How the SEC vs. Paxos-BUSD fight could impact the stablecoin market

The United States Securities and Exchange Commission may be preparing to take action against Paxos, a company that issues a type of cryptocurrency called stablecoin.

The move will have major implications for the $137 billion market, experts told CNBC.

Stablecoins are a type of cryptocurrency designed to mirror real-world assets such as the US dollar.

These stablecoins are often backed by real assets such as bonds or reserve cash. They have become the backbone of the crypto market as they allow people to quickly trade different coins without having to convert and withdraw fiat currency.

Paxos issued a digital currency called Binance USD or BUSD. It is a stablecoin associated with Binance, one of the largest cryptocurrency exchanges in the world. The BUSD is pegged to the US dollar.

Last week, the New York State financial regulator ordered Paxos to stop issuing BUSD.

Separately, Paxos said the SEC issued a notice to it that the regulator is considering recommending action alleging BUSD is a security. Paxos said the notice suggests Paxos should have registered the BUSD offering under federal securities laws.

The SEC has not begun formal action. But the agency’s actions are being watched closely because if it begins formal proceedings, it could have huge implications for all stablecoins, including Tether and USDC, the two largest which are worth $110 billion.

“If the SEC accuses Paxos, any other stablecoin issuer should register or be prepared for a legal battle with the SEC,” Renato Mariotti, a partner at law firm BCLP, told CNBC.

Although the SEC has yet to issue specific charges, the notice to Paxos focuses on whether stablecoins are securities or not.

For its part, Paxos said it “categorically disagrees with SEC staff because BUSD is not a security under federal securities laws.”

The SEC uses the Howey test to determine what is considered a security or “investment contract”. There are four criteria for determining whether something is an investment contract under the Howey test, for example, whether there is an expectation of profit from the investor.

If BUSD is considered a security by the SEC, the regulator will oversee the stablecoin. Regardless of the issuing company, BUSD should register with the SEC and accept stricter regulation.

Another implication is that other stablecoins will also receive the same label.

“The basis for this action will necessarily be specific to the facts of the Paxos BUSD structure, but will likely have broad implications for other stablecoin issuers selling coins in the United States,” said Townsend Lansing, chief product officer at CoinShares, at CNBC.

There are a number of different scenarios that could unfold. It will depend on what the SEC alleges against Paxos and how the two sides move forward.

“I think it’s likely that the SEC will come to an agreement with Paxos in which Paxos admits that this BUSD is a security, causing other stablecoins to follow suit and register,” Mariotti said. .

“It’s possible that Paxos would file an aggressive lawsuit against the SEC, but the cost of doing so would be significant,” Mariotti said.

“Litigation would take years and the risk of losing to the SEC would be significant. The mere fact that Paxos was fighting the SEC would create risk and potentially make BUSD less attractive in the market.”

Another outcome, according to Mariotti, is that the SEC can regulate assets used to back stablecoins and requirements for digital currency issuances to make market disclosures.

CoinShares’ Lansing said what the SEC considers a security or investment contract actually goes beyond the simple Howey test and that the agency has “an in-depth understanding of how to apply both the law and judicial precedent”.

“Absent a successful fight, it is highly likely that BUSD will no longer be sold in the US or will no longer be available on US-based digital asset exchanges,” Lansing said. “It is very possible that other stablecoins will follow suit.”

That will depend on the SEC allegations against Paxos and BUSD.

“We still don’t know on what exact basis the SEC is alleging the violations, so we don’t know to what extent these allegations will extend to other industry participants,” Lansing said.

Carol Alexander, professor of finance at the University of Sussex, said the US regulator’s action is “more of a move against Binance than stablecoins.”

She said Tether and Circle, the company that issues USDC, are “close to the US government.” Circle CEO Jeremy Allaire previously called for more regulation around stablecoins.

Alexander said “Binance is of growing concern to regulators around the world” in areas ranging from money laundering to violating securities laws. This could be one of the reasons the SEC targeted BUSD, she said.

The Justice Department is investigating Binance for alleged money laundering and sanctions violations, Reuters reported last year. Bloomberg reported in 2021 that US officials were investigating whether Binance employees engage in insider trading.

Binance did not immediately respond to CNBC’s request for comment.

A Binance spokesperson said at the time that the company had a “zero tolerance” policy for insider trading and a “strict code of ethics” to prevent misconduct, according to Bloomberg.