The Securities and Exchange Commission (SEC) left many scratching their heads when it designated BUSD, a so-called stablecoin, as an unregistered security. The commission’s reasoning is complex yet intriguing — and raises questions about the classification of other stablecoins.
The SEC has explicitly classified dozens of digital assets as securities, including many ICOs like cardano (ADA), solana (SOL), ripple (XRP), algorand (ALGO), tron (TRX), and filecoin (FIL).
Interestingly, commissioners also classified Terra (UST), the failed stablecoin associated with Do Kwon’s Terra Luna (LUNA), as an investment contract. Many observers dismissed this securities classification without much thought, due to UST’s obvious collapse and algorithmic dependence on the hyperinflationary LUNA token.
However, the SEC turned heads on Monday when it classified another stablecoin which still trades near $1 as an unregistered security: Binance’s BUSD. The stablecoin’s ecosystem is jointly operated with Paxos.
Today we charged Binance Holdings Ltd. (Binance); U.S.-based affiliate, BAM Trading Services Inc., which, together with Binance, operates https://t.co/swcxioZKVP; and their founder, Changpeng Zhao, with a variety of securities law violations.https://t.co/H1wgGgR5ir pic.twitter.com/IWTb7Et86H— U.S. Securities and Exchange Commission (@SECGov) June 5, 2023
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For context, the SEC recently filed a lawsuit against the companies operating Binance.com and Binance US, as well as its founder Changpeng Zhao (CZ). It alleges that Binance secretly operates many of the functions of Binance US and has violated a litany of US securities laws.
How a stablecoin can be a security
The SEC’s lawsuit alleges BUSD has been offered as an investment contract. It claims that Binance and its founder withheld information that a reasonable investor would need in order to make an informed decision about whether or not to invest in BUSD.
Like many stablecoin backers, Binance promised BUSD would always remain at, or close to, a specified value — in this case, one US dollar. By making that promise, it might seem as though Binance promised that investors would not profit by investing in BUSD.
However, according to the SEC, Binance sold BUSD as a security according to the US Supreme Court-affirmed Howey Test because it sold investors on the totality of the BUSD ecosystem.
According to the SEC, “BUSD purchasers invested in a common enterprise with each other and with Binance — the BUSD ecosystem through which BUSD holders and Binance could and did earn returns through various forms of capital deployment.”
The SEC continued to explain the BUSD ecosystem which Binance offered “part and parcel” with its promotions of BUSD.
“The proceeds from investor purchases of BUSD were purportedly pooled in reserves, and Binance earned 50 percent of the investment returns on those pooled assets (which increased as more investors purchased BUSD),” its lawsuit read.
“Binance then used at least a portion of those returns to enable and promote the Binance ecosystem that gave BUSD its profit potential. Binance has, from the outset, marketed BUSD’s profit-earning potential and referred to the various ‘APYs’ (annual percentage yield) that investors may earn with respect to their BUSD holdings.”
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Selling BUSD part and parcel with investment schemes
Rather than sell BUSD as a stand-alone stablecoin which would not increase in value, Binance allegedly marketed various interest-earning or profit-generating schemes which required the purchase of BUSD.
For reference, an offering passes the Howey Test as an investment contract if it meets the following conditions:
- An investment of money,
- into a common enterprise,
- with a reasonable expectation of profit,
- to be derived from the efforts of others.
An investment contract means an entity was selling assets in a securities offering. If the asset would only exist as part of an investment contract scheme — such as the various interest-bearing, reward-earning, or profit-generating BUSD schemes — then even the asset itself could be a security.
To be clear, there are dozens of distinct types of investment contracts.
‘Guaranteed’ $1 with the opportunity to earn more
Furthermore, the SEC could regard Binance’s promise that BUSD would not lose value as a bedrock on which it constructed its various claims about BUSD’s profit opportunities. By promising to always redeem BUSD for at least $1 — and possibly allow BUSD holders to earn more than $1 through its various schemes — Binance could have easily passed the Howey Test by providing a common enterprise in which buyers invest money expecting to profit from the efforts of others.
In its lawsuit, the SEC explained how both BNB (which fluctuates in price) and BUSD (which does not fluctuate in price) can be offered as securities.
According to commissioners, “While investors’ profits with respect to Binance’s crypto asset security BNB came in the form of price appreciation, BUSD investors’ expectation of profits came from the potential for direct, interest-like payments made by Binance, in part from the proceeds of deploying BUSD investors’ capital.”