Coinbase Interview: Regulations and the Future of CryptoBy Emily Parker
Coinbase, a US cryptocurrency exchange, has been having a strong year despite the market downturn. In recent investment talks, it’s been valued at $8 billion. The rise of cryptocurrency is challenging governments all over the world, and authorities are scrambling to find ways to regulate it. How does Coinbase, which operates in over 30 countries, navigate this environment? I sat down with Mike Lempres, Chief Policy Officer at Coinbase, to find out.
Lempres’s background may seem unusual for the Wild West of the crypto world. He spent many years working in the US government: in the Department of Justice as well as the Overseas Private Investment Corporation, spanning various presidential administrations.
“It actually all comes together,” Lempres says of his career experience. “A very important skill in crypto right now is figuring out where regulation is going to go. And so for someone who has worked in government, you have more insight.”
That’s not to say that there isn’t a culture clash between crypto and government. “The biggest challenge we have with regulators is simply speed,” Lempres says. “We need to make decisions today, and that’s just not the way regulations are designed.”
Lempres says that in late 2017 Coinbase would sometimes do more volume in a single day than it had the entire year before. Those kinds of seismic shifts can demand quick action.
Another challenge of crypto regulation is that there is no global standard. As governments try to address the rise of decentralized money, countries have adopted varying approaches. Jurisdictions like Singapore, Hong Kong, and Malta are relatively friendly. On the other extreme is mainland China, which banned cryptocurrency exchanges and initial coin offerings last year.
Then there are the countries whose approach can best be categorized as confusing. One prime example is the United States. Money transmitter businesses often have to apply for separate licenses in each state, and as the accompanying map shows, there is very little consistency across the country. Coinbase has 42 licenses in the United States alone. This is in part because of US federalism, in which states can check the power of the US government. The US is also just an enormous market. If California was a country it would have its own license, Lempres says, “and nobody would think that’s weird at all.”
The one state that makes things especially tricky, however, is New York. Cryptocurrency exchanges that operate in New York need a BitLicense, which Lempres describes as a “comprehensive crypto regime that’s specific to the state of New York.”
Coinbase has a BitLicense, “but if many other states adopted a regime that was like that, but a little bit different, that would be a real challenge.” Any new asset or product, for example, must be approved by New York.
“We move very quickly in the crypto world, so as we look to add new assets, it’s quite possible the New York [Department of Financial Services], they could take a couple of months, or longer, to consider a new product.”
As a result, Lempres says, “We have in the past geofenced New York, and just not offered assets or products to New York-based companies.”
Now, Coinbase is trying to enter another potentially challenging environment: Japan. Last year Japan was widely perceived as a crypto paradise, but that changed after January, when hackers stole over $500 million from the Japanese cryptocurrency exchange Coincheck. After that, the Japanese Financial Services Agency (FSA) became much stricter about crypto, leaving hundreds of exchanges waiting for licenses.
Lempres is unfazed. “Coinbase is very well situated to come into Japan,” he says. “There have been security breaches in the past and the FSA is properly focused on security. They want to have a high standard for security. We believe we have a very high standard for security.” He says that Coinbase has never been hacked, and that 99% of their assets are held in cold storage, meaning they are unconnected to the Internet. The small percent that is held in hot- wallet storage is fully insured.
It is unclear when Coinbase would receive a license to operate in Japan. Nao Kitazawa, Coinbase’s GM of Japan, told me: "We just don’t want to hurry, we really want to get it right.”
While some in Japan’s crypto community believe that the FSA has become overly strict in response to the Coincheck hack, Kitazawa says the correction was necessary. Clearly Japanese exchanges needed to up their security game. Just last month Japan suffered yet another hack, with the cryptocurrency exchange Zaif losing $60 million.
“I just hope that people don’t really think that crypto itself is a dangerous thing,” Kitazawa says. “We really need to distinguish between crypto and crypto exchange security.”
After Coincheck, Kitazawa said regulators set out to do on-site inspection of crypto exchanges and they actually found a lot of breaches, showing that increased scrutiny was “something that they really had to do.”
“I’m not terribly worried about their requirements as long as they are applied equally across Japan, and as long as they are not out of sync with anything else in the world,” Lempres says.
Bumps in the Night
So what does keep Lempres up at night? A lot, he says. “This whole market, it’s global and it’s young. There are good players and there are not such good players. I feel good about what we can control, but there’s a whole universe of things that we can’t control.”
“I don’t know what other exchanges are up to, I don’t know what other players are up to. I think that the whole ecosystem will take a hit if something bad occurs anywhere else on earth. And we’ll pay the price for that. ”
Lempres says he was frustrated by a report from the New York Office of the Attorney General which said that almost 20% of Coinbase’s volume came from its own trading. “It did it in a section that discussed prop trading,” Lempres says of the report. "We do not prop trade. We do not trade for our own benefit. We do not do that.”
He explains, “In order to replenish the assets that we sell, we go into the market and buy assets so that we can hold them, and we do that for the benefit of our consumer traders. So that when they come to us we can guarantee a price, we can guarantee a sale immediately.”
One thing Coinbase isn’t worried about: the market. Lempres says that the current bear market has its advantages. “Bizarrely it makes it easier; we went through a pretty crazy 2017. That stressed our systems. Now that we have a chance to breathe a little bit, to really make sure our infrastructure is solid, to invest in that, it’s probably a healthy thing for the industry as a whole.”
“You couldn’t keep that pace up, it just wasn’t going to be sustainable. Now it can be.”
And in fact, the day-to-day price fluctuations of crypto aren’t really part of the company zeitgeist, Lempres says. “If you came to visit us at Coinbase, come into our offices in San Francisco, you can spend a month before you heard anyone mention the price of Bitcoin. It’s just not something we’re focused on. We are here to play the long game.”
But is that long game -- in which Coinbase becomes an increasingly powerful exchange, working with regulators across the globe -- out of sync with cryptocurrency’s original mission? Some Bitcoin purists would argue that centralized exchanges like Coinbase undermine the dream of a digital currency that is independent of governments and banks.
Perhaps there’s no reconciling of those two visions, and Lempres is totally fine with that. “We are a bridge between fiat and crypto that needs to exist. In order to do that we need to be compliant with lots of law and regulations,” he says. “It’s absolutely essential for mainstream adoption.”