Coinbase Global, Inc. (COIN) Earnings Call Transcript & Summary

For important disclosures, please see the Morgan Stanley research disclosures website, www.morganstanley.com/researchdisclosures. The taking of photographs and the use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. I've also been asked to remind you that during today's chat, Paul may make forward-looking statements. Actual results may vary materially from today's statements. Information concerning risks, uncertainties and other factors that could cause these results to differ are described in the company's SEC filings. Our discussion today may include reference to non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures are readily available in the company's latest shareholder letter on its Investor Relations website. Non-GAAP financial measures should be considered in addition to and not substitution for GAAP measures.

Well, that's a mouthful. I'm impressed. very impressed.

All right. Good morning, everyone. Thanks for joining us at Morgan Stanley's Financials Conference. I'm Mike Cyprys, equity analyst covering brokers, asset managers and exchanges from Morgan Stanley Research. And we are thrilled to have with us here today, Paul Grewal, the Chief Legal Officer at Coinbase. And as many of you know, Coinbase is the largest cryptocurrency exchange in the U.S. with over $130 billion of assets on the platform and $145 billion of quarterly volume traded. Paul, thank you. Thanks for joining us.

Thanks for having me, Mike. Welcome. It's great to be here.

Great. Well, why don't we dive right in?

Sure.

A lot happening in the crypto markets and the regulatory backdrop, but I believe this is your first conference appearance.

It is.

So why don't we kick off with a little bit of a quick intro on your background, which actually I think is quite interesting. You've practiced law. You were a judge.

I was [indiscernible] for years.

Okay. We'll like to hear a little bit about that. You've also worked on the corporate side. So what attracted you to the crypto industry onto Coinbase and talk about your current responsibilities and how you're spending most of your time today?

Yes. Well, it's great to be here with all of you this morning. My introduction to crypto is a little different than many. It actually goes back to either 2012 or perhaps as far back as 2011, when as you suggested, Mike, or alluded to, I was serving the federal magistrate judge in the Federal District Court in Northern California. And I was sitting in my chambers 1 morning when my law clerks brought in a very unusual Rule 41 search warrant application for something called Bitcoin. The FBI was looking to seize this thing that referenced a white paper. And like a good judge, not knowing anything about what I was reading, I mean turn to the Internet to learn more.

And you cover the white paper? You googled it?

I googled it. Yes. I'm not too proud to admit that. And from there down the rabbit hole, I went, not knowing, of course, that a handful of years later, when I decided to return to private practice, this would be my career.

And how would you say you're spending most of your time today and some of your...

Yes. Well, today, and certainly, at this point in time, I'm spending a lot of my waking hours managing the regulatory landscape for not just Bitcoin, but all digital assets. And there are certainly no shortage of debates happening right now in Washington, active litigations involved in the SEC. A lot of interesting discussions happening with state regulators, I think, often get overlooked, but it's a pretty complicated landscape right now in terms of regulation.

Well, why don't we set the stage, take a step back and talk about Coinbase's approach to regulation and how it has evolved as you're girding as a public company?

Yes. Well, one of the things that really attracted me to Coinbase roughly 3 years ago was the fact that the company really took a very different approach to regulation and just about anybody else, I was aware of in crypto, which was to really be grounded principally in 2 concepts, 2 principles that I think continue to guide how we think about regulation today. One is security. We really think offer a differentiated experience for our customers in terms of the safety of their assets and the safety of their experience on the platform. But the second is really trust. And as the Chief Legal Officer, a commitment to a trusted relationship, not just with their customers, but also with regulators, policymakers and others was something that was very, very important to me in particularly coming out of my previous career in public service.

Let's dive right into, I guess, the core topic .

Let's do it.

In late March, Coinbase received a Wells notice from the SEC. And just last week, you were just mentioning, SEC announced it was suing Coinbase over its registration status and the sale of staking as a service program. So can you talk about your reaction to this decision here?

