A highlight from Crypto and the Major Questions Doctrine

The Breakdown


Welcome back to The Breakdown with me, N .L .W. It's a daily podcast on macro, Bitcoin and the big picture power shifts remaking our world. What's going on, guys? It is Monday, August 7th. And today we are talking about the latest in Coinbase's fight against the SEC. A quick note before we dive in. Sponsorship is back open again on The Breakdown. You've heard over the last few weeks a number of sponsors of the show, and we are currently booking out for the fall and into the beginning of next year. If your company is looking to reach easily the smartest audience in the crypto space, shoot me a DM or send us a note at sponsors at breakdown network. And with that, let's get into this show. Now, this morning, a really significant thing happened. And that is, of course, PayPal's announcement of PiUSD, which is their new stablecoin offering built on Ethereum. Right now, the leading contender for the most important trend of this bear market is TradFi muscling in on the territory that was seeded by crypto native companies behaving badly. And this could obviously be another big example of that. Now, this news just happened after I had already prepared today's show, so we will get all into that tomorrow. But for now, we have some big things from the end of last week to catch up on. On Saturday, CoinFund CEO Jake Brookman tweeted, This might be one of the most important documents ever produced that explains why digital assets are, in general, not securities. The document he was talking about came from Coinbase, and it was a request from that company to dismiss the SEC's case against them. Coinbase chief legal officer Paul Grewal wrote, Today Coinbase filed our brief asking the court to dismiss the SEC's case against us. Our core argument is simple. We do not offer investment contracts as that term has been construed by decades of Supreme Court and other binding precedent. By ignoring that precedent, the SEC has violated due process, abused its discretion and abandoned its own earlier interpretation of the securities laws. By ignoring that precedent, the SEC has trampled the strict boundaries on its basic authority set by Congress. So there is a lot in here. And even in that short thread, you can see that there's really at least two big things going on. The first is an argument about what is or isn't a security, and the second is about where the SEC's authority really begins and ends. So let's take a step back and get into it. Coinbase has officially asked the court to dismiss the SEC's lawsuit against them. On Friday, they filed a motion for judgment on the pleadings, which raised questions about the validity of the lawsuit and indeed whether the SEC even has the jurisdiction to police the crypto space. The Coinbase motion argues along two dimensions. First, they argue that cryptos are not securities. Now, the argument for Coinbase rests on the familiar Howey test analysis, which we've seen across all token cases to date. Howey, you'll remember, identifies investment contracts as a class of security sales which are subject to SEC regulation. And for a sale to be considered an investment contract under Howey, it has to satisfy a number of different elements. It must be an investment of money. That investment of money must be in a common enterprise. There must be the expectation of profit, and specifically the expectation of profit must be derived from the efforts of others. In other words, this isn't something that you are putting work into yourself and expecting to benefit from thusly. In their motion, Coinbase argued that sales of tokens on their platform, quote, do not involve contractual undertakings to deliver future value, reflecting the income, profits or assets of a business. They are commodity sales with the obligations on both sides discharged entirely the moment the digital token is delivered in exchange for payment. Now, of course, they also discussed last month's decision in the Ripple lawsuit. In essence, the judge in that case decided the tokens in and of themselves are not securities, but they are sometimes sold alongside promises from an issuer, which would make those particular sales subject to SEC regulations. Coinbase argued that the facts in Ripple were, quote, substantially identical to those alleged here. Specifically, one of the key decisions in the Ripple case was that anonymous sales of the XRP token through an order book were not considered to be sales of investment contracts. For that reason, they were not found to be under the SEC's jurisdiction. Coinbase are arguing that the 13 tokens named by the SEC in their case are substantially similar to Ripple's XRP and should have the same results from Howie analysis. This would mean, of course, that sales conducted through Coinbase's exchange should not be considered the sale of securities. Coinbase relied on similar arguments to claim that their staking and wallet products were not subject to registration under securities law. They claim that customers are simply using their commodity tokens within software products offered by Coinbase. This would, of course, distinguish these Coinbase products from more traditional asset management services, where profit is derived from the skill of the asset manager. Now, within