The U.S. Securities and Exchange Commission (SEC) is doubling down on its regulation-by-enforcement approach.
It is also getting a little local help from the New York Department of Financial Services (NYDFS).
This, as the federal regulatory agency reportedly issued Paxos, a New York-regulated blockchain infrastructure and financial services platform, a Wells Notice informing the crypto company it plans to bring enforcement actions against it for violating federal investor protection laws.
The news of the Wells Notice comes on the heels of a separate NYDFS investigation into the company’s issuance of Binance-branded BUSD stablecoins, as reported (Feb. 10) by PYMNTS.
In response to the news, PayPal has reportedly paused its own in-the-works stablecoin project.
The scope and rationale behind the NYDFS probe remain unclear, and Paxos has already said in a statement that it will stop issuing new BUSD by next Tuesday (Feb. 21) and that it is ending its relationship with Binance.
Paxos customers holding BUSD stablecoins will be able to redeem them through at least February 2024, per the press release announcing the company’s response to the regulatory probe.
Binance and Paxos partnered to launch the BUSD stablecoin product in 2019, and the stablecoin was approved then by the NYDFS.
“All BUSD tokens issued by Paxos Trust have and always will be backed 1:1 with U.S. dollar-denominated reserves, fully segregated and held in bankruptcy remote accounts,” the company said.
Read More: The Four Cracks in the Crypto Business Model
For its part, the SEC alleges that the BUSD stablecoin is an unregistered security. The Wells Notice sent to Paxos represents the agency’s first signaled enforcement action against a major stablecoin issuer.
Stablecoins offer a lucrative revenue stream for cryptocurrency platforms and provide much-needed flexibility and interoperability to the volatile crypto market.
The tokens provide digital asset investors wanting to easily buy and sell cryptocurrencies a “stable” token to trade in and out of without the requirement of bank settlements to facilitate transactions, which can take days to complete when dealing with the exchange of crypto for cash.
Companies that issue stablecoins tend to turn around and invest those customer deposits staked to the coin’s value into attractively safe, yield-bearing investments like short-term U.S. Treasury bonds, which have grown in value as the Federal Reserve continues to raise interest rates.
In many ways, stablecoins offer services to the crypto ecosystem that are not so different from those provided by financial institutions to more traditional investor marketplaces.
Still, some of the methods used by stablecoin issuers to justify their token’s mission-critical $1:$1 value, including those deployed by the industry’s dominant player Tether, have increasingly come under scrutiny as oversight of the cryptocurrency landscape becomes more of a priority for regulators and lawmakers.
If Crypto Is a Security, the SEC Can Regulate It
“In a time of growing markets, evolving technologies, and new forms of risk, our Division of Examinations continues to protect investors,” said SEC Chair Gary Gensler said in a recent statement announcing the SEC’s 2023 priorities.
The agency has already taken strong action against U.S.-based cryptocurrency exchange Kraken, shutting down the company’s U.S. crypto-staking services last week (Feb. 9) and charging it with a $30 million fine amid allegations that the exchange’s staking services amounted to “a sale of securities.”
The SEC’s latest action against Kraken is being viewed by industry observers as likely the first stirring of a broader federal campaign to crack down on the crypto industry by beginning to set clear definitions of whether digital assets represent securities and what registration and regulatory requirements they must adhere to if so.
The approach is shaping up to be one that relies more on regulation by enforcement to set up new guardrails for the industry.
“Instead of taking the path of thinking through staking programs and issuing guidance, we again chose to speak through an enforcement action,” wrote SEC commissioner Hester Peirce in a public dissent to the agency’s recent Kraken enforcement action.
“Nothing about the crypto markets is incompatible with the securities laws,” Gensler has said.
Industry observers are wary that the SEC chair is looking to set a foundational legal precedent around the securitization of digital assets.
In a recent insider-trading case brought by the SEC against a former Coinbase manager, nine tokens were identified as securities in the agency’s accusations. The manager has since pleaded guilty to the charges.
Coinbase has maintained that it would never allow securities on its platform and took aim at the SEC’s definition of cryptocurrencies in a recent legal filing, alleging that the SEC was taking a brute-force approach to its classifications by trying to shoehorn them into an unrelated enforcement.
“The term ‘investment contract’ requires — as the statute says — a contract. But here there are no contracts, written or implied. The developers who created the tokens at issue have no obligations whatsoever to purchasers who later bought those tokens on the secondary market. And with zero contractual relationship, there cannot be an ‘investment contract,'” says the Coinbase court filing, which also added that “The SEC lacks clear congressional authorization to deem the tokens at issue to be ‘securities.”
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