We Need to Talk About Exchanges That Sell You Coins Like UST

Happy Friday readers, David Z. Morris is filling in for Michael Casey today.

CoinDesk Editor-in-Chief Kevin Reynolds alerted me this week to a striking Linkedin post by a Coinbase (COIN) staffer. In the post, apparently now deleted, the Coinbaser wrote in part that it’s “crazy to me how much market value sits in these (probably) useless projects,” before listing a half-dozen tokens including dogecoin (DOGE), bitcoin cash (BCH), ethereum classic (ETC), shiba inu (SHIB), litecoin (LTC), bitcoin SV (BSV) and bitcoin gold (BTG).

Now, plenty of people would take issue with the idea that bitcoin cash, ethereum classic or even dogecoin are “useless.” But broadly, such sentiments wouldn’t sound out of place coming from any random account on Crypto Twitter.

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The catch, of course, is that here they’re coming from a Coinbase staffer – and Coinbase makes money from the trading of “useless” bitcoin cash, ethereum classic, dogecoin, shiba inu, and Litecoin.

To be clear, I think it reflects both good morals and good strategy that Coinbase staffers are opinionated on social media. In this industry, it’s a crucial way to keep up to date and test ideas. Employees putting their critical thinking skills on display is also good branding.

But the post raised a much larger point: Do crypto exchanges like Coinbase have a responsibility to customers when they choose what tokens they offer for sale? Should exchanges warn customers about projects or tokens regarded as questionable by their own staff? Or is an exchange’s role more neutral, simply listing tokens and letting customers make their own choices?

That’s a particularly pressing question in the wake of the collapse of the Luna ecosystem with the depegging of the terraUSD (UST) stablecoin. There have been unsubstantiated Twitter rumors of a class action lawsuit that would target exchanges that sold the LUNA or UST tokens. That group includes many centralized custodial exchanges around the world and several in the U.S., including Kraken, Binance US, and Gemini.

Coinbase didn’t sell LUNA directly, but did offer the UST stablecoin as well as “wrapped LUNA” (wLUNA) bridged to Ethereum (for, I’m sure, perfectly sound reasons). Very much to its credit, Coinbase also does not offer trading in bitcoin SV, bitcoin gold, or dogelon mars (ELON), the other tokens the Coinbase staffer called out.

Read more: David Z. Morris - Let Terra Die

You might not think it makes much sense to sue an exchange for selling you a token that collapses – as I’ll say once more for those in the back, any cryptocurrency at all is a hugely speculative investment, and this could all go to zero tomorrow. But exchanges spent much of the past two years making Super Bowl ads promising that crypto is the future, so you can at least empathize with someone who feels ripped off.

You might expect there to be a bright-line legal or regulatory answer to this question, but it’s actually somewhat unclear. That’s partly because many of the crypto assets Coinbase offers are in a gray zone relative to securities law. So a lot of the rules regarding the responsibilities of financial intermediaries for stocks, for instance, wouldn’t straightforwardly apply to an entity performing the same role for crypto-assets.

Still, without claiming any rigorous legal implications, related securities rules are interesting to consider. For instance, it’s well known by now (I hope) that a securities broker does not have a fiduciary duty to buyers of securities. Brokers represent themselves or their broker company’s interests, not yours. A certified financial advisor (CFA) is legally supposed to be in your corner, but not a broker.

However, brokers do have a lighter duty to customers. FINRA rules say that any recommendations made by a broker must be broadly “suitable,” based largely on the customer’s risk profile. Again, this applies explicitly to securities, and the status of tokens on Coinbase is largely indeterminate, but it certainly seems like a reasonable standard.

There is a further crypto complexity to all this. I’ve been talking about brokers while Coinbase is best known not as a “broker” but as an “exchange.” Because crypto is so retail-centric, exchanges are often effectively also brokers, selling assets directly to customers.

It’s also clear that crypto exchanges have long been regarded in some sense as arbiters of project quality. It’s less true now, but for many years a token earning a listing on any exchange would celebrate it as validation. A Coinbase listing in particular almost always generated a “Coinbase bump,” or a price runup after listing.

It’s a stretch, but that certainly makes a listing sound a little bit like a broker’s “recommendation.” At least, that’s an argument a plaintiff might make in a consumer protection case. Exchanges also regularly do things like write explainer blog posts about specific tokens, or about technological concepts linked to tokens. Are those “recommendations?” (This may be one reason the Nasdaq website runs third-party news content instead of just publishing promotional materials about stocks.)

Read more: Daniel Kuhn - UST Won't Be the End of Algorithmic Stablecoins

Because of this ambiguity, crypto exchanges are perhaps uniquely exposed to customer anger over losses. It’s hard to imagine someone wanting to, say, sue the Nasdaq because Netflix (NFLX) collapsed by 75% (though now that I’ve written it, I’m certain someone will). Partly that’s because nobody buys Netflix stock from the Nasdaq, but through Fidelity or another broker. But if you bought UST in April and then watched it evaporate, you know it’s Coinbase or Kraken that have your money today.

And now we get back to the FINRA broker rules. A broker/dealer does not have a fiduciary duty to customers but must meet a lighter standard of “suitability,” a general matching of risk profile to a customer. For crypto exchanges, this seems close to a reasonable standard for responsible behavior, whenever the U.S. Congress gets around to writing some of those down.

But the case of UST would seem to challenge even this lighter standard. Can any asset be considered “suitable” for even the most frothing risk taker when any monetary finance expert could have confidently predicted its failure? When it’s the fifth version of the same experiment to fail exactly as predicted?

How about when an exchange’s landing page for a token uncritically echoes the creators’ false claims – for instance, that it’s “stable”? Or how about when the venture arm of the exchange invested in the group behind the token the exchange profited from trading before it went to zero?

Well, then you have what in the legal profession is known as an “ethical morass.” It’s just the sort of thing courts specialize in untangling.