Alea Iacta Est
Vol #52 - September 10th, 2021
When Julius Caesar crossed the Rubicon, there was no turning back. Bringing his army into the city of Rome sparked a bloody civil war that ended with him holding unprecedented power.
As they made that fateful step across the river, he told his men that the die had been cast - alea iacta est.
Once the gauntlet has been thrown down, both sides have little choice but to fight. When Brian Armstrong put the SEC on blast through a Twitter thread, he sparked another front in the growing friction between crypto innovators and securities regulation.
Armstrong is the CEO of Coinbase, the public face of crypto trading in the United States. Globally they have 68 million customers and $223 billion dollars in assets. Their IPO in the late summer was a watershed moment for crypto, and gives them a market cap of over $50 billion.
Coinbase makes it very easy for customers to buy and sell digital assets. They serve as an “onramp” for people to convert their fiat currency into crypto assets. This is a crucial function, because most people get paid in dollars and euros, and they need a way to buy bitcoin or ethereum.
The specific concern that Armstrong and Coinbase have is that the SEC has been “sketchy” in their handling of a proposed new product. Coinbase Lend was going to be a way for depositors to earn interest on stablecoins that they deposit. This however, was deemed a security, and Coinbase was not allowed to offer this to retail clients. End of story, no dialogue.
This probably also sounds a lot like a savings account, but since Coinbase doesn’t have a banking license, they’re not allowed to pay interest on deposits. Stuck between regulations from over 80 years ago, and current technology, they were forced to withdraw the product launch.
Deposit accounts might not sound particularly interesting when there are coins moving dozens of percent a day, but they play an interesting role in the crypto economy. An important feature of lending digital assets is that they are almost always overcollateralized.
When you deposit money at a traditional bank, they typically turn around and lend that out in the form of business loans or mortgages. They’re required to keep a certain amount of fractional reserves in place, but the system is designed to allow them to “multiply” the power of money throughout the economy.
The price of money in the traditional economy is very cheap. Interest rates are at generational lows, and the Federal Reserve is accused of running the printing presses daily. That’s not so in the digital economy, which is why deposit accounts are so interesting.
The demand for crypto dollars is very high. Coinbase Lend was going to take advantage of the lending protocol Compound to generate these returns for their customers. Compound lets borrowers deposit crypto and borrow against it. This allows the owner to maintain their position, while also gaining access to funds for other purposes.
If you were clever enough to buy Bitcoin 10 years ago, you might not want to sell it yet, but fiat is still useful to buy the Lamborghini you’ve always wanted. Professional trading firms and liquidity providers also take advantage of this borrowing, supplying another major source of demand for digital dollars.
If the collateral ever falls below the value of the loan, it is simply liquidated through a smart contract, and automatically repaid. There’s very little room for default. The beauty of open sourced protocols is they are their own form of consumer protection - the keys to the cookie jar are visible to everyone.
In the spirit of decentralization and disintermediation, Coinbase was looking to pass these economics on to their customers.
With new technologies, definitions become muddied. There’s not only the question of what category certain products fall into, but what roles different players in the ecosystem fulfill. Coinbase is something like a broker, but they’re also an exchange. For traditional equities, you can’t open an account with the NYSE, you have to go to Charles Schwab who trades at the NYSE and other venues on your behalf.
One of the common practices of brokers is to loan out stock and get paid interest on it. Participants who are looking to sell a stock short pay an interest rate to borrow the stock for an agreed amount of time. Usually the economics of this transaction are hidden from the customer, who is none the wiser that their stock is being loaned out. The broker is able to generate an additional return on the customer's balance, in a manner that arguably harms that very customer by putting selling pressure on their holdings.
Certain brokers like Interactive Brokers will actually allow customers to participate in these earnings through a securities lending program. It’s nearly identical to what Coinbase has proposed for stablecoins.
If we take a strict reading of the securities act, what Coinbase has proposed looks a lot like a bond. The SEC even trolled back at Armstrong with an FAQ tweet. But it’s their obligation to adapt and foster innovation.
With a mandate of investor protection, preventing customers from participating in the economics of their holdings does more harm than good. It’s time for a better definition.