We learned two things about Coinbase yesterday: First, the U.S. crypto exchange will have to disburse $100 million for failing to conduct adequate background checks. And second, its stock jumped 12% in the aftermath of the news. (It’s since moderated, trading at $34.10 per share at the time of publication, roughly in line with where it traded at the very end of last year and the very beginning of this one.)
The $100 million sum is the conclusion of a settlement with the New York State Department of Financial Services, which had been investigating the company for violating anti-money laundering laws and other legal requirements.
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Among other things, regulators found that “Coinbase’s compliance system failed to keep up with the dramatic and unexpected growth of Coinbase’s business, and, by the end of 2021, was overwhelmed, with a substantial backlog of unreviewed transaction monitoring alerts, exposing its platform to risk of exploitation by criminals and other bad actors.”
While it seems baffling that Coinbase’s stock would be up after what looks like bad news, it is important to keep in mind that markets revolve around expectations. Anything that is anticipated, whether good or bad, is already taken into account — priced in — when valuing a company.
In Coinbase’s case, that it is getting fined is not a surprise. The company disclosed that this investigation was in progress in its annual 10k filing in 2021. From the stock market’s perspective, the main piece of news is that the investigation, and uncertainty around it, is finally coming to a close.
While it is harder to tell, details of the settlement likely also played a role in the market’s reaction. Coinbase isn’t simply going to throw $100 million into the void. There’s a $50 million fine to be paid to New York financial regulators, yes, but another $50 million will be spent on improving Coinbase’s compliance program.
Are markets warming up to the perspective of a more compliant Coinbase? That’s a possibility worth looking into, so let’s dive deeper.
Compliance’s past and future
Communicating on the settlement, Coinbase’s chief legal officer, Paul Grewal, emphasized two points: That the regulators’ discontent had to do with “historical” issues and that Coinbase is committed to compliance.
“Coinbase has taken substantial measures to address these historical shortcomings and remains committed to being a leader and role model in the crypto space, including partnering with regulators when it comes to compliance,” Grewal said. “We believe our investment in compliance outpaces every other crypto exchange anywhere in the world, and that our customers can feel safe and protected while using our platforms.”
It is true that the New York State Department of Financial Services was looking at past deficiencies. Its initial examination focused on the period between July 1, 2018, and December 31, 2019. But it was underwhelmed by how Coinbase addressed problems while issues mounted as the company grew exponentially.
“By late 2021, Coinbase’s failure to keep pace with its alerts resulted in a significant and growing backlog of over 100,000 unreviewed transaction monitoring alerts,” the document said, adding the backlog “was caused, in substantial part, by Coinbase’s inability to predict or manage the growing alert volume and a lack of adequate compliance staff.”
Coinbase is no longer growing as exponentially as it once was, but the problems the regulators looked at aren’t that old. This explains why the settlement doesn’t only involve a fine but also the $50 million commitment, which it refers to as a “compliance investment.”
Further investment in compliance could place Coinbase ahead of the pack in that regard, which was already a focus. The reason why the department was looking into the company’s activities in the first place was that Coinbase was licensed to engage in virtual currency business activity and as a money transmitter in New York State in 2017.
However, one of the lessons from yesterday’s document is that if Coinbase is indeed the best in class when it comes to complying with regulation, the class isn’t exactly getting top grades. For instance, regulators go into detail on how Coinbase didn’t adequately address its issues through external contractors and the real-life risks it caused, such as delays in closing accounts of people involved in crimes related to fraud or child sexual abuse material.
It is not just Coinbase that needs to up its game. In the aftermath of the FTX debacle, lawyers predict that more regulation and enforcement actions will be needed in order to rebuild trust.
Lawyers see crypto regulation coming in 2023 because industry needs to rebuild trust
Markets are clearly a lot less bullish on Coinbase and crypto than when it went public. Trading at an all-time high of $357.39 on November 9, 2021, its stock is now valued at less than 10% of that sum.
Some are still willing to bet big on Coinbase. For instance, Cathie Wood’s ARK Fintech Innovation ETF “bought the dip” in December 2022, and yesterday’s sentiment seems to indicate that the stock could go up again. But whether it happens will depend on how well Coinbase ups its compliance as part of the settlement and, perhaps more importantly, on its Q4 earnings, which are expected sometime in February. Stay tuned.
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