Well, my reaction is that as disappointed as we were to see the SEC choose to file suit last week, we were hardly surprised. And any of you who have been following crypto or Coinbase over the last several months, we're likely not surprised either because we took a very different approach to sharing our conversations with the SEC and that we were very public and very transparent about the fact that we received a Wells notice in the first place. I have to tell you, Mike, they do not teach you that in general counsel school that when you serve with the Wells notice immediately Sharewell allow others to assess for themselves whether or not the commission has been as clear and transparent on what its issues and concerns were. And at the same time, given the response as part of the Wells process or the opportunity for response rather as part of the Wells process, we thought it equally important to be transparent in sharing our brief and even a video, Brian and I had made explaining why we believe that a case against Coinbase would not just be misguided, but in fact, contrary to law.

What outcomes do you see that could come from this? What could tax be for Coinbase and implications for other crypto firms as a result?

Well, I think the outcome and implications really are better understood in the broader context of sort of where we see regulation going here in the United States. The fact of the matter is court cases can often take a lot longer than any of us would like. But in many ways, the litigation is just 1 part of the broader conversation. We were just talking earlier, Mike, last week, I testified before the House Agriculture Committee on draft legislation that is being introduced not only by that committee, but by the House Financial Services Committee I believe, tomorrow. And so we're very excited that Washington is finally waking up the need for some sensible rules that will allow us all to understand what a path to registration could look like for not just Coinbase, but for others in the industry and critically important for issuers of digital assets who from all the conversations I've been having, are quite eager to operate inside of the registration and regulatory perimeter. But at present, really don't have a practical way to do that. So I think the court case will play out over time. But more importantly, I think it has underscored the need for legislation and regulation in a way that we have been calling attention to for many months because even before the case even long before the legislation was posed. Last year, Coinbase actually petitioned the SEC court rules in crypto and laid out what we think is a sensible approach that will inform a lot of how -- what we think the legislation will ultimately look like.

And we'll come back to the legislation, but just on the case file. What's the process around that? Like what are some of the steps? What's the next step from here?

Yes. So the court case, just for -- again, for those of you less familiar, includes charges that Coinbase has listed a number of unregistered digital assets on its platform and provided to our customers certain products and services that in the SEC's view also qualifies unregistered securities. And as a result, is seeking to hold Coinbase accountable for a failure to register as a National Securities Exchange. Now the key to understand all of this is to understand that the SEC's entire case is predicated on an understanding of what is a security and in particular, type of security and investment contract. So we think plainly does not cover the types of tokens that we list or the products and services that we offer. And just one other point I'll just offer on that. Again, it can be, I think, confusing to put it gently for some -- to look at the couple of hundred of tokens or assets that we list on our platform like and assume that there must be certain securities included among them. But often gets overlooked is that Coinbase actually reviews thousands of assets. And so we reject well over 90% of them, largely because we agree. There could be securities loss concerns, and we have no interest in listing securities because we are not registered. And the reason we are not registered is currently, we don't have a path to registration. So the court case will have to resolve all those issues in due course. We think we're -- we've got the better of it on the law. And we think that some of the SEC's statements and comments around this only confirm that their view of the law was very much in line with ours until quite recently, but that will play out over time. To come back to your specific question, now that the case has been filed, we will have an opportunity to respond to the complaint that was filed here in New York. Once that response is filed, there will then be, I think, a number of legal questions that the court will have to resolve over the months that follow depending on how the court rules, we think the court could and should rule that the case lacks legal merits and that would be the end of it. But if the court disagrees or concludes that there needs to be further discovery of facts in order to inform that ultimate question. The case will then proceed through discovery and potentially to a trial. Now district judges in federal court have a lot of autonomy and setting schedules. So I can't say for sure whether this is a 6-month, 12-month or 18-month process. There really is a lot of discretion afforded, but in the meantime, business continues as usual at Coinbase. And even as we're managing the litigation, we are equally eager and engaged in pressing the legislative solutions that we think are important. The last time, I just in terms of filling out the litigation landscape for you, Mike, and for everyone. It's important to call out. I mentioned that last July, last summer, we filed a petition for rules with the SEC. And of course, now 10 or 11 months have passed and we haven't received any response. Just last month, we went to court ourselves and asked the court to order the SEC to respond to that petition that we had filed and make a decision on where the new rules would come. That case is proceeding, and we expect that case to actually be resolved in the next several weeks, if we're lucky. And so lots of different moving pieces here, but that's at least a comprehensive view of the landscape in terms of litigation.

