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

The US Securities and Exchange Commission may be preparing to take action against Paxos, a company that issues a cryptocurrency called a 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 money. They have become the backbone of the crypto market as they allow people to quickly trade different coins without having to convert and convert fiat currency.

Paxos launched a digital currency called Binance USD or BUSD. It is a stablecoin affiliated with Binance, one of the world’s largest cryptocurrency exchanges. The BUSD is pegged to the US dollar.

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

Separately, Paxos said the SEC issued a notice saying the regulator is considering recommending actions alleging that BUSD is a security. Paxos said the notice indicated that Paxos was required to register the BUSD offering under federal securities laws.

The SEC has not initiated formal action. But the agency’s actions are being watched closely, because if it were to start formal proceedings, it could have huge implications for all stablecoins, including bring and USDCthe two largest, worth a combined $110 billion.

“If the SEC indicts Paxos, any other stablecoin issuer would have to register or prepare for litigation with the SEC,” Renato Mariotti, a partner at law firm BCLP, told CNBC.

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

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

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

If the SEC recognizes BUSD as a security, then the regulator will oversee the stablecoin. Whichever company it releases, BUSD will have to register with the SEC and adopt stricter rules.

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

“The basis for such actions will necessarily be facts specific to the Paxos BUSD structure, but will likely have broad implications for other stablecoin issuers selling coins in the US,” Townsend Lansing, head of product at CoinShares, told CNBC.

There are several different scenarios that could play out. That will depend on what the SEC files against Paxos and how both sides move forward.

“I believe it is likely that the SEC will reach a settlement with Paxos in which Paxos recognizes BUSD as a security, which will lead to other stablecoins following suit and registering,” Mariotti said.

“It is possible that Paxos will actively litigate with the SEC, but the cost will be significant,” Mariotti said.

“The litigation would drag on for years, and the risk of losing to the SEC would be significant. The fact that Paxos fought against the SEC would create risk and potentially make BUSD less attractive to the market.”

Another result, Mariotti said, is that the SEC could regulate what assets are used to back stablecoins and the digital currency’s market disclosure requirements.

CoinShares’ Lansing said that what the SEC considers a security or an investment contract actually falls outside the scope of the Howey test, and the agency has “extensive knowledge of how to apply both the law and case law.”

“Absent a successful fight, it is likely that BUSD will no longer be sold in the US and will not be available on US digital asset exchanges,” Lansing said. “It is very possible that other stablecoins will follow suit.”

That will depend on what the SEC charges against Paxos and BUSD.

“We still don’t know the exact basis on which the SEC is alleging 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 actions are “rather anti-Binance than anti-stablecoins”.

She said Tether and Circle, the company that issues USDC, are “close to the US government.” Circle CEO Jeremy Aller has previously called for stronger regulation of stablecoins.

Alexander said that “Binance is of increasing concern to regulators around the world” in areas ranging from money laundering to securities law violations. That may be one reason the SEC targeted BUSD, she said.

The Justice Department is investigating Binance on suspicion of money laundering and sanctions violations, Reuters reported last year. Bloomberg reported in 2021 that US officials were investigating 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 had a “zero tolerance” policy for insider trading and a “strict code of ethics” to prevent any violations, Bloomberg reported.