Its been a long four months for the cryptocurrency exchange.
The troubles all began when Brian Armstrong released an unannounced preemptive response to an impending New York Times exposé.
Bad Press For Coinbase Part One: Coinbase Employees of Color Express Dissatisfaction, Mistreatment and Hostility
Brian Armstrong's premature response can be found here: https://blog.coinbase.com/upcoming-story-about-coinbase-2012afc25d27
The rationale for Brian Armstrong's response (encapsulated by Brian Armstrong himself), can be found here:
"The New York Times is planning to publish a negative story about Coinbase at some point in the next few days online, and it will appear in print on Sunday. Given that this story may be read by your friends, family and professional contacts, we wanted to give everyone a heads-up and provide some important context."
Unfortunately for Coinbase, the article appeared to do everything except that.
Brian Armstrong's Preemptive Response Was Arrogant, Condescending and Tone Deaf
For some reason, Brian felt it would be wise if he elected to portray the Nathaniel Popper article as an affront to both himself and Coinbase.
Brian Armstrong starts off by declaring that, "It's now clear that the story will allege that several Black employees had negative experiences at Coinbase over the last few years", as if the revelation of dissatisfied African-American employees was as much of a surprise to them as it was everyone else (spoiler: rumblings had been all over Glassdoor about Coinbase's racial insensitivity for well over a year).
For some reason, rather than taking these remarks made by the individuals that Popper spoke to as an opportunity for sincere introspective reflection, Brian felt the best way to handle the situation would be to dispute the validity of these employees' feelings - an action that, in itself, demonstrates some of the same negative behaviors that employees allege created the hostile work environment in the first place.
"I Can't Be Racist, I Have a Black Friend..."
While Brian Armstrong might not have stated these words exactly, the spirit of this phrase was certainly conveyed in his references to the 'ColorBlock ERG'.
Specifically, he states that, "The Exec Team also met with members of the ColorBlock ERG this morning to inform them of this article and to discuss their questions and concerns."
This entity - the Colorblock ERG - was unfamiliar to most readers until Brian Armstrong published this article. However, a cursory search online reveals that they are some sort of resource group for "African-American" staff. The implication here appears to be that their lack of protest to Brian Armstrong's actions was evidence that no black person would take issue with his leadership style. This not-so-subtle name drop is ironically racist in its implicit suggestion that Black people exist as such a monolith that one Black person's approval = every Black person's approval.
The next sentence, however, felt a bit...strange in its assertion that, "As Brian shared with the Colorblock ERG this morning, we don't care what The New York Times thinks", despite the fact that the New York Times was not proffering their opinion but rather that of Coinbase's former [Black] employees.
This statement is followed by the claim, "The most important thing we care about is you, our employees, and what you think", which rings hollow when considering that his entire post essentially invalidated the concerns of the Black employees to be featured in Nathaniel Popper's article.
From a glance, it seems that preserving Coinbase's public image in the face of credible claims of racism within a hostile work environment took considerable precedence over what, "you, our employees...think".
Bad Press For Coinbase Part Two: Racism and Sexism (Underpaying Employees)
Many thought that Coinbase's woes with their employees were over after the original New York Times article by Nathaniel Popper was published.
But alas, right before the end of the year (the day after Coinbase's IPO filing), the New York Times published yet another article - which was arguably more substantive in terms of its approach.
Quick Note: The word 'substantive' is not being used to suggest that the first New York Times article was illegitimate, but rather that the proof provided in the latter article could not be disputed by Coinbase with appeals to plausible deniability due to the somewhat subjective nature of the allegations contained within
A link to the second bombshell piece can be found here: https://www.nytimes.com/2020/12/29/technology/coinbase-pay-employees.html
Below are some of the highlights from the article:
- "The data, recently obtained by The New York Times, indicated that women at Coinbase were paid an average of $13,000, or 8 percent, less than men at comparable jobs and ranks within the company according to an analysis of the futures, which included pay details for most of Coinbase's roughly 830 employees at the end of 2018."
- "The picture was also unequal for the 16 salaried Black employees in the data. They were paid $11,500, or 7 percent, less than all other employees in similar jobs." (this article stated that there were 830 people working at Coinbase at the end of 2018; so if there were only 16 black employees in their data, then that means that only 1.8% of the employees that were working there were persons of color [that's profound])
- "When [factoring] in stock options for Coinbase's employees...the compensation for women and men was roughly the same while the gap between white and Black employees grew to 11 percent."
- "Numerous Black employees at Coinbase recently publicly complained about the discrimination they faced at the company."
