Original title: "Transcript: Brian Armstrong on the Challenges Facing Crypto"

Original compilation: Kxp, BlockBeats

Original compilation: Kxp, BlockBeats

On March 1, 2023, Brian Armstrong, chairman and CEO of Coinbase, a compliance-based US-listed encryption trading platform, will be a guest on the well-known podcast column Odd Lots. In this program, Brian expressed his views and insights on issues such as "whether the encryption winter has passed", "how to look at the future regulation of the encryption industry", "how to look at Bitcoin", etc. He believes that cryptocurrency can help improve the U.S. financial system, and discussed a "clear rule book" proposed in cooperation with lawmakers on the show. This article was organized by Bloomberg and compiled by BlockBeats.

Joe Weisenthal：Hi, and welcome to the new episode of the Odd Lots podcast, I'm Joe Weisenthal.

Tracy Alloway：I'm Tracy Alloway.

Joe：Tracy, a lot of things have happened in Crypto recently, the most important of which are two big events, one of which is Crypto Winter. Although the Crypto market has picked up, the currency price still has not returned to the previous level. The second thing is that the supervision is increasing recently.

Tracy：Indeed, for the crypto industry, this has undoubtedly caused a double whammy, and it is difficult to determine whether the decline in currency prices is directly related to the increase in regulatory activity.

Joe：Historically, regulators have tended to step up efforts after investors have lost money to scams. It is not surprising, therefore, that regulatory activity has increased during a period of declining investment.

Tracy：I agree, but it also raises the question of whether regulators should be more proactive and thus avoid losing money to investors?

Joe：We have one of our experts join us today as we welcome Brian Armstrong, CEO and Co-Founder of Coinbase, one of the nation's leading Crypto exchanges. Brian, thanks for joining us for this edition of Odd Lots.

Brian Armstrong：Thank you for having me.

Joe：I want to ask you a question, we have asked other executives in the Crypto field this question before, but I would like to know your opinion. What is liquidity mining and where does its reward come from?

Brian：The reputation of yield farming has been negatively affected in the current environment due to the collapse of Terra Luna, BlockFi, and similar companies. This is an interesting question, but I'm not qualified to answer it on their behalf. However, other aspects of the crypto industry remain promising, and there are many areas we can continue to explore.

Tracy：We have discussed before on the show that Crypto is the ultimate momentum asset, its price will fluctuate with the inflow and outflow of funds, so the business of Crypto trading platform will also be cyclical. However, in your most recent report, you mentioned that you want to be profitable throughout the cycle. Can you explain how you intend to achieve this?

Brian：In the past, transaction fees accounted for a large portion of our revenue. As you pointed out, this revenue stream is volatile due to the volatility of Crypto prices. We have been transitioning to a subscription and services based model in order to create a more stable revenue stream. Stablecoins like USDC have proven to give us decent growth even during bear markets. Additionally, we earn fees from escrow services and merchant transactions using the Coinbase Card. While these revenue streams are not completely independent of the Crypto market, they are less correlated than transaction fees, which helps us build a more predictable business model.

Joe：I wanted to discuss the regulatory side yesterday and I saw a new Coinbase program called Plan 435 urging people to contact their members of Congress to express their support for Crypto policies. Likewise, Uber has utilized a similar approach, requiring users of their app to contact local regulators and request the ability to drive an Uber. I want to put this in the most euphemistic way possible, because I have many acquaintances who are passionate about Crypto, and I admire many of them. However, do we really want those who would contact MPs to be the spokesperson for Crypto regulation?

Brian：The average person involved in Crypto, about 50 million Americans, or one in five households. They form a major lobby group that will influence future elections. These folks may not have exact solutions on how to regulate the crypto industry, but they want elected representatives to ensure that it is regulated while providing consumer protection and enabling innovation. Currently, 80% of Americans believe that the financial system is inefficient, expensive and not available to everyone. Today, the financial system uses 40-year-old technology, and the laws governing it were written before the Internet even existed. As such, the financial system is in dire need of modernization, and Crypto is one of the technologies that can help achieve this. American voters recognize this and hope that their elected representatives will help establish norms and laws around Crypto in the United States.

