Last week, the U.S. Securities and Exchange Commission (SEC) sent a notice to cryptocurrency issuance firm Paxos, stating that it would classify one of its stablecoins — BUSD (Binance USD) — as a security. This means BUSD will be brought under the SEC’s regulatory system. Paxos responded recently that it completely disagrees with the SEC staff’s opinion, as BUSD is not a security under U.S. federal securities laws. It also added that it will engage with the SEC and file a lawsuit if necessary. If the SEC initiates official proceedings, this could have a huge impact on stablecoins including Tether (USDT) and USDC, two major stablecoins with a combined value of over $110 billion. Renato Mariotti, a partner at law firm BCLP, said that if the SEC actually takes action against Paxos, all other stablecoin issuers will have to either register with the SEC or prepare to fight legal battles with the regulator. A stablecoin is a cryptocurrency pegged to a relatively safe asset class such as fiat currency, with relatively low volatility compared to traditional cryptocurrencies. Stablecoins are divided into three categories: off-chain, on-chain and algorithmic. Some also categorize them as fiat-backed, crypto-backed and algorithm-backed. BUSD is a fiat-backed stablecoin, pegged 1:1 to the U.S. dollar. Currently, BUSD is the third-largest stablecoin, trailing only Tether and USDC. Paxos issues and owns BUSD, while Binance licenses its brand. Additionally, Binance is the largest dealer of BUSD. As an off-chain stablecoin, BUSD’s issuance and circulation model is relatively simple. Customers deposit a certain amount of U.S. dollars into Paxos’ bank account. After confirming the funds have arrived, Paxos transfers an equivalent amount of BUSD to the customer’s wallet. If a customer wants to redeem U.S. dollars, they need to transfer their held BUSD back to Paxos’ core wallet and pay a handling fee. Paxos will then transfer the U.S. dollars back to the customer’s account and destroy the corresponding amount of BUSD. BUSD’s trading model seems to have some similarities with investment securities. However, under the SEC’s Howey Test for determining securities, a security must satisfy four conditions: an investment of money, in a common enterprise, with investors expecting profits, and such profits coming solely from the efforts of others. One point stablecoins can argue is whether customers expect to profit from stablecoins. In fact, many people use stablecoins to transfer assets cross-border or as a store of value, which is a point Paxos could leverage. However, outsiders are not optimistic about Paxos’ opposition. Law firm partner Mariotti believes the SEC may reach a settlement with Paxos, where Paxos acknowledges BUSD is a security, leading to other stablecoins also needing to be registered as securities. Another outcome is that Paxos files a lawsuit against the SEC, but this could take years and most likely end in failure, incurring massive costs. The lawsuit itself would also negatively impact BUSD, reducing its market appeal. Mariotti also pointed out another possible outcome: the SEC would stipulate and regulate which assets can be used to back stablecoins, and require issuers to disclose requirements for digital currency issuance. Townsend Lansing, head of products at CoinShares, Europe’s largest digital asset investment firm, said that if Paxos fails in the end, BUSD will likely no longer be sold in the U.S. or listed on U.S. cryptocurrency exchanges, and other stablecoins will follow suit. Paxos had also been investigated by the New York Department of Financial Services (NYDFS) previously, over issues that its packaged version, Binance-Peg BUSD, was not authorized for issuance. In fact, the NYDFS only authorized Paxos to issue BUSD on Ethereum, and did not authorize it to issue Binance-Peg BUSD on other blockchains. The NYDFS is concerned whether Binance-Peg BUSD is backed 100% by U.S. dollars. However, it is noteworthy that USDT and USDC on Binance Chain have also not been authorized, but the NYDFS does not seem to intend to pursue this. The NYDFS has not explained why it only launched an investigation into BUSD. Carol Alexander, a finance professor at the University of Sussex in the UK, said that the U.S. regulator’s actions are less about targeting stablecoins and more about targeting Binance. She further noted that Tether and Circle, the companies behind Tether and USDC, have close ties with the U.S. government, while Binance is the top target of global regulators, having long been accused of money laundering and violating securities laws. BUSD has currently been banned from new issuance. Whether the U.S. regulatory authorities are targeting BUSD as a warning example or launching an indirect attack on Binance requires further observation. © 2021 Meishun (Hong Kong) Management Consulting Co., Ltd. and Meishun (Hangzhou) Management Consulting Co., Ltd. All rights reserved. Meishun Meiyin (Hangzhou) Consulting Management Co., Ltd. is a domestic subsidiary of Hong Kong Meishun Management Consulting Co., Ltd. under the same actual controller. Both companies are controlled by the same actual controller, both fall under the same Chinese management framework, and comply with the laws of Hong Kong and mainland China.