possibility of treating collectibles like Beanie Babies as securities, Coinbase lawyer William Savitt noted, in an echo of Judge Failla’s broader concerns about excessive regulation of commodities. Savitt added that, unlike stocks or bonds, crypto tokens do not necessarily grant holders rights to a network.

“Investment contracts must have contracts,” he said, describing the types of legal “enforcement mechanisms” that must exist, at a minimum, to make a security a security.

Depending on how Failla expresses himself on this point will determine whether the case will enter the discovery phase. There are indications that this particular judge is more than sympathetic to Coinbase’s argument, at times stating that the SEC has set itself too “few limitations” in regulating cryptocurrencies and has “too broad” an interpretation of the law.

Additionally, in a note she wrote when she filed a lawsuit against Uniswap founder Hayden Adams, Failla distinguished between decentralized apps, protocols, and tokens, in an “indication of how careful she will be here,” Chief Legal Officer at DeFi Education Fund Amanda Tuminelli said.

While it’s easy to scoff at the idea that anything that might increase in value could be regulated as a security by the SEC (under its own interpretation), it’s not that the agency doesn’t have arguments. SEC attorney Patrick Costello noted that when people buy tokens, “they are investing in the network behind them.”

This is certainly true, putting aside the idea that some tokens have any utility, given how most people treat cryptocurrency investments. Costello was also right that it is not possible to “separate” a token from its network, in a blow to people who want to split hairs between “securities” and “investment contracts.” Sometimes a cigar is a cigar.

Indeed, legal expert and conceptual artist Brian Frye has long argued that most markets, from fine art to wine, and yes, including cryptocurrencies, likely fall under the agency’s umbrella, even though he hasn’t yet decided to regulate them. Frye, despite being something of a securities law troll, actually views SEC regulation as favorable, in part because it usually has a light touch.

More importantly, it would help clarify exactly what tokens are and perhaps pave the way for people to start using them. The alternative here is for regulators to create a complete and total taxonomic system for each type of token and their different uses, which seems like a long shot (at least without messing up anything else).

See also: Ripple Hires Legal Expert Behind Token Taxonomy Act

Ultimately, this is a conceptual battle that leaves room for nuance. As Judge Torres found in the SEC’s lawsuit against Ripple, sometimes a token is a security and sometimes it is not, depending on the circumstances. Personally, I would be disappointed if Coinbase wins at this stage, because it would fundamentally not answer the question of whether the SEC has the broad ability to intervene in areas that look like securities.

We can all laugh at the SEC regulating stuffed animals, or cringe at Failla’s “Beanie Baby class action” thought experiment. But what if Beanie Babies became a significant part of the global economy and people actually invested their retirement accounts in the possibility that “Patti the Platypus” would “only go up.” What exactly would be the difference between “being” and “resembling” a title?

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