Recently reported planned enforcement action against the Paxos Trust Company by the US Securities and Exchange Commission (SEC) over Binance USD (BUSD), many in the community have wondered how the regulator could view a stablecoin as a security.
Blockchain lawyers told Cointelegraph that while the answer is not black and white, there is an argument for it if the stablecoin was issued in the expectation of profit or is derivatives of securities.
A report from The Wall Street Journal on Feb. 12 revealed that the SEC plans to sue Paxos Trust Company over the issue of Binance USD, a stablecoin it created in partnership with Binance in 2019. In the notice, the SEC allegedly claims that BUSD is an unregistered security.
Aaron Lane, a senior lecturer at RMIT’s Blockchain Innovation Hub, told Cointelegraph that while the SEC may claim that these stablecoins are securities, that proposition has not been adequately tested by the US courts:
“With stablecoins, a particularly contentious issue will be whether an individual’s investment in the stablecoin has led to an expectation of profit (the ‘third arm’ of the Howey test).”
“If you look at it narrowly, the whole idea of the stablecoin is that it is stable. From a broader perspective, it could be argued that arbitrage, hedging and staking opportunities create earnings expectations,” he said.
Lane also explained that a stablecoin may be subject to US securities laws if it is found to be a derivative of a security.
This is something that SEC Chairman Gary Gensler strongly emphasized in a July 2021 speech to the American Bar Association Derivative and Futures Law Committee:
“Make no mistake, it doesn’t matter if it’s an equity token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities.”
“These platforms — whether in the decentralized or centralized finance space — are involved in the securities laws and must operate within our securities regime,” he said at the time.
However, Lane stressed that ultimately each case will “turn on its own facts,” particularly when assessing an algorithmic stablecoin rather than a crypto or fiat-collateralized one.
A recent post from Quinn Emanuel Trial Lawyers also touched on the subject, explaining that in order to “step up” stablecoins to a “stable value”, they can sometimes be offered at a discount before they have sufficiently stabilized.
“These sales may support an argument that, despite formal disclaimers by both issuers and buyers, initial buyers are buying with the intent to resell at the higher price after stabilization,” it wrote.
But while stablecoin issuers may resort to the courts to settle the dispute, many believe the SEC’s “regulation-by-enforcement” approach is inappropriate.
Digital asset attorney and partner Michael Bacina of Piper Alderman told Cointelegraph that the SEC should instead provide “sensible guidance” to help industry players who want to comply legally:
“Regulation through enforcement is an inefficient way to meet policy outcomes, as SEC Commissioner Peirce recently pointed out in her blistering dissent on the prosecution of Kraken. When a fast-growing industry does not fit into the existing regulatory framework and is looking for clear paths to compliance, engagement and sensible guidance is a much better approach than resorting to litigation.”
Cinnamhain Ventures partner Adam Cochran gave a different take to his 181,000 Twitter followers on Feb. 13, noting that the SEC can sue any company that issues financial assets under the much broader Securities Act of 1933:
The digital asset investor went on to explain that the SEC is not limited to the Howey test:
“The fact that these assets contain underlying government bonds makes them much like a money market fund, exposing holders to a security even if they are not making any profit from it. Making an argument (not one I agree with, but fair enough) that they can be a certainty.
“Worth fighting tooth and nail, but anyone shrugging this off as “lol, the SEC is wrong, this won’t pass the Howey test” needs to be reassessed. The SEC, believe it or not, has knowledgeable securities attorneys,” he added.
Related: SEC chairman compares stablecoins to casino poker chips
The SEC’s last reported planned action comes after reports emerged on Feb. 10 that Paxos Trust was under investigation by the New York Department of Financial Services for an unconfirmed reason.
Commenting on the initial reports, a Binance spokesperson said BUSD is a “Paxos-issued and proprietary product,” with Binance licensing its brand to the company for use with BUSD. It added that Paxos is regulated by the New York Department of Financial Services (NYDFS) and that BUSD is a “1 to 1 backed stablecoin”.
“Stablecoins are a critical safety net for investors seeking refuge in volatile markets, and restricting their access would directly harm millions of people around the world,” the spokesperson added. “We will continue to monitor the situation. Our global users have a wide variety of stablecoins at their disposal.”