Paxos has been ordered by New York regulators to stop issuing the Binance USD (BUSD) stablecoin.
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The US Securities and Exchange Commission may be preparing to take action against Paxos, a company that issues a type of cryptocurrency called a stablecoin.
The move will have major implications for the $137 billion market, experts told CNBC.
Stablecoin is 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 reserves. They have been 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 issues 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 one-to-one with the US dollar.
Last week, New York state financial regulators ordered Paxos to stop issuing BUSD.
Separately, Paxos said the SEC has issued a notice that the regulator is considering recommending action alleging that BUSD is a security. Paxos said the notice indicates Paxos is required to register the BUSD offering under federal securities laws.
The SEC has yet to initiate formal action. But the action of the agency is closely monitored because if it starts official procedures, it can have big implications for all stablecoins included tether and USDCthe two largest combined are worth $110 billion.
“If the SEC charges Paxos, other stablecoin issuers will have to register or prepare for a fight with the SEC,” Renato Mariotti, a partner at law firm BCLP, told CNBC.
What are stablecoins securities?
While the SEC has not come out with specific charges, the news for Paxos focuses on the question of whether stablecoins are securities or not.
For its part, Paxos said it “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 an “investment contract.” There are four criteria to determine whether there is an investment contract as part of the Howey test, for example, if there is an expectation of profit from the investor.
It is possible that Paxos will aggressively litigate the SEC, but the costs involved will be significant.
Renato Mariotti
partner, BCLP
If BUSD is considered a security by the SEC, regulators will monitor the stablecoin. Any company that issues BUSD must register with the SEC and receive stricter regulations.
Another implication is that other stablecoins will also be labeled similarly.
“The basis for this action will likely be specific to the Paxos BUSD structure but will have broad implications for other stablecoin issuers selling coins to the US,” Townsend Lansing, CoinShares chief product officer, told CNBC.
What is the likely outcome?
There are several different scenarios that can be played. It will depend on whether the SEC sues Paxos and how both sides move forward.
“I believe that the SEC can reach a settlement with Paxos where Paxos recognizes that BUSD is a security, leading other stablecoins to follow suit and register,” Mariotti said.
“It is possible that Paxos will aggressively fight the SEC, but the costs incurred will be significant,” Mariotti said.
“The litigation will take years and the risk of losing to the SEC will be significant. The fact that Paxos is fighting the SEC will create risks and potentially make BUSD less attractive in the market.”
Another result, according to Mariotti, is that the SEC can regulate what assets are used to create stablecoins and the requirements for digital currency issues to make disclosures to the market.
CoinShares’ Lansing said that what the SEC considers to be a security or investment contract goes beyond the Howey test and that the agency has “extensive knowledge of how to apply the law and court precedent.”
“Absent a successful fight, it is likely that BUSD will no longer be sold to the US or available on US-based digital asset exchanges,” Lansing said. “It’s possible that other stablecoins will follow.”
Are tether and USDC in the crosshairs?
It will depend on what the SEC charges against Paxos and BUSD.
“We still don’t know the basis on which the SEC alleges these 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 action of US regulators is “more a move against Binance than stablecoins.”
He said that Tether and Circle, the company that issues USDC, are “close to the US government.” Circle CEO Jeremy Allaire has previously called for more regulation of stablecoins.
Alexander said “Binance causes increased concern for regulators around the world” in the area of money laundering to violations of securities laws. That could be one of the reasons the SEC is targeting BUSD, he said.
The Justice Department is investigating Binance for alleged sanctions violations and money laundering, 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 the company has a “non-tolerance” policy for insider trading and a “strict code of ethics” to prevent misconduct, according to Bloomberg.