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Moody's downgrades Coinbase, warns SEC lawsuit could have a significant impact

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(Kitco News) - Credit rating agency Moody’s Investor Service has downgraded its rating for Coinbase following the SEC’s lawsuit against the cryptocurrency exchange, changing it from “stable” to “negative” in the wake of charges that it has been operating as an unregistered securities broker.

According to Moody’s, “the affirmation of Coinbase's ratings reflects its healthy liquidity position, its recent cash flow generation improvements stemming from prudent expense management, and because the SEC's charges pertain only to some of Coinbase's products, and exclude its leading traded products.”

“The change in outlook to negative from stable reflects the uncertain magnitude of impact the SEC's charges will have on Coinbase's business model and cash flows,” the agency said.

Moody’s warned that the regulatory actions could result in the disgorgement of ill-gotten gains, interest and penalties, and negative consequences for certain product offerings and business activities, including its crypto asset staking-as-a-service program.

While 20% of Coinbase’s total revenue for the trailing twelve months that ended in March was driven by Bitcoin trading and 13% from Ether trading, 28% came from other crypto asset trading. This revenue could be affected by the SEC's lawsuit as it included a list of thirteen assets listed on the exchange that the regulator deemed to be securities.

An additional 20% of Coinbase’s revenue is interest income, which could also be affected by the SEC’s focus on the platform’s staking service.

Moody's noted that interest revenue was actually a positive area for the exchange, because it rose as the Federal Reserve raised interest rates.

“Coinbase has been benefiting from the higher interest rate environment and reported $241 million in interest income in the first quarter of 2023, representing 31% of its total revenue for the period,” the rating agency said. “This interest revenue is earned on customer fiat balances as well as the fiat balances backing USDC (a fiat-backed stablecoin), a product that was not referred to in the SEC's complaint.”

Moving forward, Moody’s said that Coinbase could see its rating upgraded if there is a resolution to the SEC’s charges that does not have a significant negative impact on the exchange’s revenue streams, cost base and liquidity; a substantial and sustained increase in trading revenue; or if the exchange can achieve “revenue diversification through the strong and sustained development of non-transactional revenue streams, without adding significant incremental credit risk.”

Developments that could lead to a further downgrade include “an accelerated decline in the company's liquidity position, including through incurring significant regulatory penalties; a strategic or mandated revamp of its business model, leading to lower revenue or increased costs and a failure to return to relatively healthy free cash flow generation; a further substantial and sustained reduction in trading revenue; or a reduction in interest rate levels negatively impacting the company's free cash flow prospects.”

Coinbase CEO says SEC's Gensler is the outlier for refusing to provide guidance, but they still have the courts and Congress

Despite the downgrade, ARK Invest CEO Cathie Wood remains bullish on the long-term outlook for the top crypto exchange in the U.S., as evidenced by her investment firm’s purchase of an additional 419,324 shares of COIN, worth approximately $21.6 million, on June 7. ARK Invest is currently the fourth-largest holder of Coinbase shares.

During an interview with Bloomberg Television on Thursday, Wood pointed to the increasing regulatory scrutiny of Binance as a good thing in the long term for Coinbase. “There are questions about what’s a security, about staking, those are the two questions that Coinbase and Binance are facing, but most of the other questions about Binance have nothing to do with Coinbase,” she said, adding that Coinbase isn’t accused of any criminal activity.

Wood also remains confident in her $1 million price prediction for Bitcoin and said that Ark’s confidence in the token increases as uncertainty and volatility rises in the global economy.

“We’ve just been through an inflationary scare, we think it was very supply chain driven and Bitcoin is a hedge against inflation,” she said. “We also believe now that the bigger risk is deflation, not inflation. Why would Bitcoin do well in that circumstance? It will do well because it’s an antidote to counterparty risk in the traditional financial system.”

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