Cryptocurrency exchange Coinbase recently launched their institutional-grade custody service with much praise and excitement from the cryptocurrency community. Their partner in this service, however, has a less than perfect reputation.
To launch their custody service, Coinbase partnered with Electronic Transaction Clearing (ETC), a company founded in 2007 that provides clearing services to a select group of security industry professionals. Coinbase, who is not yet a registered broker-dealer, did not need to request or receive formal approval from the Securities Exchange Commission (SEC) in order to launch its custodial service due to their partnership with ETC, who is already operating as an institutional custodian.
Coinbase explained this in their announcements, saying:
“Coinbase Custody leverages the expertise and systems of our partner Electronic Transaction Clearing (ETC). ETC is a SEC-registered broker-dealer and FINRA member subject to regulated financial reporting and independent audits.”
The partnership with ETC is seen by many as risky due to ETC’s track record with the SEC. Four months after Coinbase announced its institutional custody product, the SEC charged ETC with “repeatedly putting customers' assets at risk.” The charge goes on to further state that ETC “illegally placed more than $25 million of customers’ securities at risk in order to fund its own operations.”
ETC has a history of misusing client’s funds. They once used a client's $8 million deposit to cover its margin requirement on funds that it had borrowed. In another instance, ETC used $17 million in clients' funds as collateral for a loan the company was trying to receive. According to the SEC, actions like these taken by ETC occurred multiple times throughout 2015.
Although no customer’s funds were ever directly impacted by ETC’s actions, the company was still required to pay fines for all their violations.
It is unfortunately common for custodial institutions to misuse clients' funds. Financial groups like J.P. Morgan have been fined billions of dollars in penalties by the SEC, and the demand for their services has only increased. The main concern is that clients looking to use Coinbase’s custodial services will be hesitant due to their relations with ETC.
10 customers have already joined the Coinbase custodial service, but it is unclear how much money has been invested through it.