How the SEC and Paxos-BUSD fight could impact the stablecoin market

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Paxos has been ordered by New York regulators to stop issuing the Binance USD (BUSD) stablecoin.

Jakub Porzycki | Nurphoto | Getty Images

The U.S. Securities and Exchange Commission could be gearing up 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 U.S. dollar.

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

Paxos issued a digital currency called Binance USD or BUSD. It is a stablecoin associated with Binance, one of the world’s biggest cryptocurrency exchanges. BUSD is pegged one-to-one with the U.S. dollar.

Last week, New York state’s financial regulator ordered Paxos to stop issuing BUSD.

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

The SEC hasn’t started official action. But the agency’s actions are being watched closely because if it starts an official procedure, it could have huge implications for all stablecoins including tether and USDC, the two largest which combined are worth $110 billion.

“If the SEC charges Paxos, any other issuer of stablecoins should register or prepare for a court fight with the SEC,” Renato Mariotti, a partner at law firm BCLP, told CNBC.

Are stablecoins securities?

While the SEC has not yet come out with specific charges, the notice to Paxos focuses on the question of whether stablecoins are securities or not.

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

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

It’s possible that Paxos aggressively litigates against the SEC, but the cost of doing so would be significant.

Renato Mariotti

partner, BCLP

If BUSD is deemed a security by the SEC then the regulator would have oversight over the stablecoin. Whatever company issues BUSD would need to register with the SEC and accept more stringent regulation.

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

“The basis for that action will necessarily be fact-specific to the Paxos BUSD structure but will likely have wide ranging implications for other stablecoin issuers selling coins into the U.S.,” Townsend Lansing, head of product at CoinShares, told CNBC.

What are the likely outcomes?

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

“I believe that it is likely that the SEC reaches a settlement with Paxos in which Paxos concedes that that BUSD is a security, leading other stablecoins to follow suit and register,” Mariotti said.

“It’s possible that Paxos aggressively litigates 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 against the SEC would create risk and potentially make BUSD less attractive to the marketplace.”

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Another outcome, according to Mariotti, is that the SEC may regulate what assets are used to back stablecoins and the requirements for issues of the digital currency to make disclosures to the market.

CoinShares’ Lansing said that what the SEC considers a security or investment contract actually extends beyond just the Howey test and the agency has “extensive knowledge of how to apply both the law and judicial precedent.”

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

Are tether and USDC in the crosshairs?

It will depend on what the SEC’s allegations against Paxos and BUSD are.

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

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

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

Alexander said “Binance is causing increasing concern for regulators around the world” in areas from money laundering to violating securities laws. That could be one reason the SEC has targeted BUSD, she said.

The Justice Department is investigating Binance for suspected money laundering and sanctions violations, Reuters reported last year. Bloomberg reported in 2021 that U.S. officials were looking into whether Binance employees engaged in insider trading.

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

A Binance spokesperson said at the time that the firm has a “zero-tolerance” policy for insider trading and a “strict ethical code” to prevent any misconduct, according to Bloomberg.

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