The top U.S.-based cryptocurrency exchange, Coinbase, is cautioning investors that U.S. regulators may inhibit its ability to compete with rivals in decentralized finance (DeFi).

"Economic freedom is a necessary, if not sufficient, condition for human progress," CEO Brian Armstrong noted in a letter embedded within a new prospectus filed Thursday with the U.S. Securities and Exchange Commission (SEC).

One entity that could benefit from a little more freedom, the document implies, is Coinbase itself.

The company dropped its Form S-1 to much fanfare Thursday morning. The prospectus portion of the document is meant to give investors all the information they will need when Coinbase shares begin trading on Nasdaq, likely under the COIN ticker.

As a leading centralized exchange, Coinbase is understandably ambivalent about DeFi and the growth of decentralized exchanges (DEXs), writing:

The prospectus doesn't attempt to quantify how much buying of assets useful in DeFi (such as ETH, DAI and USDC) the DeFi boom drove on the platform; however, its overall revenue more than doubled from 2019 to 2020. Doubtlessly, DeFi's bonanza must have played a part as retail investors converted fiat currencies to crypto in order to participate.

"We are the default starting place for new user journeys into the cryptoeconomy," the prospectus states. The product has nearly 3 million monthly users and more than 40 million verified users.

Those are numbers any DeFi product would envy.

Indeed, FTX founder Sam Bankman-Fried thinks Coinbase is waving DeFi around as a competitor only because it needs to have one.

"My honest best guess is that it's intentional misdirection," Bankman-Fried told CoinDesk via email. "If you say you don't have any competitors and also just reported $1.1B of revenue, no one will believe you. So they have to list someone. And so I don't think they listed DeFi as a competitive risk because they were scared of DeFi. I think they listed it because they weren't scared of it."

That said, Coinbase is watching DeFi carefully.

It sees developments such as exchange offerings, yield farming and token wrapping as exciting and important, but also reasonably worries about its ability to keep up.

"We expect new services and technologies to continue to emerge and evolve, which may be superior to, or render obsolete, the products and services that we currently provide," the prospectus states.

Like any smart market leader, Coinbase has invested in the protocols that could disrupt it. 

For example, Coinbase invested in the DeFi money market Compound, hooked it up with a bunch of USDC for one of its key liquidity pools and then helped get its COMP governance token out the door.

"We hold investments in various DeFi protocols. These protocols achieve their investment purposes through self-executing smart contracts that allow users to invest crypto assets in a pool from which other users can borrow without requiring an intermediate party to facilitate these transactions," the prospectus notes.

Still, Coinbase remains wary.

"We do face significant competition from parties ranging from large, established financial incumbents to smaller, early stage financial technology providers and companies native to the cryptoeconomy, such as decentralized exchanges," the exchange wrote.

As just one example: Uniswap has appeared at times to have more activity than Coinbase, but Uniswap is just one DEX. There are lots of them, such as Kyber, Loopring, Curve, SushiSwap and PancakeSwap, to name a few.

Coinbase is well aware. 

"We compete against a growing number of decentralized and noncustodial platforms and our business may be adversely affected if we fail to compete effectively against them," the firm wrote. "Such platforms have low startup and entry costs as market entrants often remain unregulated and have minimal operating and regulatory costs."

Coinbase specifically mentioned offerings on blockchains such as Polkadot and Solana.

Matthew Finestone, on the Loopring business operations team, argues that the DEXs built on layers above networks such as Ethereum could be a threat. He notes that Loopring's layer 2 is seeing $25 million in volume per day. That's tiny compared with Coinbase, but its users "have an experience which emulates Coinbase, but with the non-custodial benefits," he wrote.

Decentralized exchanges have some significant advantages, not least of which is the ability to trade without counterparties or platforms needing to know the trader's identity.

To crypto natives, that is and always was how crypto should be. To regulators, that – one would suspect – is exactly the problem.

Users are leaving Coinbase because it plays by the rules.

"We operate in a highly competitive industry and we compete against unregulated or less regulated companies," the prospectus notes. "In recent years, our commitment to compliance and the attendant customer-facing requirements, including customer due diligence requirements, have resulted in our customers transferring significant funds and crypto assets to these unregulated or less regulated competitors."

Those entities don't have to worry about a shortsighted regulation steamrolling them worldwide, but Coinbase does. It writes:

If regulators don't stymie its mojo, Coinbase appears to believe it can be very big. Even now, it's worth noting, all the DeFi products tracked by DeFi Pulse have a total of about $40 billion under their control. Coinbase says it has $90 billion in assets on its platform.

DeFi still has a ways to go, but Coinbase seems to be betting it can hold its lead and become a true giant.

"Coinbase isn't, at its heart, basically Uniswap but with [know your customer rules]. Coinbase's core user base and revenue base isn't the same as Uniswap's; in fact, it has fairly little overlap," Bankman-Fried wrote. He sees Coinbase's users – the very casual retail investor and the very big institutional investor – as completely different from those deep in DeFi.

In short, Coinbase users may never go anywhere near PancakeSwap.

Crypto is hard. So far, Coinbase has made it easier. 

"As Coinbase clearly recognizes, decentralized or non-custodial platforms represent a strong competitive threat, but up until now, Coinbase has had an important moat which mostly neutered the up and comers: UX," Finestone admits, although he believes platforms like his are catching up fast on the user experience front. 

Still, Coinbase has bet that its users don't mind being subject to lots of state-mandated rules that come in from outside the blockchain. So far that bet has worked out. If it continues to, Coinbase seems to believe it can be very large.

Armstrong noted this in his letter: 

This is obviously modeled on an observation from Amazon founder Jeff Bezos, who famously said that his business is built on things that never change, like fast delivery and low prices. 

It's one of the ways that Coinbase appears to signal in the prospectus that it believes it could join tech giants Amazon, Microsoft, Facebook, Netflix and Google. For another example, the prospectus states:

"In the early days of the internet, Google democratized access to information through its user-friendly search engine, enabling virtually any user with an internet connection to discover the world’s information. Similarly, Coinbase is democratizing access to the cryptoeconomy by enabling anyone with an internet connection to easily and securely invest in and use crypto assets."

But that potential makes it a target of, well, everybody.

Coinbase is in an interesting spot. From the perspective of crypto natives, it's the incumbent, the suit-and-tie, the monolith. To the broader world, and especially that of finance, it's still an upstart.

Caught between the megabanks and the food-branded DEXs, Coinbase is a Goliath with multiple Godzillas on one side of it and a growing army of robot Davids on the other. 

As if that's not bad enough, there's some chance U.S. regulators will leave it fighting both while standing in quicksand.