Could that have any sort of impact or bearing on the case, that was just filed?

It could. Now strictly speaking, could it bar or preclude the SEC from pursuing its enforcement case. I don't think that's likely. However, it is absolutely the case that the clarity or lack of clarity in terms of rules for crypto is a key issue in the enforcement case. The idea that somehow the industry was put on fair notice, we think, is belied by the fact that the SEC has been stalling on rules now for some time. And if and when we hope and believe the court orders the SEC to finally answer our petition. We think that will have a material impact on some of those questions about fair notice and the fairness of the proceeding overall.

The SEC also filed suit against Binance last -- I think it was the day before.

It was day before.

Okay. [ 4 ] years. Okay. Maybe you can talk about the differences and similarities between the 2? There's probably more differences than there are similarities? Maybe you could just walk through...

There are some overlapping issues to be sure. And the timing, of course, was not coincidental either, but there are very important differences between the 2. Binance is also accused of listing a number of unregistered securities and therefore, operating an unregistered exchange. But critically, the case against Binance also includes very serious charges involving everything from wash trading to operating a proprietary fund without adequate disclosures to customers to generally co-mingling or using customer funds more in a variety of contexts in ways that carry, I think, much more serious implications for the company. There's also charges against the CEO in that case personally. That is not the case again in terms of Coinbase. And critically, the government in that case, the SEC is seeking to seize a bunch of assets from Binance before the case even allowed to proceed. And there's no such request for immediate relief against Coinbase. So some pretty important differences there.

So no co-mingling acquisitions or any...

We really have -- it's interesting. We really have a fundamental question of law in our case about what is a security that sort of undergirds the entire case. For Binance, that's also true, but there are also these, I think, much more serious questions of how the business was operated, how the company was run.

Would you guys rule out registering as a broker-dealer or an exchange?

I want to register. We want to register. For many months now, we have been banging on the SEC store asking for a path to registration or way to register not just for Coinbase but for the entire industry. And so going back to last September, a few months after we filed our public petition for rules, we entered into private conversations with the commission, laying out our ideas on what registration could look like because there are some very technical differences that matter when it comes to blockchains and how they operate, what it means to settle trades, for example, this audience would appreciate, I think more than most. It just works differently when it comes to crypto. Unfortunately, the conversations were not ultimately productive. And when we finally reached the point, Mike, where it was time for us to stop talking for us to take down our slides and our 9 different ideas for how this could work and hear from the SEC, that was the point where they think this first time and invite us to have a nice day.

So you want to register as a broker-dealer, but it's not like you could just fill out a form and submit it over.

No, it's been suggested it's a matter of going to the website and downloading a form. I encourage all of you who are curious to try that, you'll see this is not like running a Google search. It is impossible to do today. But that said, like we'd like to be able to offer digital asset securities in the future. As I mentioned, we reject some 90-plus percent of proposed assets for that reason in large part. So we'd like to get to a place where we could offer securities that are in tokenized form, we just can't do it at present.

And what about registering as the securities exchange?

That's also on the table. Initially, we had proposed to the SEC in those private discussions I mentioned, a framework that would involve an alternative trading system and a broker-dealer attached to it, but the commission was very insistent that we step forward ideas for an NSE and National Securities Exchange, as you suggest. And although it wasn't our first choice, we were flexible around that too because the fact of the matter is like there are great opportunities for us if we can get to a place where we can offer digital asset securities. And so we've tried to be as flexible as we could be. Unfortunately, up until this point, there hasn't been a lot of flexibility in return.

Why don't we shift and talk about the legislation of the House Committee on Financial Services and the House Committee on Agriculture recently came out with a digital asset market structure discussion draft, you had the opportunity last week, as you mentioned, to testify.

I appreciate you're characterizing my invitation to testify as an opportunity. It was actually all serious since it was and we were was grateful for the chance to do it.

Well, they're taking feedback.

They're taking feedback.

So which is great. And we'll talk about the international in a moment. But just on the U.S., you have the opportunity to testify about the draft and the future of digital assets. So what are your thoughts on the draft that they put forward?

