How the SEC vs. Paxos-BUSD battle could affect the stablecoin market

The US Securities and Exchange Commission could 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 cash in reserve. They have become the backbone of the crypto market as they allow people to quickly trade in and out of various currencies without having to exchange fiat currency in and out.

Paxos has issued a digital currency called Binance USD or BUSD. It is a stablecoin linked to Binance, one of the world’s largest cryptocurrency exchanges. BUSD is pegged one to one 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 that the regulator is considering recommending action alleging BUSD is a security. Paxos said the notice suggests that Paxos should have registered the BUSD offering under federal securities law.

The SEC has not yet begun official action. But the agency’s actions are under close scrutiny because if it initiates official proceedings, it could have huge ramifications for all stablecoins, including tether and USDC, the two largest, which are worth $110 billion combined.

“If the SEC sues Paxos, any other stablecoin issuer should either register or prepare for a lawsuit with the SEC,” Renato Mariotti, a partner at law firm BCLP, told CNBC.

While the SEC has not yet issued 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 qualifies as a security or an “investment contract.” There are four criteria for determining whether something is an investment contract as part of 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 would oversee the stablecoin. Whatever business issues BUSD should be, it should register with the SEC and accept stricter regulation.

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

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

There are a number of different scenarios that can play out. It will depend on what the SEC alleges against Paxos and how the two parties proceed.

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

“It is possible for Paxos to aggressively litigate against the SEC, but the cost of doing so would be significant,” Mariotti said.

“Proceedings would take years and the risk of losing the SEC would be significant. The mere fact that Paxos fought the SEC would create risks and potentially make BUSD less attractive to the market.”

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

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

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

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

“We still don’t know the exact basis on which the SEC alleges the violations, so we don’t know how far these allegations will extend to other industry participants,” Lansing said.

Carol Alexander, a professor of finance at the University of Sussex, said the US regulator’s action “is more of an action against Binance than against 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 increasingly worrying regulators around the world” in everything from money laundering to violating securities laws. That could be one reason why 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 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 company has a “zero tolerance” policy for insider trading and a “strict code of ethics” to prevent misconduct, according to Bloomberg.