Coinbase Cancels Interest-Bearing Crypto Product. What’s Next?

Coinbase Lend Rates Were 40x Better Than Industry Average

The Lend program, announced by Coinbase in June, positioned itself to compete with conventional savings accounts.

Customers holding the stablecoin USDC would lend their holdings to Coinbase, who in return promised 4% APY (annual percentage yield). As their initial pitch emphasized, Lend has a staggeringly higher return than standard or high-interest savings accounts, which have been hovering, respectively, between 0.04% and 0.5% APY.

Rationale of the SEC

While Coinbase compared their Lend product to a savings account, the SEC appears to believe that it is a security and therefore subject to different rules than a savings account under their jurisdiction. After Coinbase received a Wells notice of an impending enforcement action by the SEC, they brought the situation to the public’s attention.

Paul Grewal, Chief Legal Officer for Coinbase, wrote in a September 8th announcement that the company had been proactively communicating with the SEC in the six months leading up to the Wells notice.

“The SEC told us they consider Lend to involve a security, but wouldn’t say why or how they’d reached that conclusion,” wrote Grewal. “They’ve offered us the chance to submit a written defense of Lend, but that would be futile when we don’t know the reasons behind the SEC’s concerns.”

While the specific reasoning of the SEC’s decisions have not been made public, Coinbase said that the commission cited two Supreme Court rulings, SEC v. W.J. Howey (1946) and Reves v. Ernst & Young (1990).

Difference Between CeFi and DeFi Lending Accounts

Though this is the first regulatory skirmish relating to a product like Lend, it isn’t likely to be the last, as CeFi (Centralized Finance) institutions try to catch a wave of popularity – and profits – surrounding DeFi (Decentralized Finance) options.

Centralized Finance Lending Accounts

CeFi companies like Crypto.com, Gemini, and Binance have been an accessible go-to for crypto users, mimicking qualities of traditional investment institutions and banks. As with non-crypto centralized financial institutions, their profit model is based on charging user fees and investing the balance of customer accounts. They also mirror traditional finance by operating with human oversight, which DeFi proponents would describe as a vulnerability that could lead to gross mismanagement.

BlockFi, Celsius Network, Nexo and other CeFi companies already offer lending accounts similar to Coinbase’s Lend product. The unique position Coinbase has faced with the SEC might be the result of their proactive contact with the SEC to seek regulatory approval, leading to the assumption that other CeFi companies could face similar threats and litigation in the future.

Decentralized Finance Lending Accounts

While CeFi institutions are currently under the spotlight, the underlying idea involved in Coinbase’s Lend has been growing in popularity over the last year within the DeFi community.

DeFi relies on smart contracts, a technology most associated with the Ethereum blockchain, which allows a code-driven contract to govern all uses of a cryptocurrency. For instance, a smart contract doesn’t require a regulator or centralized system to scrutinize or observe a trade. In other words with DeFi, the rules, rewards, and possible losses are all baked in. Users hold, trade, and loan cryptocurrencies using dApps (Decentralized Apps), like AAVE, PancakeSwap, and Yearn.

While a CeFi company like Coinbase used the language of savings accounts in referencing its high APY, DeFi users refer to the practice of lending your cryptocurrency to others with the smart contract’s agreement of rewards as Yield Farming.

Regulation of CeFi Crypto Companies in the United States

It’s difficult to see how exactly crypto regulation plays out in the United States with both the SEC and CFTC both making claims on the nascent industry. Here’s a look at just two of the more recent developments in the saga of crypto regulation in the USA:

Binance Under Scrutiny

As the crypto economy continues to expand, other companies are facing similar investigations. Most notable among them is Binance, currently the world’s largest cryptocurrency exchange by volume. In the last year, they have been issued warnings from Britain, Germany, Japan, among many others.

While not publicly confirmed, it has been reported that they are also the targets of investigations by the United States Internal Revenue Service and Justice Department. As conflicts with regulators have grown, Binance has shrunk its footprint, winding down services offered across Europe and in Hong Kong.

Coinbase Receives Threat

On September 17, when Coinbase updated their initial announcement of Lend with the news they were cancelling its launch, they thanked the “hundreds of thousands of customers” they say had signed up for the product’s waiting list.

As demand for DeFi-style yield farming through CeFi institutions continues to grow, regulators face a difficult choice between ignoring difficult-to-regulate DeFi and allowing CeFi to bring yield farming to their customer base.

By John Wimberly