Confusion Spirals in Crypto as US Cracks Down

The SEC declined to comment, but Paxos, which is based in New York and Singapore, confirmed today that the agency claims BUSD should have been registered as a security in the United States, which requires compliance with complex rules. In a statement, the firm said it “categorically disagrees” that BUSD is a security, but has complied with an order from the New York Department of Financial Services to stop the creation of a new BUSD, effectively suffocating the coin.

Paxos did not respond to a request for comment. Binance’s chief strategy officer, Patrick Hillmann, declined to comment on how the SEC’s action would affect the exchange, but said the firm will “review other projects to ensure users are insulated from further undue harm.”

The crypto industry is no stranger to conflict with regulators, but the Paxos case is different – ​​and it has sparked a degree of panic and confusion. The concern is that a ruling against the issuance or use of BUSD will create a precedent that can be used everyone stablecoins, knocking down an important part of the infrastructure in many crypto markets. “If supply suddenly dried up, the crypto economy would collapse,” says economist Frances Coppola, who previously worked for HSBC and other banks.

Designed to cling to a specific value, usually $1, stablecoins are a critical pillar of the crypto-economy. Most are backed by a combination of cash and bonds, anchoring tokens in circulation to the desired value.

Unlike cash, which can be difficult to move around, especially across borders, stablecoins are “easy and fast,” says cryptoanalyst Noelle Acheson, formerly of CoinDesk, helping traders jump on opportunities as they arise. They have “opened up an on-chain economy,” says Ram Ahluwalia, CEO of wealth management firm Lumida, allowing money to “flow into and stay in the ecosystem.”

The SEC defines securities as contracts that constitute “an investment of money, in a joint venture, with a reasonable expectation of profit, to be derived from the efforts of others.” The classification entails a number of regulatory requirements and information requirements. If stablecoins were universally destined to be securities, issuers would be required to register them with the SEC, giving the agency a chance to reject coins. Any stablecoins already in the market may be subject to enforcement.

Confused members of the crypto industry, including Binance CEO Changpeng Zhaonow ask how stablecoins can possibly meet the SEC’s criteria, and in particular how cryptocurrencies designed not to fluctuate in value can be said to be sold with a reasonable expectation of profit.

But action against a major stablecoin issuer should come as no surprise, Acheson says, because the SEC has said on several occasions that it believes some stablecoins qualify as securities. Acheson imagines the regulator will argue that stablecoins like BUSD, backed by their issuers’ holdings of established securities such as government and corporate bonds, are by extension securities themselves and must be regulated accordingly.

Because neither the SEC nor Paxos has specified the nature of the regulator’s complaint, Ahluwalia says, the impact of a potential lawsuit is currently unclear. But that can hardly be good for stablecoin issuers – and could signal more trouble to come.

The move against Paxos is the latest in a volley of enforcement actions launched by the SEC in the wake of the collapse of crypto exchange FTX in November. Last week, the regulator announced that crypto exchange Kraken would halt one of its services in the US, after the SEC accused the firm of failing to register a security. And in January, the agency charged crypto exchange Gemini and crypto lender Genesis Global Capital for various services offered to American customers.

This crackdown is being described in crypto circles as Operation Choke Point 2.0 – a reference to a program launched by the Obama administration in which US officials allegedly pressured banks to cut ties with unfavorable industries such as pornography and lending.

Coppola says it feels like the SEC’s intention is to “drive crypto completely offshore,” and completely out of the United States. “The SEC wants to prevent US citizens from interacting with crypto. And I think other countries may follow suit.”

Despite fears that the SEC will target stablecoins more broadly, Acheson, Coppola and Ahluwalia suspect that the agency is taking on Paxos as a way to gain some control over Binance, and that it does not reflect animosity toward stablecoins in general. Although Binance is by far the world’s largest crypto exchange, it only operates a limited service in the US. But Reuters reports that the United States has long believed that Binance facilitated money laundering.

By targeting BUSD, the stablecoin that underpins much of Binance’s activity, Coppola says, the SEC could effectively shut the company off from a source of US dollars. Ahluwalia agrees, suggesting that the SEC is looking for creative ways to “decapture” Binance. “If you’re a regulator who has suspicions but no jurisdiction, you’re pulling the levers at your disposal,” he says. Binance has always maintained that it plays a central role in helping law enforcement deal with financial crime.

Until the SEC makes its intentions known, however, the crypto industry will have to wait. “We’re just guessing,” says Ahluwalia. If the SEC were to go after other stablecoin issuers, such as Circle or Tether, the consequences would be severe. Without stable coins that act as a “bridge” between volatile coins, trading would become more expensive and riskier, Coppola says — and the decentralized financial sector as a whole could topple. “Potentially,” she says, “this could destroy the entire crypto edifice.”