(Bloomberg) — The fit thrown by Coinbase Global Inc. Chief Executive Brian Armstrong over a U.S. regulator’s threat to crack down on its proposed lending program set Twitter abuzz this week. But it also underscores the significance of the business when it comes to growth at the largest U.S. cryptocurrency exchange.
On Tuesday, Coinbase said it received a Wells notice from the Securities and Exchange Commission, threatening an enforcement action if the company launches its Lend product, which would let users earn returns on their crypto holdings by lending them out. Armstrong called the agency’s action “sketchy,” and refused to scrap the program, instead delaying its launch to at least October.
The commotion comes as Coinbase is playing catch up to competitors such as BlockFi Lending LLC, which are already offering higher yielding products. At the same time Coinbase is focusing on rolling out new products to diversify revenue, 88% of which came from trading fees in the latest quarter. Such heavy dependence on one product line can lead to large revenue fluctuations given the volatile nature of cryptocurrencies, which is seen as contributing to Coinbase’s decision not to provide revenue guidance.
What’s more, most of those fees, in turn, come from retail investors, while institutions pay much lower rates. The exchange has more than 68 million verified users. Coinbase aims to eventually make money off the larger investors via other services. It also needs to offer additional options to retail investors, as analysts worry that, with no-fee crypto exchanges launching almost daily, trading fees could eventually trend down to zero.
“Over the long run we do expect Coinbase to diversify into other business lines,” said Chris Brendler, an analyst at D.A. Davidson & Co. “Coinbase will look different.”
Coinbase officials declined to comment on whether the SEC notice will also impact other products it offers or its product plans.
The company booked 4.7% of its $2.2 billion in revenue in the second quarter from subscriptions and services, such as custody solutions and so-called staking. The SEC’s stance casts a shadow over the staking product, where investors are awarded for pooling tokens to help validate blockchain transactions, according to Owen Lau, an analyst at Oppenheimer & Co.
“If they don’t have a good relationship, or if they can’t foster a good relationship with the regulator, will the regulator go after other products?” Lau said. He also wondered if Coinbase Earn, a program that lets users watch videos and answer quizzes about various coins to get crypto rewards, could be impacted. Revenue from Earn was about $17 million in the second quarter.
At the crux of the matter for the Lend program is whether Coinbase is offering unregistered securities to investors. Similar to a bank savings account, the company had planned to offer a yield of 4% to account holders who agree to let Coinbase lend out their USDC tokens. Coinbase would likely get a cut, and pay the participants a portion.
The Wells notice could also put on ice other, upcoming efforts for Coinbase to capitalize on so-called decentralized finance — or apps that let people trade, borrow and lend to each other. Coinbase has talked about creating a marketplace for DeFi apps.
In some cases, BlockFi, Gemini Trust Co., Celsius Network LLC and others are offering annual interest rates of more than 7%. The national average interest rate for savings accounts is around 0.06%, according to a survey by Bankrate.
The controversy around Lend isn’t yet impacting analysts’ profit and revenue estimates. Offering a modest by crypto standards 4% annual yield on USDC stablecoin deposits, Lend isn’t likely to gain much traction on programs run by competitors offering much higher rates, Lau said. But lending products are growing in popularity with consumers, especially during times of high volatility, when many investors may wish to park their funds in yield-bearing accounts. Unless regulators go after all such providers, Coinbase likely needs Lend to be competitive. There is already about $90 billion in funds invested in DeFi protocols.
“The end state is very likely to be a regulated version of DeFi run by Coinbase and other large companies that make strong efforts to comply with laws, and a legal gray area of unregulated DeFi administered by decentralized autonomous entities or shadowy offshore organizations,” said Aaron Brown, a crypto investor who writes for Bloomberg Opinion. “This is one minor skirmish in the long-term war, whose eventual peace terms seem largely predictable.”
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