SEC action against Paxos paints regulatory target on stablecoins

Stablecoins look to be the next part of the crypto ecosystem facing a regulatory crackdown. 

The U.S. Securities and Exchange Commission has issued notice to crypto infrastructure provider Paxos over its involvement in Binance USD stablecoin, alleging that the stablecoin is an unregistered security.

The New York Department of Financial Services also issued a consumer alert Monday morning saying that the state financial regulator, “ordered Paxos to cease minting Paxos-issued BUSD as a result of several unresolved issues related to Paxos’ oversight of its relationship with Binance in regard to Paxos-issued BUSD”. 

According to a statement from Paxos, the notice it received a likely enforcement action from the SEC was only related to BUSD, which is the third largest stablecoin by total supply. The company “categorically disagrees” with the SEC. An SEC spokesperson reiterated the agency’s policy of not commenting on “the existence or nonexistence of a possible investigation.” The Wall Street Journal first reported the SEC’s investigation into Paxos on Sunday evening.

The moves follow through on months of concerned rhetoric from regulators over stablecoins, which led to multiple high-profile crypto market crashes last year – first the Terra/Luna collapse, then FTT’s wobble, which led to FTX’s demise. Regulators in the U.S. and elsewhere have sounded skeptical about the ‘stable‘ in stablecoins. 

“Stablecoins have features similar to, and potentially competing with, money market funds, other securities, and bank deposits, and raise important policy issues,” SEC Chair Gary Gensler told a legal conference in Washington last September. “Depending on their attributes, such as whether these instruments pay interest, directly or indirectly, through affiliates or otherwise; what mechanisms are used to maintain value; or how the tokens are offered, sold, and used within the crypto ecosystem, they may be shares of a money market fund or another kind of security.”

‘Legitimate reason to be concerned’ 

“We welcome the commissions’ vigorous enforcement of existing statutes, rules and court decisions that apply to cryptocurrency,” said Bartlett Naylor, financial policy advocate at consumer advocacy group Public Citizen, in an email. 

The U.S. government has a “legitimate reason to be concerned,” said Aaron Kaplan, co-CEO of Prometheum Inc., a fintech company, arguing that stablecoins, if not managed properly, can pose a systemic risk to the financial system.  

The Financial Stability Oversight Council, a supercommittee of U.S. regulators, chaired by Treasury Secretary Janet Yellen and tasked with preventing another 2008-style financial crisis, included stablecoins in a comprehensive report on digital assets issued last October. 

That report included a warning that, “if stablecoins were to grow rapidly without adherence to and being paired with appropriate regulation, financial stability risks could result.” Those included runs on stablecoins, like what happened to FTT a month later, resulting in FTX’s collapse. 

“If BUSD is deemed a security, then it stands to reason that other fully reserved stablecoins – including Circle’s USDC – might be as well,” Kaplan said. Circle’s USDC is the second-largest stablecoin by market capitalization, according to CoinMarketCap.  

Richard Mico, CEO and chief legal officer at fintech platform Banxa, saw Circle’s USDC as the potential next regulatory target but thought that both Paxos and Circle could win in court against the SEC.  

A spokesperson for Circle did not respond to multiple requests for comment. 

All stick, no carrot

The move against Paxos holds significance in that the company embraced regulation, marketing itself as “the first regulated blockchain company,” and putting former FDIC Chair Sheila Bair and retired Sen. Bill Bradley, D-N.J., on its board. Given the firm’s profile, it’s likely other stablecoin issuers could face similar scrutiny from the SEC. 

Mico saw the agency’s move as another example of “how the regulatory body appears to have escalated its regulation-by-enforcement campaign.”

Stablecoin legislation that would have created a framework for issuers in the U.S. stalled out, due in part to disagreement between congressional authors and the Treasury Department, leaving the SEC with continued leeway to approach digital assets as it sees fit. 

Paxos is another example of how “the regulatory status quo” is challenging for crypto projects, said Jack Solowey, a policy analyst at the libertarian think tank Cato Institute’s Center for Monetary and Financial Alternatives. 

“One of the reasons for that concern is that there has not been adequate guidance,” Solowey said. “It does contribute more evidence and more data points for why we need regulatory clarity in the U.S. and that could come and frankly should come through Congress acting through legislation.”

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