SEC Scrutinizes PayPal’s Stablecoin, Questioning Crypto Security Definitions

Key Insights:

• SEC’s scrutiny of PayPal’s PYUSD hints at broader crypto oversight.
• Howey Test’s ambiguity challenges stablecoin classification.
• Regulatory boundaries for crypto remain undefined.

In a regulatory move, PayPal, a global payments leader, confirmed its compliance with the SEC’s request in a recent quarterly report. This action isn’t the SEC’s first foray into scrutinizing the crypto domain. Earlier this year, the regulatory body also filed a suit against the Binance-brand BUSD stablecoin, a product of Paxos, which similarly co-manages PayPal’s PYUSD.

Many industry observers view these actions as evidence of the SEC, under Chairman Gary Gensler, potentially “picking winners” in the rapidly growing cryptocurrency world. While crypto-natives have mostly steered the crypto sub-sector, PayPal distinguished itself as the first significant fintech to venture into the stablecoin arena, soon followed by VISA.

The Importance of PYUSD’s Launch

During the challenging phase known as “crypto winter,” PayPal’s decision to launch its stablecoin was a beacon of hope for many crypto enthusiasts. It was interpreted as a strong endorsement of the technology. Given that most stablecoins are linked to the U.S. dollar, their growth might boost the global desire for this currency, strengthening America’s financial hold.

Yet, not every response echoed approval. Rep. Maxine Waters (D-CA), formerly at the helm of the esteemed House Financial Services Committee, voiced her apprehensions regarding the stablecoin the previous August. Waters believes such an innovative “form of money” mandates “federal guardrails.”

The Howey Test and Stablecoins

Jesse Austin Campbell, commonly known by his middle name, delves into the complexities surrounding the “Howey Test.” This guideline, adopted by the SEC, helps to determine what falls within its regulatory jurisdiction. Campbell suggests that if the SEC opts for litigation, they might argue that PYUSD is an “investment contract” under existing securities laws based on this test.

But there’s a catch. As Campbell points out, the Howey Test doesn’t encompass “banking activities and insurance.” Drawing a parallel, he emphasized that a JPMorgan checking account, despite accruing interest, isn’t classified as a security. Most indications suggest that PayPal adhered to regulations during PYUSD’s launch, even securing oversight from the New York Department of Financial Services (NYDFS), a renowned global financial regulator.

Are Stablecoins Truly Securities?

Stablecoins are blockchain-integrated assets designed to maintain a constant value. Their resemblance to securities remains a point of contention. Campbell, attempting to provide a reasonable faith interpretation of the SEC’s perspective, states that if a ‘collective enterprise’ exists to make money, then that is a securities arrangement. By this logic, PayPal and Paxos, in jointly creating PYUSD, are engaged in a securities enterprise.

Nevertheless, this interpretation has flaws. For a venture to be labeled a collective enterprise, the primary expectation of profits should arise from the efforts of others. Here, both PayPal and Paxos are actively involved, raising the question of where external funds originate.

One could argue that these funds come from customers who transfer money to PayPal in exchange for stablecoins. These stablecoins could then be stored and potentially invested to earn interest. Yet, if we label such enterprises as securities, many traditional financial tools, like checking accounts or even PayPal’s primary service of online money transfers, could be lumped into the same category.

Campbell terms this scenario as “reductio ad absurdum,” implying that if the SEC can arbitrarily label any entity as a security, it essentially negates the very foundation of securities law. This sentiment has been echoed by crypto-specialist lawyers like Brian Frye and Lewis Cohen, mainly because the Howey Test’s ambiguity could potentially label any profit-yielding purchase, even art or sneakers, as a securities offering.

As the crypto world watches closely, the question remains: Where should the line be drawn? Only time and a series of legal battles will clarify the true nature of stablecoins in the eyes of regulators.