Tracy：On the political front, Joe and I have hinted at this before, with crashes and scandals leading to increased activity from industry regulators. Can you share how the way you deal with US authorities has changed from 2020 to now?

Brian：Compared to 2020, I find that more officials in the Washington authorities have a better understanding of Crypto now. It is no longer a niche topic, and now everyone has discussed it more deeply. There are two main camps in this. The first camp is brooding about the collapse of FTX, and has not dared to approach Crypto; support. Personally, I support the latter camp.

Joe：So, I would like to ask, considering that FTX, one of the largest trading platforms, collapsed without any major impact or consequences, why do you suggest that Crypto be included in the scope of regulation, it seems that placing Crypto in a gray area has been effectively avoided" too big to fail" problem. Also, what do you think about the view that regulators have done a good job preventing the volatile crypto industry from having any negative impact on the financial system?

Brian：I disagree with the statement that the FTX crash didn't have a bad effect, because after all, a lot of people lost money.

Joe：It is true that many people have lost large sums of money.

Brian：Crypto has had some bad activity, so the key issue is consumer protection. I don't think there should be a bailout in Crypto because nothing in Crypto is too big to fail, which is against the principles of Crypto. Bitcoin was created in response to the 2008 financial crisis, and the first Bitcoin block included a message that the prime minister was moving to provide financial assistance to banks. However, I do think that centralized players, such as exchanges and custodians, should be regulated to prevent fraud and corruption. But for the decentralized parts of Crypto, like Bitcoin and Ethereum, they should not be subject to any centralized authority, which is necessary for a more global and fair financial system.

Tracy：In your opinion, what should consumer protection for Crypto look like? In addition, people are likely to suffer losses from a product like Dogecoin that has no clear economic use. What is your opinion on this issue?

Brian：I think centralized players such as custodians and trading platforms should be responsible for regulation and consumer protection, and the object of regulation is not necessarily Dogecoin, it will be another decentralized currency. But I also believe that companies built around custody or trading need to adopt some of the best practices of the traditional financial services industry. These include having audited financial data, keeping client funds separate from company funds, implementing anti-money laundering/KYC programs to prevent fraudulent transactions, and providing proper disclosures. However, these practices should be aimed at the centralized players, not the decentralized ones.

Joe：Interesting that you differentiate between centralized players and decentralized DeFi. However, you seem to have integrated these two parts recently and launched a layer-2 rollup to expand Ethereum. As a regulated entity you are obligated to comply with FINCEN and AML laws, can you please clarify that when implementing rollup Layer-2 with a centralized orderer, transactions made on it are batched to the Ethereum main On-chain, will there be any tensions? As a regulated entity, how do you address this issue? If someone wants or tries to launder money through layer 2, are you facilitating them by putting those transactions on the Ethereum main chain?

Brian：Earlier, I mentioned that we should regulate centralized players like Coinbase, especially when it comes to our primary revenue streams like custodians and exchanges. But you're quite right, Coinbase is embracing decentralization through our various products and legal entities, including a layer 2 solution called Base. We built Base because we wanted to provide more scalability and better usability for layer 2 solutions. We want to bring Ethereum transactions down to a penny or less and help scale it to hopefully one day reach 1 billion or more people.

I think what you're asking is how do we differentiate between the centralized and decentralized parts. Base today still has some centralized components, but it will become more and more decentralized over time. So, we still need to monitor transactions now, especially in the early stages. However, as Base becomes decentralized, I think centralized actors may need to bear the greatest responsibility to avoid money laundering issues, set up transaction monitoring programs, etc.

Tracy：When it comes to taking responsibility, there are about thousands of coins and tokens on Coinbase.

Brian：No, there are only about 250 species.

Tracy：I haven't read every page, but there are many. Although you have never launched securities, judging from the current regulatory environment, it is very likely that one day the SEC will declare a certain currency as a security. For example, not long ago, there was an enforcement action against Kim Kardashian for promoting an illegal Crypto security. Given the current situation, how can you assert with certainty that there are no securities on Coinbase?

