Coinbase Global had at least one bright spot in a dismal quarter: fees earned from staking, where investors can earn returns by locking in certain cryptocurrencies.
The problem? Coinbase says that same program is under scrutiny by the Securities and Exchange Commission.
The company’s quarterly filing on Aug. 9 expanded the list of topics about which it says the SEC has sent it investigative subpoenas or other requests for documents. New to the list was the company’s process for listing assets, the classification of certain listed assets and its participation programs. This was in addition to queries shown in the company’s Q1 report on its yield-generating products and stablecoin.
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The company, in its shareholder letter, said it received a voluntary request for information about its quotes in May, an investigation that had already been widely reported. The letter did not address the query about the staking program.
A Coinbase spokeswoman did not respond to questions about why the stake was added to the disclosure this quarter, but pointed to a section of the company’s shareholder letter that said the company often provides input to policymakers .
Betting is a primary way crypto investors earn returns. Some tokens, such as a new version of Ethereum, offer rewards to investors who are willing to lock their coins so they can be used to store information or validate transactions for the rest of the network. Investors have staked about 13.9 million Ethereum tokens and are earning an annual return of 4.2%, according to a website maintained in part by the Ethereum Foundation.
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Coinbase charges a 25% commission for staking tokens on behalf of customers. Its website on August 10 said customers could earn a return of up to 5.75% on six tokens: Algorand, Cardano, Cosmos, Ethereum, Solana and Tezos.
In its earnings report, Coinbase said engagement is becoming an increasingly important part of its business and highlighted it as one of five product areas the company is focusing on.
With retail clients trading less during the crypto crisis, the company said more than two-thirds of its transaction users were engaged in “non-investing activities,” which include participation. During the quarter, the company also rolled out staking capabilities for new tokens and, for the first time, made it easy for institutional investors to stake coins through Coinbase.
Staking “has also become a big source of subscription and service revenue and is growing very well,” CEO Brian Armstrong said on the company’s earnings call.
The company does not generate participation income, including it in a segment called “Blockchain Rewards”.
This segment brought in $68.4 million in the quarter, nearly double the previous year. Blockchain Rewards accounted for 8.5% of net revenue, up from 7% in the first quarter and 1.7% in the second quarter of 2021.
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It’s unclear what the SEC’s investigation is about. The agency did not respond to a request for comment.
Last year, the SEC threatened to sue Coinbase if it went ahead with a plan to let users earn interest by lending their tokens. Coinbase then canceled this project.
Some securities lawyers believe the holding likely falls within the purview of the SEC.
“Even the phrase ‘staking’ suggests some degree of direct interest in a company that you think will be profitable,” said Tyler Gellasch, a former SEC attorney who now heads the Healthy Markets Association.
Coinbase has noted in the past that it is unclear how regulators will treat the holdings. In its prospectus before going public last year, Coinbase acknowledged “regulatory uncertainty regarding the status of our participation activities under US federal securities laws.”
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But if the SEC inquiry escalates, it would add to potential disputes Coinbase already has with the agency. The company has also asked the SEC to have a public rulemaking process that more clearly outlines the agency’s crypto oversight.
What is the impact for stocks? For now, investors are either missing disclosure from the SEC’s investigation into the stake, or they don’t seem all that concerned. The stock rallied 7.4% on August 10 as Bitcoin and other cryptos gained strength. Despite the gains, Coinbase shares are still down 62% this year, trading around $98.
This article was first published by Barron’s.
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