Coinbase facing state, federal actions over crypto staking program (updated)

Listen to this article

The New Jersey Attorney General’s Office announced June 6 that it issued a Summary Cease and Desist Order against Coinbase, citing crypto staking offerings that it says violates the state’s Securities Law.

The action, issued through the New Jersey Bureau of Securities, is the result of a multistate task force investigation conducted by 10 state securities regulators and in coordination with an investigation by the Securities and Exchange Commission (SEC), which separately announced charges against the crypto asset trading platform the same day for operating as an unregistered national securities exchange, broker and clearing agency.

In its investigation, the Bureau determined that Coinbase violated the law by offering unregistered securities through its staking offerings to New Jersey residents without first registering these securities. Officials say that this action does not prohibit Coinbase from offering staking securities as long it complies with state law, adding that the purpose of registering an offering is to ensure investors receive all material information needed to evaluate the investment risks.

In a press release announcing the action, officials explained how staking works: Investors lock their crypto assets for a set period to help support the operation of blockchain transaction validations and in return, the investor is promised more cryptocurrency. Under Coinbase’s staking offerings, investors deposit crypto assets with Coinbase, which then facilitates the staking of those assets on a particular blockchain.

Through the program – which is offered to the public – Coinbase advertises a return of up to 10% on investments. It pools investors’ crypto assets and employs a team of engineers to operate contracts with third-party validators to generate staking rewards. Coinbase then takes a cut of those profits before sharing them with investors.

As of end of the March, Coinbase’s staking securities had more than 3.5 million investors nationally, which are not insured by the Federal Deposit Insurance Corp. (FDIC) or Securities Investor Protection Corp., including more than 145,000 here in New Jersey.

“The cryptocurrency securities market is not a free-for-all where companies can make up their own rules,” said New Jersey Executive Assistant Attorney General Shirley Emehelu. “These companies play up the rewards but are less likely to address the risk of investing in crypto and through this action we are making sure they comply with our rules.”

The Summary Cease and Desist Order calls for a $5 million penalty against Coinbase for the sale of unregistered securities.

“The rules are clear,” said Cari Fais, acting director of the Division of Consumer Affairs. “Anyone selling securities in New Jersey must register and comply with the state’s Securities Law.”

“This action is another step toward ensuring that investors in crypto asset products are also offered that protection,” said acting Bureau Chief Amy Kopleton.

‘Calculated decisions’

The SEC also charged Coinbase for failing to register the offer and sale of its crypto asset staking-as-a-service program, alleging that since at least 2019 the company has been engaging in this practice, making billions of dollars by unlawfully facilitating the buying and selling of crypto asset securities.

The SEC complaint, filed in U.S. District Court for the Southern District of New York, alleges that Coinbase and its holding company, Coinbase Global Inc. (CGI), violated certain registration provisions of the Securities Exchange Act of 1934 and that Coinbase violated the securities offering registration provisions of the Securities Act of 1933.

Officials allege that the failure to register has deprived investors of significant protections, including inspection by the SEC, recordkeeping requirements, and safeguards against conflicts of interest. The complaint seeks injunctive relief, disgorgement of ill-gotten gains plus interest, penalties and other equitable relief.

“We allege that Coinbase, despite being subject to the securities laws, commingled and unlawfully offered exchange, broker-dealer, and clearinghouse functions,” said SEC Chair Gary Gensler. “In other parts of our securities markets, these functions are separate. Coinbase’s alleged failures deprive investors of critical protections.”

“You simply can’t ignore the rules because you don’t like them or because you’d prefer different ones: the consequences for the investing public are far too great,” said Gurbir Grewal, director of the SEC’s Division of Enforcement and a former New Jersey attorney general. “As alleged in our complaint, Coinbase was fully aware of the applicability of the federal securities laws to its business activities, but deliberately refused to follow them. While Coinbase’s calculated decisions may have allowed it to earn billions, it’s done so at the expense of investors by depriving them of the protections to which they are entitled. Today’s action seeks to hold Coinbase accountable for its choices.”

In a statement to NJBIZ, Coinbase responded to the state and federal actions.

“Following the SEC’s complaint, several state securities regulators have taken steps related to our staking services, which we are currently reviewing, and we expect to have productive conversations with those regulators,” a Coinbase spokesperson told NJBIZ. “We are confident that our staking services are not securities under federal or state law.”

“The SEC’s reliance on an enforcement-only approach in the absence of clear rules for the digital asset industry is hurting America’s economic competitiveness and companies like Coinbase that have a demonstrated commitment to compliance,” added Paul Grewal, Coinbase chief legal officer and general counsel. “The solution is legislation that allows fair rules for the road to be developed transparently and applied equally, not litigation. In the meantime, we’ll continue to operate our business as usual.”

Editor’s note: This story was updated at 9:31 a.m. ET June 7, 2023, to include a statement from Coinbase.