the whole security discussion, there is one particular analogy that's getting a lot of attention. Austin Campbell tweeted, one of the interesting parts of the SEC interpretation for me is that, if correct, I don't really see a dividing line between crypto and many other activities. Are limited edition Nikes now securities? I think Coinbase lays bare some of the issues well. Now, the specific analogy in the Coinbase argument is actually around baseball. They write, one can invest in a baseball or other trading card company through an instrument that imposes obligations on the company, and that will be a security. Or one can buy baseball cards on the open market, hoping they appreciate in value, and one will have bought a commodity. That remains true even if the company makes representations about plans to create a premier trading card platform to drive up the value of the cards it sells. Those representations can't turn baseball cards into securities. Baseball cards are not shares in the baseball card enterprise. This principle applies equally here. Coinbase goes on, the transactions over Coinbase is platform and prime are not and do not involve contractual undertaking to deliver future value reflecting the income profits or assets of a business. They are commodity sales with the obligations on both sides discharged entirely the moment the digital token is delivered in exchange for payment. The SEC's complaint does not allege otherwise because it does not and cannot plead the required elements of an investment contract. The SEC's Exchange Act claims should be dismissed. Now, still, even with colorful analogies like this, the in many ways more significant part of Coinbase's argument involves the major questions doctrine. And this is something you've heard me reference a number of different times on this show, but let's give a little bit of background. This is a legal doctrine that has been relatively recently developed by the Supreme Court. The major questions doctrine, or MQD, holds that administrative bodies, such as regulators like the SEC, require explicit guidance from Congress when tackling issues which have a major impact on the U .S. economy. It was recently used to strike down the Biden administration's student loan forgiveness program as it exceeded the authority of the White House. More classic cases include subjects like the tobacco industry and emissions reduction within the energy sector. Now, the point of MQD is not that regulators are never allowed to take on new areas of responsibility, but rather that Congress needs to be very specific when expanding a regulator scope. In a way, MQD is a statement about how regulatory legislation should be interpreted. In the original Supreme Court case, Whitman versus American Trucking Association from 2001, Justice Scalia said that Congress, quote, does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions. It does not, one might say, hide elephants in mouse holes. For the Coinbase lawsuit, the argument is that Congress did not intend to hide widescale jurisdiction over the crypto industry for the SEC within the Securities Act of 1933. In their brief, Coinbase claimed that, quote, the major questions principle applies directly here. The wholesale regulation of secondary markets for trading digital assets qualifies as extraordinary, and the digital asset industry worth around one trillion dollars is a, quote, significant portion of the American economy. Now, digging a little bit deeper into this from, you know, an actual lawyer, Morrison Cohen's Jason Gottlieb wrote a really good thread about this exact MQD issue. He writes, Coinbase's brief is fantastic. No surprise, given the strong arguments in their favor and great lawyers in -house and outside working on it. One point, though, the major questions doctrine, I think Coinbase actually undersold just how major a question this is. As background, the major questions doctrine is basically that when an agency claims the, quote, power to regulate a significant portion of the American economy that has, quote, vast economic and political significance, it must point to clear congressional authorization for that power. A different district court judge in the same courthouse recently found that the crypto industry, though certainly important, falls far short of being a portion of the American economy bearing vast economic and political significance, unlike, say, energy or tobacco. I think that judge and other folks, even within crypto, vastly underestimate the majorness of this industry. I often see references to it being a, quote, trillion dollar industry, which is basically just the headline market cap of all crypto. Coinbase's brief skillfully lays out the base case. The industry is worth around one trillion, one in five adults in the U .S. is on crypto. Hundreds of millions of people globally use crypto currencies for myriad purposes. But this is an underestimate that one trillion dollars is just the market cap of all the tokens. The value of the industry isn't just the market cap of tokens any more than the value of the smartphone industry is the stock valuation of Apple and Samsung. What about all of the people, the productivity of all the engineers, programmers, designers, lawyers, accountants, auditors, all the IP, the network of