Coinbase, Inc. v. SEC: Third Circuit Challenges SEC’s Approach to Digital Asset Regulation
R Tamara de Silva
Summary: In a significant decision, the U.S. Court of Appeals for the Third Circuit addressed Coinbase’s challenge to the Securities and Exchange Commission’s (SEC) denial of its petition for rulemaking on digital assets. Coinbase argued that the SEC’s current approach—applying existing securities regulations to digital assets—is both impractical and unfairly opaque. The court’s ruling, issued on January 13, 2025, determined that the SEC’s denial of Coinbase’s petition lacked sufficient reasoning. It also failed to adequately address the unique challenges of regulating digital assets, such as their decentralized nature and diverse use cases. Consequently, the court remanded the matter to the SEC, requiring further explanation of its decision. [Opinion]
Background of the Case
Coinbase filed its petition in July 2022, urging the SEC to promulgate rules tailored specifically to digital assets. The company argued that the existing securities framework, designed for traditional financial instruments, is incompatible with the unique characteristics of blockchain-based assets. According to Coinbase, requiring digital assets to fit into traditional securities regulations creates compliance challenges that are "economically and technically infeasible."
Despite these concerns, the SEC denied Coinbase’s petition, stating in a single paragraph that it disagreed with Coinbase’s assertions and that it preferred to proceed incrementally while prioritizing other regulatory agendas. Coinbase subsequently petitioned the Third Circuit for review, arguing that the SEC’s denial was arbitrary, capricious, and insufficiently reasoned under the Administrative Procedure Act (APA).
The Court’s Analysis
1. How Much Discretion Does the SEC Have in Regulating Digital Assets?
The court reaffirmed that federal agencies like the SEC enjoy broad discretion in determining whether to engage in rulemaking. Citing precedent, the court noted: "An order denying a petition to institute rulemaking proceedings is scrutinized at the most deferential end of the arbitrary and capricious spectrum" (p. 16).
However, the court emphasized that this discretion is not absolute and must align with the APA’s requirement for reasoned decision-making. The SEC’s decision to rely on enforcement actions instead of rulemaking does not, in itself, violate administrative law. Still, the agency’s reasoning must be adequately explained.
The court also criticized the inconsistency in the SEC's enforcement actions. It noted that the SEC treated similar digital assets differently in lawsuits against Coinbase and other entities. For instance:
"The SEC sued two exchanges, Coinbase and Binance, one day apart. Betraying internal inconsistency, it named six crypto assets as securities in the Coinbase suit that Binance also lists, but without targeting them in the Binance suit" (p. 18)
Additionally, the court noted that the SEC’s counsel was noncommittal when asked whether Bitcoin and Ether, two of the most prominent digital assets, are considered securities under the agency’s framework. During oral arguments, the SEC’s lawyer stated:
"I am not aware of the Commission statement about the status of Bitcoin as a whole... there’s not an answer to [the] question" (p. 18).
This hesitation underscores the broader uncertainty surrounding the SEC’s stance on key issues in the digital asset industry and its reluctance to offer definitive guidance.
2. Challenges of Applying Securities Laws to Digital Assets
Coinbase raised several issues regarding the unworkability of existing securities laws for digital assets:
Decentralization: Many blockchain networks lack a centralized issuer to register digital assets or provide disclosures.
Utility Tokens: Some digital assets are primarily used for services or governance, not investment.
Custody Rules: Blockchain private keys do not fit within traditional requirements for physical possession or control.
The court found the SEC’s response to these concerns lacking, stating:
"A single sentence disagreeing with the main concerns of a rulemaking petition is conclusory and does not provide us with any assurance that the SEC considered Coinbase’s workability objections" (p. 40).
Coinbase also argued that the SEC’s regulatory framework is premised on the assumption that compliance must be possible for all firms. The court rejected this argument, explaining:
- No Obligation for Seamless Compliance: The court clarified that the SEC is not required to ensure its rules are always easy to comply with, especially for firms engaging in novel or complex activities. Regulatory frameworks inherently impose burdens and may even prohibit certain activities if they conflict with regulatory objectives:
"The existing securities-law framework is not predicated on the assumption that it will never burden any potential new market participants. To the contrary, law often works by regulating or even prohibiting conduct that some would like to pursue." (p.36)
- Novel Instruments and Regulatory Fit: Digital assets, as novel financial instruments, may not always fit neatly into existing securities rules. This mismatch does not invalidate the framework but reflects the inherent complexity of balancing regulatory objectives with emerging technologies:
"In the securities-law context, it is unremarkable that novel complex financial instruments may not always fit neatly within existing securities rules, especially if inherent attributes of those novel financial instruments may undermine the objectives of those rules." (p.36)
- Misapplication of the 'Changed-Factual-Predicate' Doctrine: Coinbase’s reliance on this doctrine was misplaced. The court noted that this principle applies only when an agency’s actions were explicitly justified on a fact that has subsequently changed. Coinbase did not point to any specific SEC action or justification that relied on such a fact:
"The changed-factual-predicate principle applies only in the narrow set of cases in which an agency explicitly justifies its action on a fact that subsequently changes."
