Coinbase Wants to Pay Interest on Crypto Coins, Sort Of

Even in the context of the volatile cryptocurrency world, Tezos had a rough start. After raising $232 million by selling a token without a network in place, the project descended into chaos over a management dispute. The ship eventually righted itself, but regulatory questions have dogged it and other projects.

The SEC has made clear that people should assume tokens used to raise money are securities, says Joshua Klayman, an attorney who specializes in blockchain and digital assets at Linklaters. Some coins have gotten a pass based on a variety of reasons, but “there is no bright line,” he adds. “It really is a case-by-case basis.”

Last week, in an interview at San Francisco Blockchain Week, Hester Peirce, an SEC commissioner known for her cryptocurrency enthusiasm, noted her colleagues should be looking at the “structure of the product” instead of the underlying assets. Coinbase says it’s confident the Tezos token is in the SEC’s good graces. (The SEC did not respond to a request for comment.)

Staking adds a few other wrinkles. Bitcoin doesn’t use staking to keep its network secure; it has a system called proof-of-work, in which a network of computers, known as miners, race to solve cryptographic problems. In exchange for their services, the miners are rewarded with bitcoin and can also vote on proposed changes to the protocol. Staking puts both the incentives and the voting rights in the hands of token holders, not miners. To some, that has all the hallmarks of an investment relationship. “Initially [the SEC] said it would have serious concerns about this,” says Brian Brooks, Coinbase’s chief legal officer.

Brooks says the SEC became comfortable with the arrangement because of the unique structure of the Tezos staking process. Rather than having customers stake the tokens, Coinbase stakes coins itself using funds from its custody business. It then distributes the profits as “rewards” to customers based on how much Tezos they hold in the company’s accounts. Coinbase says the arrangement insulates customers from the potential risks of staking. Staked coins are harder to trade quickly during price swings, and more vulnerable to hacks than coins stored offline.

Still, nothing in the arrangement protects investors from the frequent whiplash of cryptocurrency prices. If Tezos were to crash, the customer’s funds would go with it. Max Branzburg, head of product for Coinbase’s consumer product, compares the idea to picking stocks, with all the attendant dangers. Of course, public companies are required to make extensive disclosures about their risks and financial health; Branzburg notes Coinbase has invested in making information available about specific coins. “The principle here was to make it as simple and easy for customers as possible,” he says.

That pitch is likely to irk independent-minded crypto enthusiasts, who already see companies like Coinbase as unnecessary middlemen who stand between users and their coins. A more practical tradeoff to convenience are fees. Tezos offers nearly 8 percent rewards to those who stake their coins directly. Coinbase plans to take a hefty percentage off the top, leaving users with a roughly 5 percent annual return that pays out every three days.

Coinbase says it will consider staking for other tokens, especially as other networks, including Ethereum, adopt similar security models. The company also has other ventures outside of trading, including an expanding crypto custody business for larger institutions to park their coins. It has also invested in efforts like Coinbase Commerce, which enables partner merchants to accept cryptocurrency. (The company also joined the Libra Association, the struggling Facebook-led group that hopes to enable global crypto payments.) Armstrong has also speculated on the possibility of offering crypto-based loans.

The fate of those products is unclear, given the hurdles of regulation and user adoption. Crypto loans have been called a bubble, and payments have gained little traction so far. Coinbase has stumbled in its attempts to get other ventures off the ground. Last spring, the company closed its Chicago office, the central hub of an effort to get into high-frequency crypto trading.

In the meantime, Choi says the company is focused on making sure the core product works and remains secure. During the big run-up in 2017, the onslaught of users forced portions of the trading system offline. This summer’s spike was a calmer affair; staffers seemed visibly relieved that no major gaskets had been blown—a reflection, Choi pointed to at the time, of the company’s investments when cryptocurrency prices were low. “It feels like the lessons have been learned.”

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