Coinbase will argue in court today that the US’s powerful securities regulator lacks the authority to claim that the exchange facilitated the trading of unregistered securities.
The pretrial hearing in the Southern District Court of New York sets the stage for what could become a drawn-out court battle with the Securities and Exchange Commission — and compound Coinbase’s financial woes.
Should the SEC emerge victorious in this legal battle, analysts say it could wipe almost a third of Coinbase’s revenue off its books — this at a time when the exchange faces competition from newly-launched spot Bitcoin exchange-traded funds.
‘Haltcoins’ hit revenue
In the event of an SEC win, Coinbase could be forced to shut down or register parts of its business — including its staking service — and delist tokens.
Revenue from staking services account for 11% of Coinbase’s revenue in the third quarter of 2023, analysts at Mizuho estimated.
Measuring the exact impact of staking services on Coinbase’s bottom line is difficult as the firm includes staking rewards owed to customers in its quarterly earnings under “blockchain rewards.”
Based on this the net revenue from staking was actually closer to 3%, a person familiar with the matter told DL News.
Trading in altcoins — assets other than Bitcoin, Ethereum, and Tether — accounted for 20% of the crypto exchange’s revenue in the same period.
In a report by investment bank Mizuho published in the wake of the lawsuit, analysts said that the SEC’s complaint could turn these key revenue drivers from altcoins into “haltcoins.”
Coinbase could face further headwinds if these cryptocurrencies were declared unregistered securities.
The “cumbersome process and risk of application denial for tokens may inhibit Coinbase’s ability to generate transaction revenue,” Mizuho said.
While altcoin activity on Coinbase fell in 2023, it’s still an important revenue generator for the exchange.
In the third quarter, altcoin trading volumes decreased to 28%, a drop from the 38% seen in the previous quarter. However, the proportion of trading revenue attributed to altcoins actually experienced an increase.
The lesser-known cryptocurrencies accounted for 46% of transaction revenues, up from 39% in the second quarter, according to quarterly filings.
In addition to Bitcoin and Ethereum, Coinbase lists a wide array of cryptocurrencies with much lower market capitalisations.
The ability to trade them is a key lure for retail investors when choosing Coinbase, Coyne told DL News in June. Without these assets, he said, Bitcoin and Ethereum volumes could also drop.
Coinbase could face a “painful reality check” in the upcoming quarters, Mizuho said in a report last week.
Court battle
Today, the exchange and the regulator are allotted two hours each to present their cases before Judge Katherine Polk Failla in the Southern District Court of New York.
A source close to the company told DL News that Coinbase isn’t optimistic that Failla will dismiss the lawsuit, at least in whole.
Nevertheless, they are encouraged that Failla scheduled such a generous amount of time for this hearing.
“The judge is taking these issues seriously, she’s digging into the details, and that’s good news,” they said.
The SEC filed suit against Coinbase in June for violations of securities laws.
Coinbase responded by filing a motion to dismiss the suit, arguing that none of the tokens it lists are securities, and the regulator is overstepping its authority.
That’s what Failla will be weighing up today.
Should Failla decide not to dismiss the suit, the case will proceed towards a jury trial. That will tie up both sides in litigation for months, if not years.
Coinbase chief legal officer Paul Grewal told the Wall Street Journal earlier this week he was ready to engage in a prolonged legal battle with the regulator, potentially extending into 2025.
He, along with CEO Brian Armstrong, has embarked on a very public campaign to defend the company.
Both have expressed that despite their diligent efforts to comply with regulatory standards, they were slapped with the lawsuit.
Fresh competition
Coinbase has other worries, however.
The approval of spot Bitcoin exchange-traded funds in the US poses another difficult question for the exchange.
Although eight of the ETF providers — including asset management giant BlackRock — chose Coinbase as their custody partner, the upside “may be more muted than thought,” Mizuho said.
Coinbase will likely see just a 1% to 2% benefit to revenue from custody fees, and 5% to 10% total revenue growth if the newly launched ETFs drive additional spot Bitcoin trading, the investment bank estimates.
“Plus, deeper cannibalisation of high-margin spot Bitcoin trading and/or share loss to brokers offering an ETF could offset future benefits,” Mizuho said.
Coinbase’s fee structure for retail users has come under scrutiny in the past, with fees for simple retail transactions as high as 2.5%.
The competition is heating up now with Bitcoin ETFs charging fees of around 0.19% to 0.30% — while some have launched with zero fees initially as a fee war broke out among issuers.
Custody fees could come down over time too, said Nate Geraci, president of financial advisory firm ETFStore.
“Issuers will likely negotiate down already low custody fees and ETFs will syphon trading away from exchange,” Geraci wrote on X.
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