The court concluded that while Coinbase’s workability concerns are not frivolous, they are considerations for the SEC to address in its future regulatory efforts, rather than grounds for invalidating the current framework.
4. Resource Allocation and Incremental Action
The SEC also justified its denial by citing competing regulatory priorities and a preference for incremental action. The court recognized the SEC’s discretion to allocate resources but noted that:
"At a minimum, [the SEC] must explain why it is prioritizing other regulatory actions..." (p. 44).
Similarly, the court acknowledged the legitimacy of incremental rulemaking but criticized the SEC’s vague explanation:
"These are many words that mean very little—the SEC might take future action on digital assets, and if it does, it might consider experience it accumulates..." (p. 46).
The Remedy: Remand, Not Rulemaking
Coinbase had requested that the court compel the SEC to initiate rulemaking. The court declined, emphasizing that such an order is reserved for extraordinary circumstances, such as cases involving public health risks. Instead, the court remanded the case to the SEC, directing the agency to provide a more reasoned explanation for its denial.
"The remedy is not at this stage to order the SEC to institute rulemaking proceedings but to remand to the agency for a sufficiently reasoned disposition of Coinbase’s petition" (p. 49).
Concurring Opinion: Broader Implications
Judge Bibas’ concurring opinion delved into constitutional concerns surrounding the SEC’s approach to regulating digital assets. He highlighted the lack of fair notice provided to the industry, noting:
“The SEC repeatedly sues crypto companies for not complying with the law, yet it will not tell them how to comply. That caginess creates a serious constitutional problem; due process guarantees fair notice” (p.19).
"The SEC’s haphazard enforcement strategy... does not give potential defendants the notice that due process requires. That is especially true because the field is novel" (p. 21).
He emphasized that regulatory enforcement must not serve as a substitute for clear and predictable rules. The opinion also questioned whether the SEC’s current methods align with its statutory mandate, pointing out that enforcement strategies alone cannot provide the regulatory clarity necessary for emerging industries. Judge Bibas noted:
"The SEC insists that its old rules apply to the novel crypto market but refuses to spell out how" (p. 19).
This lack of guidance, he suggested, risks undermining innovation and fairness in a rapidly evolving sector.
So the SEC has sidestepped the rulemaking process by pursuing a de facto ban through enforcement instead. By combining regulatory uncertainty with unpredictable enforcement against the infrastructure for trading crypto, it can get near total deterrence.” (p.22)
Conclusion
The Third Circuit’s decision in Coinbase, Inc. v. SEC highlights the ongoing challenges of applying traditional securities laws to emerging technologies like digital assets. By remanding the case to the SEC, the court has made it clear that regulatory agencies must offer clear and reasoned explanations when addressing industries with unique complexities. Enforcement without clarity risks stifling innovation and fair competition.
A key takeaway from this opinion is that the court found Coinbase’s argument about ease of compliance unconvincing. It concluded that while workability concerns are relevant, they do not constitute a factual predicate underlying the entire regulatory framework. In other words, the court concluded that while Coinbase’s concerns about the challenges of compliance are valid and important, they do not invalidate the SEC’s existing regulatory framework. Instead, they are considerations for the SEC to address in its future explanations and rulemaking efforts.
Practical Implications for the Digital Asset Industry
The Third Circuit’s decision in Coinbase, Inc. v. SEC has several important implications for the digital asset industry. The court’s remand provides an opportunity for companies to advocate for clearer and more tailored rules through comment periods, petitions, and industry coalitions. At the same time, existing securities laws remain enforceable, highlighting the need for firms to review their compliance policies, particularly regarding token sales, custody, and trading activities. The SEC’s often preference for enforcement over rulemaking underscores the importance of proactive risk assessment, including preemptive regulatory filings where applicable. The court’s acknowledgment of due process concerns, as highlighted in Judge Bibas’ concurring opinion, may offer a foundation for constitutional defenses against enforcement actions in cases where fair notice is lacking. Additionally, the lack of clear guidance on significant digital assets, such as Bitcoin and Ether, leaves companies in a state of regulatory uncertainty, making it essential to seek legal advice and closely monitor evolving case law and regulatory actions.