I was very impressed. And I shared during my testimony, our view that the discussion draft represents a very important first step towards legislation that can work. There are several features that I think are critically important. And the approach the draft took was, I think, extremely productive in resolving some of the key uncertainties that we all face in this particular market. First and foremost, the discussion draft for proposal would, for the first time confirm on the Commodity Futures Trading Commission, spot market authority over digital commodities. And that's critically important even if you agree on nothing with the industry because even the chair and the SEC have acknowledged at Bitcoin, for example, is a commodity. Today, at the federal level, we don't have spot market authority. The CFTC's ability to effectively monitor and police that market is limited to fraud and market manipulation and a lot of backwards looking after the fact assessments. We think having a comprehensive registration and oversight authority at the CFTC would be terrific and much more effective. The other thing that the bill does that I think is tremendously important is that it would recognize for the first time that digital assets can and often do change character over time as these networks and projects evolve. And so there would be an opportunity for an asset that initially perhaps was appropriately treated as a security, subject to oversight by the SEC to be certified as a digital commodity as ownership and distribution decentralized. And as it became clear that for investors, the information asymmetry that you normally focus on when you're regulating securities no longer really was true and it made sense to treat this much more like other commodities that we're very familiar with.

And what areas do you feel the draft doesn't address or maybe could address things maybe a bit differently?

Yes, it's not perfect. And the bill in market, I have no doubt will be adjusted in several important ways. One example where I think there's room for improvement, for instance, is that I mentioned this idea that an asset can change character over time and that it could be certified as having essentially transition from a security into commodity. Right now, that's a call that only the SEC has an opportunity to make in that the assets are self-certified but then the SEC under the current draft has the right to essentially jump in within 30 days and raise objections. I think that because these assets are being jointly regulated by the SEC and the CFTC, there's an opportunity there for the CFTC to also weigh in as part of that certification review. That may sound like a technical issue, but I think it's actually quite important. And I also think that -- as the draft currently recognizes there are open questions about DeFi. As the draft currently is structured, there's a call for further study and essentially a parking of the issue to allow that study to take place. I think eventually, we're going to have to reach some stronger consensus on how to manage and over -- think about DeFi within the regulatory framework. And so that's something else we're very eager to engage in.

Where does the draft go from here? How does this sort of play out you think from a...

It's real interesting, Mike. So it's a very kind of peculiar legislation in that. It has been introduced not just by 1 committee, but by actually 2 committees. So House Ag went first last week, House Financial Services goes later this week. And once each committee has formally introduced the bill, there will be a markup period. And then both chairs of both committees have committed publicly to moving this forward quickly. We're hopeful this means that we will see an actual bill passed through each committee and go to the House floor by the end of the summer. That could delay because, of course, Washington has other things to worry about at on any given day. But we're optimistic that we're going to see legislation go through the house this year, which would be, I think, pretty remarkable.

And then after it goes to the house, I imagine and then goes to the Senate. What's that process like? And any sort of views on how it may be received?

Yes. No, this is like going back to Schoolhouse Rock, right? You go over to the Senate side and Senate Banking and the Senate agriculture community can also have a process to work through. To be very clear, the politics in the Senate are different and perhaps more challenging than they are in the house. One of the things though that I was particularly encouraged by, Mike, suggests that there is a strong support out there in the Senate to be had is that, it wasn't just a Republican bill only. Even though it was introduced by the House Republicans, the Democrats in the House Ag Committee last week were asking very serious, thoughtful questions. I had a chance to meet with a number of them as part of my testimony. And I was encouraged that we're going to see democratic support coming out of the house. And I think depending on how strong that support is I think that will encourage a number of Senate Democrats to join as well, which, of course, will increase the odds that we'll see that legislation pass and then ultimately go to the President desk for Signature.

All right. Why don't we go overseas, talk about international markets. You have mentioned in the past that you've seen good progress overseas. We have. Maybe talk a bit about that, what are you seeing in other markets that keeps you optimistic?