- "The people would speak only on the condition they not be named because they had signed nondisclosure agreements." (interesting that the employees that have worked there are binded by nondisclosure agreements; this must have been in response to the Glassdoor reviews that were left, making it clear that Coinbase facilitates a hostile work environment)
- "More than 60 employees - or 5 percent of the company - resigned this fall after Mr. Armstrong ." (this stat seems to indicate that Coinbase was able to eventually expand to have approximately 1200 employees working at their facility, 'this fall')
Potential Implications For Brian Armtrong and Coinbase
Unfortunately for Brian Armstrong, it appears that its illegal to refuse to pay your employees equal wages on the basis of race, sex,or any other protected class.
Sometimes these cases are opaque because there are few that are as egregious as Brian Armstrong was in this situation.
Specifically, according to their website:
"The U.S. Equal Employment Opportunity Commission (EEOC) is responsible for enforcing federal laws that make it illegal to discriminate against a job applicant or an employee because of the person's race, color, religion, sex (including pregnancy, transgender status, and sexual orientation), national origin, age (40 or older), disability or genetic information." (https://www.eeoc.gov/overview)
Failure to adhere to this federal mandate can result in a number of penalties, sanctions, disgorgement of ill-gotten funds, etc.
Below is a graph showing the disparities in payment among gender lines for Coinbase (shameful):
Bad Press For Coinbase Part Three: CFTC Fines and Humiliates Coinbase
It was somewhat of a surprise the day that the CFTC's press release on Coinbase came out as we hadn't heard anything in the general media to suggest that Coinbase was being investigated by the CFTC.
Fortunately, the CFTC made sure that everyone was caught up to speed on March 19th, 2021 in their press release, published here: https://cftc.gov/PressRoom/PressReleases/8369-21
The opening paragraph alone serves as an incredible rebuke against Coinbase.
Specifically, it states:
"The Commodity Futures Trading Commission today issued an order filing and settling charges against digital asset exchange operator Coinbase Inc., based in San Francisco, California, for reckless, false, misleading on Coinbase's GDAX platform."
The full text of the order can be found on the same page as the CFTC press release.
Coinbase Lied About its Volume and Liquidity
The implications of this accusation has wide-ranging consequences for Coinbase as well as their investors.
Specifically, Grayscale is an entity that will be adversely effected by this ruling in a profound manner.
Why is That?
Following the inception of the Osprey Bitcoin Investmen Trust circa February 2021, the premium that GBTC once enjoyed has fallen down to a steep discount.
Above we can see that around December 2020, GBTC shares were trading at a +40% premium.
However, since then, we can see that this is no longer the case.
At the time of writing, GBTC shares are trading at a -11% discount to the NAV, which is a steep loss.
This is Having an Adverse Impact on GBTC
The reason for this is fairly obvious. As mentioned in one of our previous deep dives into Grayscale, we observed that most of the investment into the Grayscale shares is due to the fact that individuals are contributing bitcoins directly to the Trust in exchange for the shares (which have a fixed ratio of bitcoins / share).
- Since the shares are subject to Rule 144A stipulations, investors must wait a certain time frame before being able to sell their shares on GBTC.
- Since Grayscale recently became an SEC reporting company that time frame was shortened from 12 months to 6 months, which was beneficial for their investors.
What puts Grayscale in a bind at present is the SEC's ruling against them in 2016. This ruling barred Grayscale from being able to redeem any future shares of GBTC.
The impact on current investors is that those that are invested in GBTC are unable to redeem those shares for the underlying value in Bitcoin. However, this was no material issue when the shares were trading at a premium because investors were able to offload those shares on the OTCQX (over-the-counter) exchange once their 6-month holding period had concluded and make a considerable profit (when factoring in the premium over the NAV that GBTC enjoyed earlier).
This created a feedback loop that was extremely beneficial for Grayscale and their parent company - Digital Currency Group.
Why Was This So Benefiical For Them?
The primary benefit that this had for Grayscale was that this funneled a ton of investors over to Genesis as well.
Genesis' role in this pipeline was to loan out bitcoins to said investors (in exchange for cash / stablecoins), which afforded said investors the ability to invest that Bitcoin directly in Grayscale's Trust in return for its shares, which were trading for a premium to the NAV at the time.
USD / Stablecoin Loans Increased Significantly as Well
Another contributing factor to Bitcoin's price gain that helped Grayscale and Genesis (collectively), is the fact that there were significant USD / stablecoin loans made by Genesis as well.
More than likely, the entities receiving loans from Genesis were receiving said loans in exchange for collateralized cryptocurrencies (i.e., just like MakerDAO).
However, the cryptocurrencies that were given as collateral in exchange for USD (cash) was more than likely not bitcoins.
This was exposed in the following article on 'The Block', published around April 2020:
With this borrowed USD, could then sell futures contracts (call options) on the futures market (Bakkt) where Bitcoin is physically settled.
This is evidenced by reports claiming that Bakkt volume had surpassed "all-time highs" consistently throughout the back half of 2020.
