Dive Brief:

• The Securities and Exchange Commission (SEC) warned Coinbase that it will sue the cryptocurrency company if it launches a product that would allow customers to earn an annual percentage yield starting at 4% by lending their holdings of a stablecoin, USDCoin, to other users, according to a blog posted Tuesday by Coinbase's chief legal officer, Paul Grewal.
• Coinbase said it has been communicating with the regulator about the product, called Lend, for about six months. "The SEC told us they consider Lend to involve a security but wouldn't say why or how they'd reached that conclusion," Grewal wrote in Tuesday's post. Coinbase announced the product in June and opened a waitlist without revealing a launch date. Lend will not debut until "at least October," Grewal wrote in the post.
• State regulators in New Jersey and Texas in July ordered another crypto platform, BlockFi, to stop selling interest-bearing accounts to state residents on the grounds that the product represents an unregulated security. Regulators in a third state, Alabama, gave BlockFi 28 days to show why it should be allowed to continue selling its interest accounts to state residents.

Dive Insight:

Enforcement actions — or the threat of litigation over interest-bearing accounts in the crypto sphere — come as regulators have said the offerings from decentralized finance platforms represent a risk to users because losses are not insured by the Federal Deposit Insurance Corp. (FDIC) or protected by the Securities Investor Protection Corp. (SIPC).

Coinbase, for its part, said Lend doesn't qualify as a security because it's not an investment contract. "Customers won't be 'investing' in the program, but rather lending the [USDCoin] they hold on Coinbase's platform in connection with their existing relationship," Grewal wrote.

In a series of tweets, Coinbase CEO Brian Armstrong wrote, "Seems strange, how can lending be a security?"

Armstrong categorized the SEC's communication as "sketchy behavior."

The regulator, he said, is "refusing to offer any opinion in writing to the industry on what should be allowed and why, and instead are engaging in intimidation tactics behind closed doors. Whatever their theory is here, it feels like a reach/land grab vs other regulators."

Armstrong said he visited Washington in May, shortly after Coinbase became publicly listed, to talk to regulators.

"The SEC was the only regulator that refused to meet with me, saying 'we're not meeting with any crypto companies,'" Armstrong tweeted. "[SEC Chair Gary] Gensler had been confirmed just a month prior, so I brushed it off as the SEC still getting its feet under it. Now I'm not so sure."

Gensler told the Financial Times last week that crypto firms need regulation to survive, and last month told Sen. Elizabeth Warren, D-MA, that regulators need more resources to protect crypto investors, according to Bloomberg.

A spokesperson for the SEC told Reuters on Wednesday the regulator "does not comment on the existence or nonexistence of a possible investigation."

After initially discussing Lend with the regulator, Grewal wrote, Coinbase "answered all of the SEC's questions in writing and then again in person. But we didn't get much of a response." After the company announced the product, however, the SEC opened a formal investigation, Grewal wrote.

The company provided documents the SEC sought and allowed one of its employees to give sworn testimony on the product in August, Grewal wrote.

The SEC "also asked for the name and contact information of every single person on our Lend waitlist," Grewal wrote. "We have not agreed to provide that because we take a very cautious approach to requests for customers' personal information."

A 1946 Supreme Court case determined that an "investment contract," by the Securities Act's standard, is one in which "a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party."

In the case, which established the "Howey test," investors bought rows of orange trees in Florida and agreed to let the Howey Company manage the trees, harvest and sell the fruit, and give investors a share of the proceeds. By that measure, a Bloomberg op-ed writer said in July, the oranges, trees and land are not securities, but the agreement is.

Grewal said the SEC has not detailed how it intends to apply the Howey test. But in notifying the company of its intent to sue if Lend launches, "the SEC would rather skip those basic regulatory steps and go right to litigation." 

"Mystery and ambiguity only serve to unnecessarily stifle new products that customers want and that Coinbase and others can safely deliver," Grewal wrote.

Armstrong, in his tweets, echoed that idea.

"Regulation by litigation should be the last resort for the SEC, not the first," he wrote. "If we end up in court we may finally get the regulatory clarity the SEC refuses to provide."

The final tweet in Armstrong's thread included a call for unity — a prospect other crypto enthusiasts seized as a chance to ask for Armstrong's solidarity over the SEC's suit against blockchain payments company Ripple. The regulator sued Ripple in December for allegedly selling nearly $1.4 billion in the currency XRP, which the SEC called an unlicensed security. The currency lost 60% of its value the following week.

In his own tweet, Grewal expressed the desire for more SEC feedback. "The 'di' in 'dialogue' is everything," he said. "Put another way, to get to the right result, it takes two."