Brian：I believe it is good for our industry if there is a clear set of rules that everyone must follow. We have filed a petition with the SEC to this effect, outlining that current securities laws do not adequately cover the Crypto segment. At the same time, we have developed our own internal process to review assets, which includes a 72-point legal analysis and consideration of compliance and cybersecurity risks. We have evaluated about 1,000 assets, rejected 800 of them due to securities, compliance or cybersecurity concerns, and listed about 200-250 assets. If the SEC determines that an asset is a security, we will be happy to update our procedures. However, if the SEC declares all assets to be securities, we will submit to the court's decision because we all have to follow the law.

Joe：Can you provide an example, not necessarily related to a specific coin, that you think is not suitable for listing due to its resemblance to securities?

Brian：There are many factors that need to be considered, just like the Howey test has many contents, so I will not conduct an in-depth legal analysis here.

Tracy：We've never done a show about the Howey test, so this one might cover that.

Brian：Yes. So there are multiple aspects, right? I think, you know, if people are buying it primarily with the expectation of making a profit, and there's a common business...

Joe：Have you noticed a pattern within the Crypto project, particularly in the actions taken by the team, that some tokens don't meet Coinbase's standards? Have you observed practices in the industry where teams may push the boundaries of what you would consider a common corporate aspect that makes it unsafe to list them on the platform?

Brian：I'll provide one example in securities, but there are others in cybersecurity and other fields. Securities laws governing the investment of funds in a common enterprise with the expectation of profit from the efforts of others apply to legally seeking funds for a business or project, such as an apartment complex. This is a necessary aspect of business and should continue to exist.

Our broker trading license is currently dormant, but we plan to activate it and are working with the SEC to make this happen. Crypto technology has the potential to provide benefits that improve the financial system, including settlement times and more.

We attach great importance to consumer protection and will avoid some bad models, such as those tokenomics seen on YouTube that appear to be very rough, and insiders are selling. Additionally, we may reject assets for other reasons, such as cybersecurity risks. For example, we assess possible vulnerabilities in smart contracts and the issuer's ability to safeguard investors' funds.

If the issuer loses the key, this could accidentally or maliciously sweep everyone's funds, which does not meet our security standards.

Tracy：In some ways, did Crypto kill itself by resisting securities regulations? Does this tacitly assume that perhaps there is no reasonable profit expectation here?

Brian：I mean, we want crypto securities to exist. We are not saying that none of these things are securities, or that all things are securities, which is not accurate. The mere expectation of profit doesn't make something a security; it has to pass every part of the Howey test. For example, buying a Picasso painting or gold does not make them securities. We consider Bitcoin, Ethereum, and the assets we trade on the platform to be Crypto Commodities that people sometimes trade to add value, similar to buying gold, and other times for other uses.

Joe：Before we discuss regulation, can I ask your opinion on Bitcoin? Even though the Crypto industry has evolved from Bitcoin to a new level in many ways, there are still some people on Twitter who think you don't like Bitcoin. Having said that, you launched Ethereum layer 2, and I'm curious if you will launch the Coinbase Lightning node after that?

Brian：We want to do more with Lightning nodes.

Joe：But it’s not there yet, and there are some unresolved issues like funding for the Bitcoin core developers, who are not getting enough funding to stay afloat, which is frustrating for them. What is your take on Bitcoin?

Brian：I love Bitcoin, but I really don't understand why anyone would think otherwise.

Tracy：We've all been devastated by Bitcoin minimalists.

Brian：I'm not sure about the seriousness of the situation. While I've seen similar claims on Twitter, I'm not sure how influential it is. Given that I have devoted a large part of my life to Bitcoin and its development, this seems implausible. In fact, I even quit my job to start this company after reading the Bitcoin white paper. While the crypto industry has evolved in many ways since then, I remain a staunch supporter of Bitcoin, which I believe to be the gold standard in the crypto economy. I expect this to remain the same and its popularity continue to grow, especially if Lightning continues to gain traction and if Bitcoin evolves into a settlement layer. I run an exchange and custodian and try to be unbiased, listing and offering every coin that meets our standards and necessary legal requirements. My neutral stance may lead some to think that I am against certain coins, but that is not the case.