Referring This All Back to Coinbase
If we take a look at the most recent 10-K filing by Grayscale with the SEC (filed on March 5th, 2021), we receive confirmation on what Grayscale is using as its NAV.
Specifically, they state:
"The value of BItcoin is determind by the value that various market participants place on Bitcoin through their transactions. The most common means of determining the value of a BItcoin is by surveying one or more Digital Asset Exchanges where Bitcoin is traded publicly and transparently (e.g., Bitstamp, Coinbase, Kraken and LMAX Digital)."
Additionally, the 10-K filing confirms that:
"Grayscale Investments, LLC is the sonsor of the Trust (the 'Sponsor'), Delaware Trust Company is the trustee of the Trust (the 'Trustee'), Continental Stock Transfer & Trust Company is the transfer agent of the Trust (in such capacity, the 'Transfer Agent') and the administrator of the Trust and Coinbase Custody Trust Company, LLC is the custodian of the Trust (the 'Custodian')
Doesn't Bode Well for Grayscale's ETF Chances
For those that aren't aware, Grayscale recently announced to their investors that they intend on making a concerted effort to obtain a Bitcoin ETF for the Grayscale Bitcoin Investment Trust.
The reason for this being that an ETF would finally afford Grayscale a vehicle by which they would be able to redeem their investor's shares for their underlying worth in Bitcoin.
The obvious impact of this decision would be a quick return to the NAV value for Grayscale as it would no longer be logical for traders to sell shares in Grayscale at a discount.
This would more than likely hold true for the other digital assets that Grayscale is holding as well.
Where Coinbase Could Screw Grayscale
As we discovered above, one of the underlyhing exchanges that Grayscale uses to determine the NAV value for Bitcoin is Coinbase.
In evaluating whether the commission will rubber stamp an ETF, the key isssue of contention is the reliability of the NAV exchanges that would be used for such a product.
In other words, the SEC does not feel like the NAV value for a Bitcoin ETF would be one that's fairly derived.
Using an SEC Response as Our Benchmark and Guideline
On February 26th, 2020, the SEC gave a response to NYSE Arca's ETF proposal.
Their specific response can be accessed on their site, here: https://www.sec.gov/rules/sro/nysearca/2020/34-88284.pdf
Specific Reason for Denial
In specific, the SEC stated that:
"This order disapproves the proposed rule change, as modified by Amendment No. 1. The Commission concludes that NYSE Arca has not met its burden under the Exchange Act and the Commission's Rules of Practice to demonstrate that its proposal is consistent with the requirements of Exchange Act Section 6(b)(5), and, in particular, the requirement that the rules of a national securities exchange be 'designed to prevent fraudulent and manipulative acts and practicews' and 'to protect investors and the public interest.'"
Thus, as the SEC make explicitly clear, one of the major impediments here for receiving a Bitcoin ETF is the rampant fraud and manipulation in the underlying Bitcoin spot markets as well as a general failure on the part of the the crypto industry to provide any such guidelines that would mitigate the impact of that fraud or at least render the markets transparent enough to allow for a thorough investigation.
CFTC's Allegations Against Coinbase Destroy Grayscale
Since Graysale uses Coinbase as one of the exchanges used to derived the NAV for the fund, the CFTC's ruling on the actions of Coinbase is devastating here.
In specific, the CFTC said in their filing, that:
"Between January 2015 and September 2018, Coinbase violated Section 6(c)(1)(A) of the Act, 7 U.S.C. § 9(1)(A) (2018), and Regulation 180.1(a)(4), 17 C.F.R. § 180.1(a)(4) (2020), by recklessly delivering false, misleading or inaccurate reports concerning transactions in digital assets, including Bitcoin, on the electronic trading platform it operated, GDAX."
"During this period, Coinbase operated at least two trading programs which generated orders that, at times, matched with one another. Coinbase included the transactional information for these transactions, such as price and volume data, on its website and provided that information to reporting services, either directly or through access to its website, resulting in a perceived volume and level of liquidity of digital assets, including Bitcoin, on GDAX that was false, misleading or inaccurate."
Given this finding alone, it will be difficult, if not impossible for Grayscale to argue that they have sufficient provisions in place to prevent Coinbase from perpetrating such fraud in the future.
Even asserting that they have the ability to identify such fraud will be an uphill climb for Grayscale.
Making matters worse is the fact that Coinbase as serves as the custodian for Grayscale's crypto funds.
However, that's not even the worst.
To make matters even worse than that, it is known that Digital Currency Group (the parent of Grayscale) is directly invested in Coinbase
Thus, given this confluence of factors, Grayscale could be in a bit of trouble.
In the next portion of this report we're going to look at the potential implications of the U.S. tax authorities' investigation into Coinbase and Circle on Coinbase's future fate, Bitcoin, as an asset, Grayscale and the rest of the crypto space