Underwood v. Coinbase Glob.

• Decision Date: 01 February 2023
• Docket Number: 21 Civ. 8353 (PAE)
• Parties: CHRISTOPHER UNDERWOOD et al., Individually and on Behalf of All Others Similarly Situated, Plaintiffs, v. COINBASE GLOBAL, INC., COINBASE, INC., and BRIAN ARMSTRONG, Defendants.
• Court: U.S. District Court — Southern District of New York

CHRISTOPHER UNDERWOOD et al., Individually and on Behalf of All Others Similarly Situated, Plaintiffs,
v.
COINBASE GLOBAL, INC., COINBASE, INC., and BRIAN ARMSTRONG, Defendants.

No. 21 Civ. 8353 (PAE)

United States District Court, S.D. New York

February 1, 2023

OPINION & ORDER

PAUL A. ENGELMAYER, UNITED STATES DISTRICT JUDGE

This decision resolves a motion to dismiss a putative class action brought under the federal securities laws against defendants Coinbase Global, Inc., Coinbase, Inc,, and Brian Armstrong (“Armstrong”) (collectively with Coinbase Global, Inc., and Coinbase, Inc., “Coinbase” or “defendants”).

Coinbase operates two online digital trading platforms on which users can transact in the cryptoeconomy. The Amended Complaint (“AC”), Dkt. 43, alleges that among the assets that Coinbase enables customers to buy and sell on these platforms are ones qualifying as securities. It alleges that these include 79 digital assets known as the “Tokens.” It alleges that, notwithstanding Coinbase's practice of transacting in these securities with plaintiffs and other users, Coinbase is not registered with the U.S. Securities and Exchange Commission (“SEC”) as an exchange or broker-dealer.

On this basis, lead plaintiffs here-each of whom transacted in the Tokens on the Coinbase platform-bring three sets of claims: (1) under Section 12(a)(1) of the Securities Act of 1933 (the “Securities Act”), for damages arising from Coinbase's sale or solicitation of

1

unregistered securities, AC ¶¶ 931-41; (2) under Section 29(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), arising from illegal contracts Coinbase entered into with its users to purchase and sell securities in violation of the Exchange Act's registration requirements, id. ¶¶ 956-88; and (3) under state law, based on Coinbase's sale of unregistered securities and failure to register as a broker-dealer, id. ¶¶ 1016-1106. They also bring control-person claims against Coinbase Global and its Chief Executive Officer, Armstrong, who allegedly orchestrated Coinbase's strategy to profit by violating the securities laws, id. ¶¶ 942-55, 1002-15, 1038-49, 1094-1106. These claims are brought on behalf of a nationwide class consisting of all persons or entities who transacted in the Tokens on the Coinbase trading platforms between October 8, 2019 and the AC's filing on March 11, 2022 (the “class period”), and of subclasses keyed to citizens of three states who so traded during that period.

Pending now is defendants' motion to dismiss the AC for failure to state a claim under Federal Rules of Civil Procedure 12(b)(6) and 8(a). Dkt. 69. For the reasons that follow, the Court grants in full the motion to dismiss. The Court dismisses the federal claims with prejudice and the state claims without prejudice.

I. Background

A. Factual Background^[1]

1. Crypto-Assets and Blockchains

This case involves the modern financial concoctions known as crypto-assets. Also sometimes called “cryptocurrencies,” “tokens,” or “crypto-securities,” these are digital assets created and traded in the digital world. AC ¶ 19. Crypto-assets often rely on a technology

2

known as “blockchain” to “secure transactions, control the creation of additional units, and verify their transfer.” See id. Blockchain is a digital ledger system that tracks the ownership and transfer of different kinds of crypto-assets. See id. ¶¶ 20-21.

Users on the blockchain have a “public key” and a “private key.” See id. ¶¶ 24-26. A user can publicly identify herself to other users with her “public key,” which is akin to a conventional bank account number an individual might share with another who wishes to send the individual funds. See id. ¶¶ 24-25. A user also retains a “private key,” which is akin to a pin code associated with the “bank account” public key. See id. The blockchain makes use of the public keys and unique addresses associated therewith to document transactions. See id. ¶¶ 2021. For example, with the well-known crypto-asset known as “Bitcoin,” “[a] transfer of Bitcoin is public to the extent that anyone can see the transferor's Bitcoin address, the recipient's Bitcoin address, and the quantity of assets transferred.” Id. ¶ 27. By tracking who owns any given unit of a crypto-asset at any given time, the blockchain allows for the secure exchange of cryptoassets, enabling users to verify each transaction involving that particular unit. Id. ¶ 22. This system, by documenting ownership, aims to prevent counterfeiting. Id.