Tracy：Back on the subject of the SEC, it appears to be emphasizing enforcement at the moment. So there is the potential for a lot of new announcements from the SEC tomorrow. In your opinion, what is the ultimate goal of the SEC when it comes to Crypto? Is the SEC’s goal to eliminate Crypto entirely, or is the agency trying to keep the industry going differently?

Brian：My approach is not to speculate on the SEC's motives, even though we have developed positive relationships with several staff and commissioners. While it's hard to be sure, there may be mixed opinions on the matter within the organization. I wouldn't be surprised if some inside the SEC just want Crypto to go away. However, I believe this is not the view of the majority, as it is not in the best interest of US citizens or consumer protection. One in five U.S. households uses this technology, and if we don't establish regulation, consumers will turn to unregulated overseas options. I believe the prevailing attitude is that this technology is here to stay and we have to bring it into the regulatory framework. Ideally, this will be achieved through the publication of clear guidelines and an industry-engaged regulatory rulemaking process. However, so far, this has not been the case. If necessary, a law enforcement-based approach could be taken to resolve some issues through case law. This method may take more time but is acceptable.

Tracy：What do you think are the reasons for the incoherent or unclear actions of regulators? Is it due to a lack of resources, or simply a lack of understanding of the industry by regulators?

Brian：Maybe you can clarify, what do you mean by incoherent?

Tracy：I think the first is that they are slow to respond and somewhat unclear.

Joe：You go in and ask them questions and they don't give you answers, is that right?

Brian：Frankly, I've spent a lot of time in Washington trying to figure things out. Maybe I'm a little naive to think that regulators will simply provide the rules for running a business and we will abide by them. However, things seem to be more complicated than that. There are different factions within the authority, and they have different goals. So, those who successfully pass legislation call it a miracle, because it requires the agreement of the House, the Senate, and the president, and some push. I believe that the FTX debacle may bring further clarity to the legislation next year.

Joe：Let me ask you another regulatory question, although not related to the SFC. It appears that some banks are de-banking Crypto companies, but I don't see this as a threat to Coinbase. Do you see this as a regulatory advantage for Coinbase as it may be difficult for smaller exchanges to secure banking partners in this environment?

Brian：I don't see it as an advantage, we don't have any issues with our banking partners. However, in the wake of the FTX incident, banking regulators have understandably raised tough questions about the liquidity risk associated with Crypto deposits. Specifically, they are asking about the viability of lending against those deposits and whether doing so would be too risky. We believe that the banking industry will not be required not to handle any Crypto business. No one mentioned this to me, and in the absence of input from Congress, it would likely be beyond their purview to do so. Still, regulators are right to question liquidity issues.

Joe：Have you made any lobbying or other attempts by Washington authorities to ensure that Crypto is not treated discriminatoryly within the banking system?

Brian：In our conversations with members of Congress and the Senate, we have highlighted the need for crypto to be treated fairly and equitably compared to traditional financial services. We do not advocate preferential treatment, but a level playing field, not unduly punishing the Crypto industry, but simply achieving a balance.

Tracy：We've discussed this topic before, but I'd love to hear your thoughts on the events at FTX. The events of that week in November were staggering to many, and reactions varied from person to person. However, I'd be curious to see how it affects you, considering how quickly everything happens -- from a Twitter exchange to a bankruptcy filing in seven to ten days.

Brian：It was a pretty tumultuous week, and while I was in Japan meeting with our team and authorities, I was told that FTX could crash within the next 48 hours and that Sam could face jail time. After this, I contacted Sam and CZ and started to assess the situation we were facing. We wrote to our counterparties, including FTX and any other parties with potential secondary influence, and validated our approach to building compliance over the past decade. While the industry may suffer as a result, Coinbase could benefit from increased trust and compliance awareness given our longstanding commitment to these values.

