Coinbase and Others Want to Rate Cryptoassets But Their System has Several Problems

To reassure regulators about the legal status of assets listed on their platforms, leading crypto firms and exchanges within the United States have formed a council to assign ratings for tokens.

The Crypto Ratings Council counts top-tier crypto exchanges, such as Coinbase and Kraken, and firms like Grayscale Investment and Cumberland Mining as members. It rates tokens based on previous court decisions and SEC statements and case law.

The effort has evoked derision and mockery from members of the crypto community. More troublingly, it could represent an effort to centralize the listing process of assets in a supposedly-decentralized ecosystem.

Best Practices for Regulators

The SEC uses the Howey test to determine whether a given token is a security. But promoters of crypto tokens claim that the test’s criteria can be confusing in a decentralized ecosystem like the one for cryptoassets.

Unscrupulous characters have taken advantage of the ambiguous language to raise funds by masquerading securities as utility tokens. In recent times, the SEC has cracked down on such cases and expressed concern about their listings on crypto exchanges.

The current initiative is an effort by the Crypto Ratings Council is an effort to allay their concerns. Regulatory compliance has become especially important for exchanges as the SEC greenlights crypto-related investment projects that have been hanging in balance for the last couple of years.

The federal agency will rule on Bitcoin ETFs this month and issued a broker-dealer license to a subsidiary of securities platform Harbor. The license allows Harbor to act as a broker for tokens and advise clients about their regulatory holdings.

Coinbase has also applied for the license and acquired a crypto custody company in preparation. The exchange, which was once selective about tokens listed on its exchange, has become more accommodating in its criteria. More tokens on its exchange will help it attract more institutional investors to its platform. Brian Brooks, the company’s chief legal officer, told WSJ that the reason asset managers are not comfortable with cryptoassets is “the uncertainty around which is a security and which is not.”

The ratings are also meant to demonstrate a tangible process of evaluation for cryptoassets that might enable Congress to follow suit.

“This gives us a model for best practices that Congress may decide to use if and when it decides to legislate in this area,” Gus Coldebella, chief legal officer of Circle, told WSJ.  

The ratings are assigned on a points scale system and vary from 1 to 5, with a 1 rating denoting a token that is safe to be listed on a platform while a 5 rating is a sign that the token is unregulated. Per the council’s ratings system, Bitcoin is rated 1. Ethereum, the world’s second most popular blockchain, is assigned a rating of 2 while Polymath, a token that is used while launching security tokens, scored the lowest among the current batch with a rating of 4.5.

“The Blockchain Investigation Agency”

But members of the crypto community are less-than-impressed with the ratings council.

This is primarily because of the arbitrary and opaque nature of the assessment. For example, an absence of “investment-like language or marketing” and “securities-like language” is held up as criteria for evaluation. However, examples of such language or clarity regarding the meaning of those terms have not been provided. Similar listing criteria have also resulted in differing ratings, as in the case for Zcash and Stellar. In other words, the ambiguity in interpretation of criteria, which is the main complaint for crypto token issuers, still has not been resolved.

There is also the danger that the ratings could centralize the listing process among select players within an ecosystem that claims to be decentralized. Members of the ratings council represent some of the most prominent and well-capitalized exchanges and firms the crypto ecosystem.

For example, Coinbase is North America’s biggest cryptocurrency exchange while Grayscale Investment is part of the Digital Currency Group, which owns industry publication Coindesk. Considering the absence of detail about the ratings, it could very well be that the ratings council replaces the SEC (or works in concert with it) in deciding the regulatory status of tokens.