2. Crypto-Exchanges

The crypto-asset ecosystem depends on digital exchanges known as “crypto-exchanges.” “Crypto-exchanges emerged to enable smoother and faster trading between investors, just as stock and commodities exchanges emerged to enable easy trading of securities.” Id. ¶ 28. Crypto-exchanges come in two primary forms: decentralized and centralized. Id. ¶ 29.

Decentralized exchanges use different approaches. “[W]hat they have in common is that the crypto-assets are transferred between individual accounts.” Id. ¶ 30. Such exchanges may be analogized to Craigslist.com, the website that allows users to match directly with other users to

3

enable individualized transactions. See id. ¶ 31. Decentralized exchanges, “like Craigslist, do not own or hold the assets in question-they simply provide a platform for exchanges between users, along with some features designed to facilitate trading (for example, Craigslist's creation and maintenance of message boards organized by product type or a decentralized exchange's smart contracts), possibly in exchange for advertising revenue or a transaction fee.” Id.

Centralized exchanges play a more substantial role in transactions between individuals. First, a customer must “create an account” on the centralized exchange, Id. ¶ 32. “The exchange will then provide that customer with a deposit address that the exchange controls.” Id. Then “[w]hen the customer deposits crypto-assets into that deposit address, the exchange will credit her trading account with the corresponding crypto-asset.” Id. “The exchange will typically then transfer the crypto-assets into one of its other addresses for storage.” Id. When that customer wants to make a transaction-say, to transfer one Bitcoin to the address of someone else-the centralized exchange “then debits the [customer's] account and transfers a corresponding amount of crypto-asset from the exchange's reserves to that address” of the user with whom he or she wishes to transact. Id. ¶ 42.

3. The Coinbase Exchanges

Coinbase operates two digital asset trading exchanges: Coinbase (the “Coinbase Platform”) and Coinbase Pro (the “Coinbase Pro Platform”). Id. ¶ 5. The Coinbase Platform is “marketed towards newer users,” id. ¶ 35, and “allows users to place only market orders”- transactions of digital assets “at the digital assets' market price as displayed on the Coinbase Platform at the time of placement of the order,” id. The Coinbase Pro Platform, in contrast, “is designed for use by advanced and active digital asset traders,” id. ¶ 37. It “allows three types of orders: a market order,... a limit order to buy or sell a digital asset at a specific price or better,

4

or a stop order to buy or sell a digital asset if the market price of the digital asset falls to a specified price.” Id.

The AC alleges that the Coinbase platforms operate as centralized exchanges. Id. ¶¶ 32, 34. Trades “do not in fact happen on the blockchain and do not actually involve the transfer of any assets between users. Instead, it is Coinbase that faces both the buyer and the seller.” Id. ¶ 33. If two users wish to transact, each does so by transacting with Coinbase directly-not with each other. Id. “Thus, if [a customer] wishes to trade one Bitcoin for 10 Ethereum on Coinbase, Coinbase will update its internal records to debit [that customer's] account one Bitcoin and credit it 10 Ethereum; no actual crypto-assets are moved on the blockchain.” Id. Customers are charged fees on both Coinbase platforms. See id. ¶¶ 34-40.

4. Coinbase's Alleged Failure to Register as a Securities Exchange or Broker-Dealer

The AC's central premise is that Coinbase lists and sells securities but is not registered as a securities exchange or as a broker-dealer. Plaintiffs purchased and sold the Tokens^[2] on the Coinbase platforms during the Class Period,^[3] id. ¶¶ 1, 91819, during which neither Coinbase Platform was registered with the SEC as a securities exchange, id. ¶ 64; see 15 U.S.C. § 78c (registration requirements of “exchange” under Exchange Act), or broker-dealer, AC ¶ 64; see 15 U.S.C. § 78o(a)(1) (registration requirements for “brokers” and “dealers” under Exchange Act),

5

nor “subject to exemptions from such registrations,” AC ¶ 5. “Because Coinbase brings together buy and sell orders for the Tokens[,] and the Tokens are securities,” id, the AC alleges, Coinbase “stands between the buyer and seller in each trade on its platform, meaning that is the actual seller of the unregistered securities that transact each day on its platform,” id ¶ 6.

5. The Class Allegations

Plaintiffs bring this action as a putative class action under Federal Rules of Civil Procedure 23(a) and 23(b)(3). Id. ¶ 917. Plaintiffs seek certification of a nationwide class defined as “all persons or entities who transacted in the Tokens on the Coinbase Platform and/or the Coinbase Pro Platform during the Class Period.” Id. ¶ 918. Plaintiffs also seek certification of three subclasses: (1) “all persons or entities who transacted in the Tokens on a Coinbase platform during the Class Period while in the State of California”; (2) “all persons or entities who transacted in the Tokens on a Coinbase platform during the Class Period while in the State of Florida”; and (3) “all persons or entities who transacted in the Tokens on a Coinbase platform during the Class Period while in the State of New Jersey.” Id. ¶ 919.

...