Well, there's a lot to be optimistic outside the United States, even as regulators in Europe, in the U.K., in Australia, you name it, are just as focused on investor protections and consumer protection issues as anyone here in the United States. MiCA in the European Union, I think, is proving to be a watershed moment in terms of legislation now being passed that will impact all 27 member states and create a framework for digital assets that gets past this sort of silly turf battle we have in America over. Is it a commodity? Is it security? Does it go to the SEC? Does it go to the CFTC? Europe, I think, has a much more sensible approach of treating this as an asset period end stop and then imposing strict requirements for disclosures, managing conflicts, all the other issues that you might have concerns about. And I think we're going to see in the coming year that regulatory framework enacted and fully online in a way that will encourage and incent development. The same is happening in the U.K. by the way. The current government, I think, has been very public in declaring its support for digital assets. I saw just late last night, the Prime Minister himself welcoming a16z as they open up their first international office in London. It's a very different attitude than the I confronted in Washington last week and have -- we have been dealing with for some time. So you're just seeing a much more, I think, mature recognition in other markets that, yes, the investor protection issues are important, but this is like asset class that's here to stay. Crypto isn't going anywhere. And so let's stop talking about it as some sort of buggy man and rather recognize it for what it is, an opportunity for economic development, innovation that needs to be properly regulated, but that is very important for any aspiring economy to embrace if he wants to be part of the financial system future.

Given that sort of backdrop internationally, how do you think about new product launches internationally, particularly as you with clarity in the U.S.? And maybe remind us what portion of Coinbase's business as overseas today?

Yes. So Coinbase is operated as an international business for some time now. And so it's not unusual that -- or shouldn't be terribly surprising that we will continue to look for opportunities in overseas markets. I think in a recent quarter, something like 20% of our top line revenue came from markets outside the United States. So this is a significant part of who we are and how we operate. That said, between the clarity and certainty we're seeing in some of these other markets outside the U.S. and the continued questions we have here state side, we're looking for ways in which to invest in new opportunities overseas and in overseas markets, whether it is in doubling down in markets where we've had a licensure or registration for some time. Germany, for example, the U.K., Australia or in serving other markets through our international exchange that we just announced and are quickly bringing online in Bermuda. So there's a lot of exciting stuff happening outside the United States. And we're not giving up on America. We're very much committed to reforming the broken process we have here. But the rest of the world isn't waiting. And we feel very strongly we can't afford to wait either to be part of that progress.

Speaking of new opportunities. Let's talk about derivatives. Maybe just give us an update where we are with the build-out of Coinbase's derivatives platform and the ability to offer leverage and access customers directly? What's the journey for that in the U.S.? And how do you think about that overseas?

Yes. We're very excited. So we have been pleased with the progress we have made in securing our full license to operate a derivatives market. The CFTC and the NFA have been, I think, very positive and productive in reviewing our applications. And we're not yet ready to announce we've got everything in hand. But that progress is quite good. And again, more importantly or equally important from my perspective, the tenor and tone is how do we solve for the problems that we need to solve to make sure that these markets are efficiently operated and overseen, but the line of travel, the direction of site is quite positive. And so we're eager to see that all come to a head very, very soon. And in a way that would allow us to move forward here in the U.S. In the meantime, outside the United States, again, we're seeing a very positive embrace of leverage and derivatives, opportunities through our exchange that we will operate out of Bermuda and perhaps elsewhere at some point in the future. The fact of the matter is that I think, in order to operate a global business and participate in market opportunities to the degree that we want to, on behalf of our shareholders, we need to be able to offer derivatives. We need to offer leverage products and services and that remains a top priority for the company.

And just to clarify for everyone, what portion would you say is operating today versus what's still to come on the derivative front?

I don't have exact percentages. Also, I'm hesitant to be terribly precise. What I can say is that the main challenge we've had here in the U.S. has been just achieving full licensure from the CFTC and from the NFA. And in both cases, we have received very positive feedback as our application has preceded. So very encouraged by that. And of course, that will open up some significant opportunities here in the U.S.

So still in the process of obtaining licenses is where you're at. Okay. Maybe just last question for me before I open it up to the audience. So get your questions ready, and then we'll open it up. Clearly, the industry has been through a lot, whether it's from Terra Luna to the FDX, most recently, the bankruptcy of this and this has led some to be concerned around the parent of the digital currency group, a sister company, Grayscale, just on and on, a lot of risk out there. So just curious how you think about your take on why people are concerned? What risk do you see? And how do you protect Coinbase?

