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It has been a bad week in crypto for Coinbase. VIXIO dips into its Q2 earnings report, and asks why Securities and Exchange Commission (SEC) inquiries and investor lawsuits against the exchange continue to multiply.
Coinbase, the largest crypto exchange in the US, has suffered its worst quarter since going public last year, with net losses totaling $1.1bn.
In its Q2 earnings report, Coinbase reported that its net revenue was down 31 percent compared with Q2 last year, coming in at $808m.
Although the platform increased its verified user base by 51 percent over the same period, its total trading volume dropped by 53 percent.
Coinbase attributed its poor performance to external factors and to the overall downturn in the crypto markets, which appears to have left many of its users sitting on the sidelines and staying out of the downtrend.
“At Coinbase, we live by the mantra ‘It's never as good as it seems, and it's never as bad as it seems’,” the company said in a statement.
“Despite crypto market capitalization declining $1.3 trillion or ~60% in Q2, primarily driven by macroeconomic conditions and shocks to the crypto credit environment, we remain as bullish as ever on the future of this technology.
“Coinbase is an all-weather company with experience in navigating through crypto-asset price cycles. We continue to take a long-term view and remain focused on building for the future.”
In a letter to shareholders, Coinbase listed five “highest priority product opportunities” that it will focus on in 2022 and beyond: Coinbase Retail App; Coinbase Prime (aimed at institutional traders); Staking; Developer Products under Coinbase Cloud; and Web3.
Although all of these product areas may have potential, the problem for Coinbase is that at least three of them are being looked at by the SEC, which may take a different view of their legality.
More legal battles ahead
For example, Coinbase revealed that it is facing a new SEC inquiry into its token listing processes, staking services, and its stablecoin and yield-generating products.
In a disclosure on page 46, Coinbase said it has received “investigative subpoenas” and “requests for documents and information” from the SEC regarding each of the above.
Coinbase downplayed the significance of the SEC’s inquiry, but it is not the first time that the SEC has probed these same areas for potentially illegal activity.
As mentioned in a previous Week In Crypto, a former Coinbase product manager is currently facing SEC and criminal charges for his alleged role in an insider trading scheme — the first in US history involving crypto-assets.
According to the SEC, at least nine of the 25 crypto-assets that the staffer allegedly profited from can be deemed securities, hence the SEC’s jurisdiction in the complaint.
Coinbase hit back at the SEC immediately, insisting that it “does not list securities on its platform. Period.” Ultimately, however, that will be for the SEC to decide.
And with Coinbase’s latest disclosure that staking is also in the SEC crosshairs, the company’s two largest sources of revenue — trading (81 percent share) and staking (9 percent share) — are facing an uncertain future.
Staking allows Coinbase customers to earn rewards for depositing a certain proof-of-stake crypto-asset, such as ethereum. The exchange then connects the deposited crypto-asset to the blockchain network in question, and uses it to verify transactions.
In so doing, the exchange receives payouts generated by transaction fees on the underlying blockchain, most of which it relays to the customer while keeping a cut for itself.
Staking has gained in popularity at the expense of trading during the current crypto downturn, as investors seek the safety of staking rewards while trying to avoid price volatility.
However, as noted by crypto legal firm Gulovsen Law Office, proof-of-stake crypto-assets such as ethereum may meet the criteria of the Howey Test used to define securities under US law, setting up another potential conflict between Coinbase and the SEC.
More disgruntled investors
As if losing $1.1bn was not bad enough, two more lawsuits have been filed against Coinbase in the past week, both by investors alleging material damage due to false and/or misleading statements.
The first is a class action complaint filed on behalf of all persons or entities who purchased or acquired shares in Coinbase between April 2021 — when the company went public — and July 2022.
The complaint alleges that, throughout this period, Coinbase and its executives made materially false and misleading statements regarding the company’s business, operations and compliance policies.
On May 11 this year, for example, Coinbase clarified in its Q1 earnings report that, in the event of bankruptcy, customer deposits would be deemed property of Coinbase, while customers themselves would be deemed general unsecured creditors.
When the markets opened, Coinbase’s share price dropped more than 26 percent in a single day, prompting an emergency tweet-storm from CEO Brian Armstrong.
“We should have updated our retail terms sooner, and we didn’t communicate proactively when this risk disclosure was added,” he said. “My deepest apologies, and a good learning moment for us as we make future changes.”
By the end of June this year, Coinbase stock had dropped 90 percent from its IPO price a year earlier, hitting a new all-time low.
Later, on July 26, Bloomberg reported that Coinbase is facing a new SEC probe into whether it wrongly let Americans purchase crypto-assets that should have been registered as securities. Once again, Coinbase’s share price fell more than 21 percent in a single day.
In both cases — bankruptcy policy and unregistered securities risk — the plaintiffs allege that Coinbase knowingly misled its investors or misled them through reckless disregard.
As such, it is alleged that Coinbase executives opened up the company to further regulatory scrutiny and potential enforcement actions, with material effects on the company’s share price.
The plaintiffs have until October 3 this year to apply to the court and to appoint a lead plaintiff.
A lone warrior targets Coinbase
The final lawsuit, filed by Coinbase shareholder Donald Kocher, is known as a verified shareholder derivative action.
In this suit, Kocher has appealed to nine current and former Coinbase executives to pay damages to the company for alleged breaches of “securities law, fiduciary duties, unjust enrichment, abuse of control and gross mismanagement”.
This type of lawsuit, where a shareholder sues his own company’s executives on the company’s behalf, can only be filed by a shareholder of a publicly traded company.
In line with the class action suit described above, Kocher accuses the executives of repeatedly making “false or misleading” statements, including “omitting material information” in public filings.
Referring back to 2019 and 2020, Kocher argues that Coinbase executives capitalised on a surge in retail crypto trading that coincided with lockdowns and COVID-19, so that they could grow the company to a size that they knew was unmanageable in terms of users, volume and expenses.
According to Kocher, this was done to inflate the company’s share price going into the IPO in April 2021, so that the executives could immediately cash out at a higher price when the shares became publicly available.
As noted by Kocher, the nine executives collectively sold more than $711m worth of shares on Coinbase’s first day of trading.
“The plaintiff and other public investors in Coinbase unknowingly made an investment that was materially different and substantially riskier than what had been represented in the Registration Statement,” the complaint notes.