Joe：I would like to know about the price of Crypto during the current market downturn. While there has been a slight recovery, it appears to be mostly due to an uptick in the NASDAQ index. It appears that many of these coins have high correlations with other risky assets. In the past, investors had two reasons to invest in Crypto: It was classed as a new uncorrelated asset class, especially for Bitcoin, and it could serve as a hedge against inflation. Despite recent record-breaking inflation, Bitcoin has not grown significantly in value over the past few years. In fact, it has remained relatively stable. At this point, most Cryptos seem to be closely correlated with NASDAQ, QQQ and similar indices.

Tracy：Now we have a new narrative approach.

Joe：What new arguments can be made about the industry, given that previous claims that have been hyped by some in the industry have proven ineffective in convincing investors to invest? I'm not referring to you specifically as I don't know your involvement, but it's clear that many in the industry have been unsuccessful in trying to make a convincing investment case.

Brian：certainly. I find it interesting that Crypto has become as volatile as the stock market. During my time at Coinbase, people often questioned whether anyone would use it due to its volatility. However, now that its volatility has reached levels similar to the stock market, I see this as a small victory and a step in the right direction.

Joe：Well, we don't buy coffee with Tesla stock either, but whatever.

Brian：It is clear that stablecoins can now be used in commerce, which is a positive. However, let's talk about your doubts about inflation hedging. Initially, it was widely believed that Crypto, and Bitcoin in particular, would serve as the new gold standard for the crypto economy. This idea is shared by many, including Bitcoin minimalists, who believe that in uncertain times, people buy Bitcoin because it is as scarce as real estate.

However, the reality is different, and in an environment of high inflation, Crypto has experienced a rapid decline. It is believed that the world has changed and people are ready to consider Crypto as an inflation hedge. Unfortunately, this assumption proved premature. Currently, Crypto is still a small part of the global economy, and it is seen more as a growth asset than a real "golden" asset. Therefore, in order to play a substantial role in the broader macro environment, the crypto economy needs to grow 10 or 20 times from its current state.

Tracy：Regarding stablecoins, I remember Sam Bankman-Fried was on the show a few years ago, and we asked about the potential impact of Tether's sudden collapse. In hindsight, it might be more pertinent to ask about the impact of the FTX debacle. However, can you share your thoughts on Tether's function in the Crypto ecosystem?

Brian：I don't want to criticize anyone in the ecosystem, and I'm not sure where they stand. Tether has been used in a number of ways on our platform in the past, and I know they've been investigated by all parties, and they've all agreed and are happy with the various approaches. Right now, we're focused on USDC, we're working with Circle, it's well supported, one-on-one, audited. Although I lack information about Tether, I have no negative things to say about them, nor any complaints.

Joe：I would also like to ask you that even without the FTX incident, there have been doubts about the validity of Crypto, with many seeing it as purely speculative with no practical application except for certain market segments. While many people have made handsome profits from Crypto, most of these digital currencies serve no purpose other than financial gain, and there is currently no decentralized platform akin to Facebook. Not having such a platform is worrisome given the level of power wielded by the likes of Musk and Zuckerberg. When do you predict there will be a Crypto that has practical uses and is not limited to speculative investments?

Brian：I don't quite agree that Crypto is purely speculative. While that may have been a reasonable statement five years ago, there won't be a clear tipping point. Instead, the transition will be gradual. We have been monitoring the activity of Coinbase's active customers to determine what percentage of them are engaged in activities other than crypto trading. As of now, this figure has exceeded 50%.

Joe：So what is the example? Is buying NFT something other than trading?

Brian：Besides those already mentioned, there are many other use cases for Crypto. However, I will provide a framework to explain its evolution over time. While people are doing business, borrowing, earning, and staking, there are three main use cases for Crypto. First, it serves as a new form of money and asset class. While early activity has been speculative, we must recognize what it means to have a global, decentralized, and scarce new form of money. This is a luxury that most people in the world do not have. Secondly, Crypto is also a new type of financial service, such as DeFi, which can carry out loans, loans, payments, pledges, etc. Third, it is a new application platform outside of financial services, including decentralized identity with ENS, which allows for the creation of decentralized social networks, public profile pages, badges and certifications. With this technology, access to buildings, concert tickets and other items can be managed through proof of attendance. This development has opened the door to new business models in industries such as music, YouTube, and Spotify.