Yes. I think people are concerned because the fact of the matter is that even if you have a strong appetite for volatility and understand that in emerging markets, you're going to see successes and failures over a relatively short life cycle. The failures in the last 12 or 18 months in crypto have been somewhat spectacular, right? There's just -- there's been a lot of dramatic developments, a number of dramatic developments that I think only a Hollywood script writer could have imagined in certain cases. But the line of sight again, the direction of travel, I think, should give all of us a lot of confidence that this is just part of the maturation and these are growing pains that we have to go through in order to get to a better place. The way I think about it, Mike, is that we look at peaks and troughs. And as 1 cycle ends and other cycle begins, the reality is that yesterday's peak is tomorrow's trough, and we see this over and over again in a number of different assets. So that gives me a lot of confidence. The other thing that gives me a lot of confidence, as I said, is that crypto has remained a largely bipartisan issue. There are partisan elements of the conversation in Washington, but we still see Democrats and Republicans engaging with proposals for sensible rules. And there's not a lot that they engage in collectively in these days. So I think that says something about the long-term potential and future. And then the last thing I will say is that I think that the fact of the matter is that the use cases that we're seeing emerge in crypto even in the midst of all of this uncertainty and on the regulatory front suggests that there are real needs that crypto can and will solve for people, whether it's digital health ID, whether it's digital health records, whether it's decentralized ID, very interesting gaming applications. So the fact that developers continue to pour time, energy, creativity and resources into building interesting use cases with all of this tumult around us suggest that once and when we get this resolved on the regulatory front and the legislative front, there are opportunities ahead.

All right. I'll see if there's any questions here in the audience. Over here. Sorry, you mind just waiting for the microphone, right behind you.

Yes. Two-part question. First of all, do you think the SEC has jurisdiction over crypto because there's a lot of debate or do you think Congress needs to authorize that? That's my first question. Second of all, there's thousands and thousands of registered broker-dealers and almost every one of them has a small legal department than you and less financial resources. So if we slice through what you're saying and what they're saying, are you trying to register as a traditional broker-dealer? Or are you looking for some type of special crypto broker-dealer that is not available.

So on the last point, I'll say that -- I'll take them in reverse order. The broker-dealer application or structure that we would ideally want would accommodate some certain unique features of the way the technology operates. So for example, settlement just works very differently and the blockchain offers a settlement layer. It strikes me as somewhat unproductive and perhaps unnecessary to have the same requirements for settlement agents and transfer agents that would apply in a traditional broker-dealer model. But we're very flexible around this, I think the main point is, yes, we need to accommodate some structural elements that are unique to crypto. But the other thing that I think is equally important is that issuers need to have a clear path to registration as well. And for example, Coinbase has had now for some time, 2 broker-dealers registered with the SEC, but we can't really do anything with them because no issuer can effectively list or meet the current disclosure requirements in ways that will allow us to list them. So I do think there does need to be some accommodation. But the fundamental point we have made to the SEC and even in the midst of all this current challenge, we remain open-minded and keeping. We're flexible on how we can meet some of the obligations. The point is we do need there to be some framework in place for this to make sense. And I believe your first question, if I remember correctly, is just around the role of the SEC and of course, the SEC has a role to play. As I mentioned, many or most of the digital assets that we reject for listing today are rejected because they are security. So we would love to have a world where the SEC had complete oversight over digital asset securities, but that allowed for a registration framework and disclosure standards that would allow those assets to come out from the cold and into a perimeter that was inside the perimeter in a way that allows us to list them subject to full SEC oversight.

We're just about out on time here. So maybe just in the last 6 seconds that we have remaining, what keeps you optimistic in the midst of all these legal regulatory challenges?

More than anything else, it's just talking to developers. I mean, I think if you spend a lot of time talking to policymakers and regulators, it's easy to get sort of sad or at least discouraged because lots of good people and people operating in good faith are struggling in the government, I think, to understand the right way to regulate. But when you actually go out and see like the creativity and the energy in the ecosystem, the fact that you've got these young energetic companies and groups of developers pushing forward with new use cases. That tells me that like crypto is going to happen. The only question is, are we going to be part of it here in the U.S.? Are we going to let it all move overseas?

That's per part of it.

I hope so, too. I think we will be.

We'll leave it there. Thank you very much, Paul.

Thank you, Mike. Appreciate it.