SEC reportedly preparing a battle against stablecoins

Last week it became known that the financial regulator of the state of New York started hostilities against Paxos. This is the issuer of one of the most important stablecoins in the cryptocurrency sector, BUSD. The agency asked the firm to stop the “minting” of that coin linked to the Binance cryptocurrency exchange.

The news immediately set off alarm bells in that market and makes many investors fearful about the future of this type of digital currencies. Unlike decentralized cryptocurrencies such as Bitcoin, stablecoins do not have a variable price. In that sense, their exchange value mirrors that of fiat currencies or resources and commodities such as gold.

The rise of these coins has been explosive, as they became the dream peer for domestic cryptocurrency trading. With them, people do not need to turn to traditional money to exchange virtual currencies. But this onslaught by New York regulators is seen as a prelude to the next battle of these assets. This would be precisely against the U.S. Securities and Exchange Commission (SEC).

Authorities target stable currencies

The stable coin market is approximately $137 billion. This is more than double the losses suffered by the entire sector in May 2022 with the fall of Terra, UST and Luna. Thus, it can be taken for granted that the implementation of strong prohibitive measures in the United States would have a colossal impact on the crypto market and sink prices again.

On the other hand, there are those who believe that the authorities’ crackdowns are focused on Binance and not on stablecoins in general. The rise of large centralized trading platforms is seen as a potential threat by many regulators. In the United States, there is no shortage of voices calling for a ban on such platforms. The precedent of the FTX bankruptcy becomes a cause for suspicion on the part of regulators.

Be that as it may, Binance’s stablecoin BUSD is in trouble due to the New York regulators’ measures against Paxos. In parallel, the strongest battle against the SEC could be on the way. According to experts consulted on the CNBC portal, the Commission would be preparing the offensive.

Thus, the SEC would take legal action against Paxos for the issuance of Binance’s stable coin. However, in the event of such a lawsuit, the company could react with determination, since it has reasons to do so. It would be a process full of ups and downs and the main affected would be the investors in the sector.

The impact of regulatory measures on other stablecoins

Aside from the episode with New York regulators, Paxos warned in a separate release about possible action against it by the SEC. In that paper, the firm says that regulators would rely on the assumption that BUSD falls into the securities category. As a result, the firm would have committed a crime by issuing such assets without the protection of federal securities law.

The recommendation of the action, therefore, would be based on a financial crime on the part of the company. For its part, Paxos categorically rejects that Binance’s stablecoin falls into that category. Although the SEC has not initiated action, the cryptocurrency market is closely watching the Commission’s steps. Action against BUSD would have major consequences for other similar coins. Notable among them are Tether’s USDT and Circle’s USDC.

To get an idea of the possible implications, it should be outlined that these two currencies have a combined market of $110 billion. “If the SEC charges Paxos, any other stablecoin issuer should register or prepare for a court fight with the SEC,” asserts Renato Mariotti of law firm BCLP, during a consultation with CNBC.

This context seems to put stablecoin issuers in particular and the crypto market in general in trouble. However, there is also potential for the SEC to fail in its attempt to manhandle the sector assuming that is its goal. The latter issue revolves around whether or not stablecoins such as BUSD, USDT or USDC are securities under official federal rules.

The hypothetical scenarios: lawsuit and Paxos’ reaction

At the moment it is not known what would be the SEC’s arguments to pursue the lawsuit against Paxos. However, there is a suspicion that its motive has to do with the fact that stablecoins are securities. In any case, the beleaguered company denies that the BUSD coin has these characteristics.

“The SEC staff’s view is not shared because BUSD is not a security under the federal securities laws,” they state. The Commission generally uses the Howey test to determine whether a given asset is a security or an “investment contract.”

They also point out that there are four criteria that serve as the basis for reaching a conclusion in this regard. One of the most obvious is whether there is an expectation of gain on the part of the investor. In this case, the company may aggressively litigate against the commission, since a stable currency has little chance of profit merely because of the fact of investing in it.

But going to court against the SEC can be a slow and costly process for any company. Moreover, the guarantees of winning start conditional on facing the organized power of the State. Thus, if the SEC considers BUSD to be a security, then that regulator will be tasked with overseeing this and other stable currencies.

The latter means that any company that accepts the commitment to issue BUSD is obliged to register with the SEC. This implies that it has a duty to accept extremely strict regulation. The end result is that nothing will prevent the rest of the stablecoins from receiving the same treatment almost automatically.

What will be the results of this battle?

There are several possible scenarios for the outcome of this impending battle between Paxos and the top U.S. regulator. At the end of the day, everything will depend on the stance taken by both sides. In other words, whether there will be a climate of belligerence or of negotiation to reach an agreement. Mariotti believes that a sort of amicable compromise is inevitable, with the SEC having the last word.

“I think it is likely that the SEC will reach a settlement with Paxos so that in it Paxos will recognize that BUSD is a security. This will lead other stablecoins to follow suit and register,” he opines. He notes that Paxos could pick up the gauntlet and respond aggressively in the course of the lawsuit. However, that would come at a cost to the firm.

As mentioned above, litigation could take years and could completely wear the company down. Apart from the advantage that the SEC as a state has over a company, the mood of investors comes into play. The firm’s defiance of regulators could take away the attractiveness of BUSD and other stable currencies in the market.

Currently, stablecoins are in the crosshairs of regulators, who argue that the companies behind those assets have questionable market behaviors with respect to funds. There is an accusation against Tether that it has no reserve backing. Although the firm has repeatedly denied by showing third-party results, the precedent of the accusation is already playing its part.

Against stablecoins or against Binance?

The outlook looks murky for the entire stablecoins market in general. However, there is a chance that the SEC’s problem is not with them, but against Binance. The exchange became a nuisance for regulatory authorities in several countries. Since 2021 many administrations banned the platform from operating within their borders.

“Binance is openly accused of money laundering and insider trading to profit illegally by taking advantage of its position. The exchange strongly denies these allegations and calls them unfounded.”

Since then, the company has undertaken multiple maneuvers to keep regulators happy. It has had some notable successes in this area. But in countries such as the United States, they do not seem to enjoy the sympathy of the authorities, who are keeping up the pressure. The collapse of FTX, the world’s second largest exchange, and Binance’s role in that collapse increased regulators’ concerns.

Carol Alexander, a professor at the University of Sussex, quoted in the same media, believes that the SEC is going after Binance and not against stable coins in general. While this may represent a relief for many issuing companies, targeting the leading exchange would put the cryptocurrency market in a complex situation.

It should not be forgotten that in 2022 the bear market drove the major coins to the bottom. A new episode of large magnitudes could mean further falls and a greater loss of capital for already battered investors.