By: Casey Reilly
The market value of digital assets, specifically cryptocurrencies, is valued in the trillions of dollars and steadily continues to grow. In 2021, the market capitalization of digital assets jumped from $1.95 trillion to $2.14 trillion in a one-month span. Digital assets are transforming the roles of financial markets and commerce around the world, but still often lack baseline regulatory measures. However, on January 4, 2023, Coinbase reached a $100 million settlement with the New York Department of Financial Services (“NYDFS”), highlighting the need for increased regulation over the industry.
Coinbase is one of the most prominent cryptocurrency exchanges in the world. Founded in San Francisco in 2012, Coinbase has over 100 million users worldwide. The process of opening a Coinbase account is quite simple; a user needs to be at least 18 years old, have a government-issued photo ID, internet access, a phone number for SMS verification, and an updated internet browser. After an account has been created and a payment method is added, a user can immediately start trading cryptocurrency. Not only does it make the process of buying cryptocurrency seamless, but it allows users to trade over 120 different types of cryptocurrencies on the platform, including Bitcoin, Ethereum, and Solana.
In order for crypto companies to operate in the state of New York, they must obtain a BitLicense or charter a limited purpose trust company that is authorized to conduct virtual currency business. The BitLicense is simply a “term used for a business license of virtual currency activities, issued by [NYDFS] . . . under regulations designed for companies or individuals that engage in Virtual Currency Business Activity.” Many emerging crypto companies have found the requirements to obtain a BitLicense to be expensive and burdensome; applicants may face up to $100,000 of fees from the application, legal costs, and compliance requirements. New York’s BitLicense requirement has forced some new companies to relocate to other jurisdictions, however if they are accepting New York residents into their fund(s), they may still be required to obtain a BitLicense and thus be subject to NYDFS regulation.
New York regulators began investigating Coinbase in the early months of 2022, as they recognized that Coinbase’s compliance program “failed to build and maintain a functional compliance program that could keep pace with its growth.” According to New York’s superintendent of financial services, Adrienne Harris, Coinbase failed to conduct appropriate due diligence in their anti-money laundering and know-your-client (“KYC”) programs. The shortcomings of Coinbase’s compliance program included the following: (1) immature KYC programs, (2) failure to review transaction alerts timely, and (3) failure to file suspicious activity reports in a timely manner. As a result, there was ample opportunity for criminals to leverage the crypto platform to partake in actions like money laundering, narcotics trafficking, and child sexual abuse-related activity. Specific aspects of Coinbase’s deficiencies included: failing to assign a “risk rating” to retail customers, allowing customers to open an account with only a copy of a photo ID, and not conducting enhanced due diligence on customers that were deemed high-risk.
Furthermore, Coinbase did not have appropriate staffing to conduct adequate transaction monitoring alerts. When they hired an outside contractor to do so, Coinbase failed to provide oversight of these processes. By the end of 2021, Coinbase had a backlog of more than 100,000 alerts about potential suspicious customer transactions that had not been properly examined. In the same year, Coinbase’s customers’ accounts were illegally accessed via a phishing scam and they failed to inform NYDFS within the required 72-hour time frame. Following these findings, Coinbase agreed to pay NYDFS a $50 million civil penalty and invest the other $50 million in improving their compliance program over the next two years; this included appointing a NYDFS-selected independent monitor. After the settlement was made public, Coinbase saying that they are taking NYDFS’s concerns seriously and are taking substantial measures to address these problems. Part of the statement reads, “[w]e recognize that the crypto industry is at an inflection point right now and that every public move by a crypto company will receive intense scrutiny. . . . We believe our investment in compliance outpaces every other crypto exchange anywhere in the world, and that our customers should feel safe and protected while using our platforms. And although we have not always been perfect, our goal has always been and will always be to build the most trusted, compliant, and secure crypto exchange in the world.” However, there is sometimes speculation over the real goal of these settlements. Within the industry, these settlements can be viewed as the regulator simply doing their job, focusing on one entity, giving their opinion, and then moving on with little to no accountability for the company.
In comparison to Coinbase’s annual revenue, the $100 million fine was relatively small and didn’t seem to affect investors’ confidence in the company. In 2021, the company’s annual revenue surpassed $7.4 billion and on the platform were valued at $101 billion. Most recently, the value of Coinbase’s stock rose nearly 90% in one month; at the end of December 2022, COIN was valued at $32.65 and rose to $61.47 by January 27, 2023.
Though the settlement with NYDFS will not have a detrimental effect on Coinbase, it does serve as a warning to other firms in the digital asset industry. There needs to be legitimate and strict compliance programs in place to ensure that crypto-platforms are not furthering illegal activities. New York may be leading the way in terms of regulating this space, but it is only a matter of time until other states and federal regulators ramp up their own protocols.
Student Bio: Casey Reilly is a second-year student at Suffolk University Law School. She is a staff writer on the Journal of High Technology Law. Prior to law school, Casey received a Bachelor of Science Degree in International Business, with a concentration in Finance, from Bryant University and spent several years working at a financial services institution in Boston.
Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.