Tracy：I guess the question is why hasn't it happened yet? You know, it's been over ten years since the white paper was published. So, if this is a revolutionary technology that's so much better than the way we've always done things, why isn't it being adopted more quickly?

Brian：One reason for the slow development of blockchain technology is the lack of scalability, which needs to be addressed. In addition, improving the usability of the technology is crucial, as ordinary people may not understand technical terms such as "private key" and are unwilling to install extension packs. For blockchain to gain widespread adoption, it must become better accessible to ordinary Internet users. To use an analogy with the development of the Internet, although the basics of the Internet date back to the 60s, it wasn't until the 80s that early versions of Telnet and similar technologies appeared. Although the internet has achieved widespread adoption today, it took years of groundwork and technological advancements, such as broadband, to become scalable.

Joe：Of course, the same is true for Crypto technology. I mean, in some cases, people have been working on hashcash and all that for decades. Therefore, Bitcoin also experienced a long process before its birth.

Brian：To be honest, the current regulatory environment is not conducive to progress. In the U.S., there is a sense of apprehension that starting a business in this space will generate massive legal bills and subpoenas. That kind of thinking doesn't help, but we can't entirely blame it either. The technology has to become more scalable and user-friendly, and while it's making progress, it's taking longer than expected.

Joe： I want to ask a question about Coinbase, this question was inspired by our previous guest Jim Chanos, who has been critical of Coinbase. He questioned why Coinbase wasn't profitable during some of the most incredible crypto bull markets, and also pointed out that most of the revenue came from the huge gap between institutional traders on Coinbase Pro and regular Coinbase commissions. While it's easy to switch between the two, people may not realize how cheap it is to trade in the Pro. What steps are you taking to close the gap, and what do you think about the notion that retail investors are being treated unfairly compared to more professional traders?

Brian：Our profitability has declined in 2022, however, in 2021 our company is highly profitable with $4 billion in EBITDA and 600% revenue growth. Although we experienced a decline in 2022 due to market conditions, we have implemented cost reduction measures to ensure profitability in any market environment. Your question seems to be related to fee compression, which has several aspects. One is that pricing varies based on a client's choice of a professional or simple interface and their transaction volume. Our customers are willing to pay for ease of use and trust. Our fees are comparable to other companies in the market, and while some claim to have zero fees, they may be accepting payment for order flow or other non-obvious fees. We also launched Coinbase One, a subscription service that provides customers with reduced-fee trading and other benefits, especially to our premium users.

Joe：Brian Armstrong, thank you so much for being on Odd Lots. We've wanted you here for a long time, and I'm so glad we finally met.

Brian：I am also very happy to be able to communicate with you today.

Tracy：Yeah, I'm glad we finally got to do that. I'd like to thank Brian for his willingness to answer our questions during Crypto Winter.

Joe：The current regulatory landscape is quite complex and many entities within the industry face challenges in complying with various regulations. Concerns have been raised about the SEC's lack of clarity on securities rules. In addition, some entities are cautious about starting up until they have established that they are operating within the bounds of the law. However, this caution has resulted in some entities still in the pre-launch phase three years later, while others have made billions. Notably, several in the industry share this view.

Tracy：Yes, you will be penalized for participating, and sometimes it's better if you post without asking a question.

Joe：The industry tends to focus on tokens like the Kim Kardashian Token, which may not have a major impact. In this regard, however, I do empathize with entrepreneurs.

Tracy：While I think it is important to discuss the clarity of regulations, it is also important to discuss why regulators do not go further. If regulators start enforcing or establishing new rules, they may inadvertently give crypto legitimacy. If regulators want to avoid legalizing crypto, they should make their position clear.

Joe：While many did experience financial damage, there is an argument that the failure of FTX to have a broad macroeconomic impact should be seen as a positive outcome. This is especially important when compared with the significant fallout from the shadow banking collapse in 2008. As such, it may be worth considering certain parameters when deciding whether to include FTX. However, the specific parameters involved are still unknown.

Tracy：People lost money, but at least the financial system didn't collapse, which is the best we can hope for today.

Joe：It's not scary.

Tracy：Okay, let's wrap it up for a moment.