The Securities and Exchange Commission this week decided to go to war against stablecoins. In their latest action against Binance, the regulators claimed that BUSDBUSD – a stablecoin promoted by Binance – has been a security “since the beginning”. The SEC’s move comes several months after the New York Department of Financial Services ordered crypto exchange Paxos to end its role as manager of BUSD. If BUSD crumbles under regulatory pressure, other stablecoin projects could also be vulnerable.
The SEC alleged the following: Binance and “Trust Company A” issued BUSD. It would have agreed that Binance would collect money from the customer upon the purchase of BUSD and that trust company A would put the money into money-generating opportunities. The SEC didn’t seem to care if the money-making opportunities involved something as safe as Treasury bills or as risky as DeFi yields. It only cared that the opportunities were “profit-generating” and the entities “equally split the net interest income earned on BUSD’s underlying reserves.”
The SEC continued: Binance promised “interest-like” payments to people in the US who “just bought BUSD” and to those who stake BUSD in Binance-created yield programs. Binance allegedly funded those payouts to customers with “a portion of those proceeds” from the money-generating opportunities exploited by Trust Company A.
Any armchair securities attorney can do the how so analysis embedded in the alleged facts of the SEC. how so refers to a 1946 Supreme Court case that provides a framework for determining whether an arrangement or plan is an “investment contract”, a class of securities set forth in the Securities Act of 1933. That framework states that a plan is a security if a buyer invests money, that money goes to a joint venture, the buyer expects a profit (either capital appreciation or a share of earnings), and the buyers’ expectation is based on the management efforts of others. According to SEC allegations, private buyers invested money in BUSD by buying it from Binance. That money went into a money-making machine, the “Community Venture,” run by Trust Company A. And because Binance promised BUSD holders money and created a money-making ecosystem accessible only through BUSD, all BUSD buyers expected profits from the governance effort from Binance and Trust Company A. Instant security, just add private buyers.
At least, that’s probably how the SEC sees it. Binance certainly has a different view, which will be made public once it has filed a response to the SEC’s 136-page complaint. A judge may have a different opinion. The bottom line is that the SEC has put a flag high enough for any stablecoin issuer to get the message. According to them, stablecoins can be securities.
While the SEC relies on a how so analysis in its complaint against Binance, it has other attack capabilities at its disposal regarding stablecoin issuers. For example, the regulator may argue that a stablecoin represents a share in an open-ended company under the Investment Company Act of 1940. This argument becomes more convincing the more the stablecoin looks and behaves like a share in a money market fund, which the net asset value of their shares pegged 1:1 to the US dollar. Or, the SEC may argue, a stablecoin backed by a bundle of real-world assets is, in fact, an asset-backed security under Regulation AB.
However it decides to do it, the SEC has more hooks than how so offensive action against operators of stablecoin ecosystems. It could also exert its enforcement power against foreign actors offering their stablecoins in the US
A stablecoin report released by the Federal Reserve in December 2022 noted that stablecoins backed with off-chain assets, which often require central management, make up the “lion’s share of the stablecoin market.” That report also noted that stablecoins “typically [pegged to] the US dollar.” The majority of stablecoins thus have some connection to the US, either because buyers buy in the US or because the issuer or asset managers operate within the US. In the Binance complaint, it is suing Binance’s Swiss subsidiary for its role in issuing BUSD sold to US persons.
The SEC’s complaint envisions a bleak future for stablecoins with a US nexus. While the regulator takes their vision of the future to US courts, others are taking an alternative to Congress. The “McWaters” stablecoin bill represents a more hopeful future, one with a path to comprehensive regulation for stablecoin issuers, and one that may evade the onslaught of SEC enforcement action.
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