companies that don't have tokens but support the ecosystems, the interconnections with companies outside the U .S.? And most of all, our lives are becoming more digital with no clear line between cryptocurrency and other digital assets. So when the SEC says, quote, all tokens are securities, it is aggregating authority not just over crypto, but the entire digital asset economy. The market cap of all crypto tokens may be one trillion dollars, but the value of the digital asset economy is certainly many multiples of that. It is literally the future of the entire economy minus a few necessarily analog portions of analog industries. Coinbase was right and smart not to go into this depth and a motion for judgment on the pleadings. It's not the right legal or procedural place for it. But in future arguments on the major questions doctrine in crypto, let's not understate or undersell the majorness of the questions. If everything is becoming digitized, this fight isn't just about cryptocurrency. It's a much larger battle for the right to your digital life and whether the Securities and Exchange Commission is the proper regulator for the entire digital economy. Spoiler alert, it is not. Now, one of the things that really stands out in this whole engagement is Coinbase not really being super solipsistic in their fight. This is not a document that reads like an exchange fighting for its survival or even just asserting that they are in the right in a particular case. Instead, it's about these much bigger questions about authority and how authority is determined. It's fundamentally about questions of administrative power in America and what the limits on that should be. In many ways, crypto is just serving as the next logical battleground for that legal point. Now, tactically, right from their initial defense filing, legal commentators have suggested that Coinbase may be rushing to get a major questions doctrine decision on the books in a lower court. This would allow Coinbase to take the issue before the Supreme Court ahead of other crypto cases that also might deal with the major questions doctrine, including the Binance and Terraform Labs lawsuits. Some have speculated that Coinbase is concerned that having an MQD fight with those much less favorable lawsuits will be an extreme negative to the industry. In any case, the SEC will have until October 3rd to file a response. And overall, I think that the tweet that best captures the vibe of this weekend was Zcash founder Zuko tweeting, I never knew it could be so fun to read legal filings. Anyways, that is the big one that we wanted to explore today. But real quickly, before we get out of here, just one more from the rumor mill, New York Attorney General Letitia James is reportedly locking horns with Barry Silbert as the digital currency group empire comes under additional scrutiny. According to an article from Bloomberg, the AG's office is conducting a probe into DCG. According to anonymous sources, investigators have requested information from former Genesis executives. Genesis is, of course, the crypto lending arm of DCG, which filed for bankruptcy in January. That bankruptcy stowed controversy when it was revealed that the largest creditor was a group of Gemini customers who had lent out their crypto. Early during bankruptcy proceedings, it was also discovered that DCG had taken out 1 .6 billion in intercompany loans from their subsidiary. At the time, DCG had given the public impression that Genesis losses from the bankruptcy has been extremely acrimonious. The Gemini co -founders, the Winklevoss twins, have publicly called out DCG numerous times for failing to do enough to refinance the loans, along with a whole other slew of accusations. Now, the SEC has already sued both Genesis and Gemini for offering unregistered securities for sale in relation to the lending arrangement, and there had been rumors of a Justice Department probe in January, but nothing appears to have come from that investigation. According to this new Bloomberg report, former Genesis chief risk officer Michael Patchen has already been questioned in the AG's investigation. That investigation is rumored to have taken place over recent months, and according to one anonymous source, the DCG loans are a critical part of the inquiry. Particularly, it seems like the AG is interested in how they were characterized to investors in the market. Of course, DCG CEO Barry Silbert has remained adamant that the loans were, quote, always structured on an arm's length basis and priced at prevailing market interest rates. Following the Bloomberg article, a spokesperson for DCG said the company is assisting regulators and investigators upon request and that, quote, DCG has always conducted its business lawfully and with the highest ethical standards. So, my friends, that is going to do it for today's episode. There is a lot coming up this week. I tease the PayPal stablecoin story, and then there is also a lot of smoke around Huobi, although it may take a few episodes to really understand exactly what's going on there. In any case, it appears that we are not in for that quiet August that so often happens in financial spaces. So, as always, until tomorrow, be safe and take care of each other. Peace.

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