The Paxos company, which produces a stablecoin cryptocurrency, may face enforcement measures from the US Securities and Exchange Commission.
According to experts who spoke to CNBC, taking action against Paxos could have significant consequences for the $137 billion market.
Stablecoins are a type of cryptocurrency aiming to replicate assets like the US dollar.
Frequently, stablecoins are supported by genuine resources such as cash reserves or bonds. They have emerged as the foundation of the cryptocurrency market since they permit individuals to quickly trade between coins without changing to fiat currency.
Paxos created a stablecoin called Binance USD or BUSD, linked to Binance, one of the largest cryptocurrency exchanges globally. BUSD is tethered to the US dollar at a one-to-one ratio.
Paxos was instructed by the financial regulator of New York state to halt the issuance of BUSD last week.
In a separate development, Paxos reported receiving a notification from the SEC stating that the agency is contemplating a potential enforcement action claiming that BUSD is a security. The notice indicates that Paxos should have registered the BUSD offering under federal securities laws.
While the SEC has not yet initiated formal proceedings, its actions are being closely monitored. If it were to do so, it could have significant repercussions for all stablecoins, including rope and USDC, which are the two largest and have a combined value of $110 billion.
Renato Mariotti, a partner at BCLP law firm, informed CNBC that if the SEC decides to take action against Paxos, any other stablecoin issuer should be ready to register or prepare for a legal battle with the SEC.
Are stablecoins securities?
Although the SEC has not made any specific accusations, the notification given to Paxos pertains to the issue of whether stablecoins should be considered securities.
Conversely, Paxos strongly disagrees with the SEC staff and maintains that BUSD is not a security under federal securities laws.
The SEC employs the Howey test to determine whether something is considered a security or an “investment contract.” The Howey test involves four factors used to determine whether an investment contract exists, such as whether there is an expectation of profits from the investor.
If the SEC classifies BUSD as a security, the regulator will gain supervision over the stablecoin. The company issuing BUSD must register with the SEC and be subject to more rigorous regulation. Additionally, other stablecoins may also be classified similarly.
Townsend Lansing, the head of product at CoinShares, informed CNBC that the basis for any action against Paxos would rely on the BUSD structure’s specifics. Still, it would have considerable consequences for other stablecoin issuers who sell their coins in the United States.
What are the likely outcomes?
Several different possibilities could occur, contingent on the nature of the SEC’s allegations against Paxos and how the parties move forward.
Mariotti suggests that it is probable that the SEC will agree with Paxos, in which Paxos acknowledges that BUSD is security. Other stablecoins will follow suit by registering.
Mariotti suggested that while it is feasible that Paxos may take an aggressive legal approach against the SEC, its expenses would be considerable. Litigation would require several years and present a significant risk of loss to the SEC. Even the fact that Paxos is battling the SEC would generate uncertainty and perhaps make BUSD less appealing to the market.
Mariotti suggested another possible outcome: that the SEC might impose regulations on the assets utilized to back stablecoins and the prerequisites for issuing digital currencies to provide disclosures to the market.
Lansing, from CoinShares, stated that the SEC’s interpretation of what constitutes a security or investment contract goes beyond just the Howey test and that the agency possesses comprehensive knowledge of how to utilize legal statutes and precedents.
Lansing added that if Paxos is unsuccessful in its legal fight against the SEC, it is probable that BUSD will no longer be available for sale in the US or on US-based digital asset exchanges. Other stablecoins might have to do the same, he said.
Are tether and USDC in the crosshairs?
According to Lansing, it is unclear to what extent the allegations made by the SEC against Paxos and BUSD will apply to other industry players, as the exact basis of the allegations has not yet been revealed. The outcome will depend on the details of the allegations made by the SEC.
Carol Alexander, a finance professor at Sussex University, says the action taken by the US regulator is not so much about stablecoins as it is about going after Binance. She pointed out that Tether and Circle, which issues USDC, have close ties to the US government. In fact, the CEO of Circle, Jeremy Allaire, has previously called for greater regulation of stablecoins.
Professor Carol Alexander suggests that the SEC’s action against BUSD could be more of a move against Binance, which has been causing increasing concern for regulators globally, particularly for possible violations of securities laws and money laundering. She believes this could be why the SEC has targeted BUSD.
Some previous reports hints, the US Justice Department has been investigating Binance for potential money laundering and sanctions rules violations. In addition, Bloomberg reported in 2021 that US officials were examining whether Binance employees engaged in insider trading.
According to Bloomberg, a Binance spokesperson said last year that the company has a “zero-tolerance” insider trading policy and a “strict ethical code” to prevent any misconduct.
