The SEC sues the Cryptos

Last Tuesday morning, the U.S. Securities and Exchange Commission filed a 101-page lawsuit against U.S. crypto exchange Coinbase (COIN). The SEC alleges that the company has been operating as an “unregistered broker” since at least 2019.

This lawsuit is specific to Coinbase, the largest crypto platform in the U.S. But the outcome of this litigation will likely have a much broader and longer-lasting influence.

This is large-scale stuff and has been coming for a while.

Specifically, the SEC named 13 cryptocurrencies – not including bitcoin or Ethereum, notably – that it says Coinbase offers and sells “as investment contracts, and thus as securities.” That would put the company in violation of the Securities Act of 1933 and the Securities Exchange Act of 1934, and the suit therefore seeks to force the platform to stop offering these cryptos.

In an interview Tuesday morning on CNBC, SEC Chair Gary Gensler suggested that he’s thinking about all crypto exchanges when filing the suit.

These trading platforms, they call themselves exchanges, are commingling a number of functions. We don’t see the New York Stock Exchange operating a hedge fund.

That last part could be taken as an obvious reference to FTX. That’s the exchange once run by Sam Bankman-Fried, which had allegedly taken customer deposits to fund speculative Coinbase has long contended that the U.S. needs clarity around crypto rules, a statement that its CEO Brian Armstrong made. He said the company has actually tried to register as a broker and met with the SEC 30 times in 2022 to ask for policy guidance.

In fact, just last week, a massive draft bill was introduced in the House of Representatives that aims to govern the so-called crypto “Wild West” right now. This includes creating official definitions of crypto terms, like the blockchain itself.

First off, this news came a day after the SEC filed a separate suit against Binance, the world’s largest crypto exchange, and its founder, Changpeng Zhao. (Ironically, he’s the guy who started Bankman-Fried’s fall from grace by calling him out on cozying up to U.S. regulators.)

In yesterday’s suit against Binance, a little longer at 136 pages, the SEC similarly considered several crypto coins as securities. It was also more critical of Binance than Coinbase, alleging in the second sentence of the filing that Binance’s leaders “enriched themselves by billions of U.S. dollars while placing investors’ assets at significant risk.”

This lawsuit against Coinbase doesn’t read as strong, but it’s still significant. It seems to be more about the SEC taking its biggest step yet into the conversation about what it considers securities in the cryptocurrency world.

The SEC also raised concerns about Coinbase’s “staking” offers. That’s where owners of certain cryptocurrencies agree to lock up their cryptos on a blockchain network for a set period of time in exchange for a reward.

The feds aren’t happy with how Coinbase goes about it. For example, the company offers a “pro rata” return on staked coins and charges a 35% commission on staking rewards from crypto coins Cardano (ADA) and Solana (SOL). The SEC says this means Coinbase’s staking program is a “common enterprise” and users are entering an “investment contract” – making these coins a security.

And more broadly, the SEC says that Coinbase acts as a broker, exchange, and clearing agency all wrapped into one.

Yet, Coinbase has never registered with the SEC as a broker, national securities exchange, or clearing agency, thus evading the disclosure regime that Congress has established for our securities markets.

All the while, Coinbase has earned billions of dollars in revenues by, among other things, collecting transaction fees from investors whom Coinbase has deprived of the disclosures and protections that registration entails and thus exposed to significant risk.

SEC Chair Gary Gensler declared. “Frankly, the public should really be more careful… We don’t need more digital currency. We already have digital currency. It’s called the U.S. dollar. It’s called the euro, or it’s called the yen; they’re all digital right now.”

Inverted Yield Curve

The 10-year/3-month Treasury yield spread is one of the most reliable recession indicators, but capitalizing on it can be hard. This article does a good job explaining why: The economy can take many paths to reach the same outcome.

Key Points:

The 10YR3M spread has inverted before every recession since the late 1960s with virtually zero false signals. The only modern false signal occurred in 1966.
On average, a recession begins about 12 months after the curve inverts, but the interval has ranged from 6 months in 1974 out to 17 months ahead of the 2008 recession.
Today’s historically deep inversion began in November 2022, meaning we are still early in the process by historical standards.
Stock market performance at 15 months post-inversion has ranged from -47% to +12% on the S&P 500.
In the labor market, jobless claims are rising in line with previous inversion cycles.

If the pattern holds, the US economy should enter recession no later than Q1 2024. It’s worth noting, however, the 1966 false signal occurred at a time of similar labor market strength and stubborn inflation. Maybe this time will be different… or maybe not.

US Economy

The May payrolls report topped expectations once again. Despite some dire predictions, hiring remains robust for now.

Job creation was broad in May.
After three months of declines, May saw an increase in temporary services employment, which often serves as a leading indicator.
However, the unemployment rate jumped last month. This could be a sign of a looser labor market.
Removing the seasonal adjustments, the unemployment rate is back at 2022 levels.
Permanent employee share of job losses has been climbing.
Labor force participation was flat in May.
But prime-age participation was the highest since January 2007.
Wage growth edged lower, further extending the ongoing downtrend.

Hours worked reached the low end of the pre-COVID range. This is another indication of easing labor market imbalances.

There were enough signals in the employment report to give the Fed cover to forego a rate hike in June. Market-based rate hike expectations are being pushed into July.
The debt ceiling increase arrived at a pivotal moment, with the US Treasury’s cash balances hitting their lowest level since 2015 last week.
The ISM Services PMI signals stalled business activity growth in May.