Coinbase Under Fire: Is Paper Bitcoin the Next Big Scandal?

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• Critics argue lack of visible Bitcoin reserves for cbBTC could lead to over-issuance risks, echoing previous industry downfalls.
• Ongoing scrutiny and competitive market dynamics underscore the challenges Coinbase faces against rivals like BitGo’s WBTC.

On September 15, Coinbase faced scrutiny over allegations concerning the transparency of its Bitcoin reserves, especially after launching its wrapped Bitcoin (cbBTC). This derivative is primarily used as collateral in the decentralized finance (DeFi) space.

Amid these discussions, some cryptocommunity members accused Coinbase of selling “paper Bitcoin” to BlackRock without ensuring a one-to-one backing.

Blackrock can take as much Bitcoin as they want from Coinbase and the transaction is recorded off chain.

I'd like to see the all of the ETF's wallets.

Thanks Brian you massive cunt. pic.twitter.com/i77OzRctMJ

— Tyler (@TylerDurden) May 16, 2024

Coinbase CEO Brian Armstrong addressed these concerns by affirming the company’s commitment to regulatory and auditing standards.

Baldilocks here.

Not sure what this is all about TBH. All ETF mints and burns we process are ultimately settled onchain. Institutional clients have trade financing and OTC options before trades are settled onchain. This is the norm for all our institutional clients. All funds…

— Brian Armstrong (@brian_armstrong) September 14, 2024

He highlighted that Deloitte, a globally recognized auditing firm, conducts annual audits of Coinbase, given its status as a public company. Armstrong emphasized that revealing clients’ wallet addresses is beyond the company’s remit and is unnecessary for public scrutiny.

“These allegations have been addressed before. In May, similar concerns were raised, and they were found to be related more to the structural design of the ETF than to any malpractice by us” Armstrong stated. 

Bloomberg’s ETF analyst Eric Balchunas supported this view, pointing out that the primary issue was the absence of ‘in-kind’ redemptions in the ETF’s structure, rather than a lack of transparency.

People been tagging me and @JSeyff in tweets about this today. Our official response: https://t.co/QqNPiVCrZQ pic.twitter.com/XVZ912k0tX

— Eric Balchunas (@EricBalchunas) September 14, 2024

Despite these defenses, the community’s concerns about the backing of Coinbase’s cbBTC remain largely unaddressed. Armstrong’s comments on cbBTC suggested that while the company acts as a centralized custodian for the underlying Bitcoin, it has never misrepresented this role. 

However, this reassurance did not satisfy all community members, some of whom demand more tangible proof of the Bitcoin reserves backing the cbBTC.

Critics argue that without such transparency, the risk of over-issuance of cbBTC could lead to issues similar to those faced by other entities in the cryptocurrency sector. 

“The lack of reserve transparency might set a precarious precedent akin to FTX’s downfall,” remarked one market observer.

In response to these concerns, Coinbase continues to be competitive, especially with the rise of BitGo’s WBTC and the upcoming transfer of custody operations to a firm owned by Justin Sun. 

#cbbtc lacks Proof of Reserve, no audits, and can freeze anyone's balance anytime. Essentially, it’s just 'trust me.' Any U.S. government subpoena could seize all your BTC. There’s no better representation of central bank Bitcoin than this. It’s a dark day for BTC.

— H.E. Justin Sun🌞(hiring) (@justinsuntron) September 12, 2024

As the situation unfolds, the industry watches closely to see how Coinbase will manage these challenges and adapt its strategies in the evolving cryptocurrency custody space.