Crackdowns, and Chinchillas: The Future of  Cryptocurrency

The SEC's activities regarding stablecoins would be the most recent in a long line of issues about the definition of security.

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The past of chinchillas may hold clues to the future of cryptocurrency.

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A company selling hundreds of the fluffy critters registered its offering with the Securities and Exchange Commission more than 80 years ago, just a few years after the enactment of the country's fundamental securities rules. Nowadays, there are still ongoing discussions regarding what exactly qualifies as a security, particularly in relation to cryptocurrencies and more recently, so-called stablecoins. These may not be contracts for living things, but SEC Chair Gary Gensler has alternately likened them to bank deposits or playing cards, comparisons that may turn out to be much more significant.

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The so-called algorithmic stablecoin TerraUSD and other crypto assets were the targets of a civil fraud lawsuit filed by the SEC on Thursday, which included a claim that the TerraUSD founder and firm were selling unregistered securities. The SEC allegedly filed a staff notice to Paxos Trust Co. stating that it intends to sue the business and that Binance USD, a stablecoin that Paxos issues and lists, is unregistered security, according to a report inTrade Algo. BUSD is not a security under federal securities regulations, according to a later statement from Paxos.

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It is not yet known why the SEC would file a lawsuit in the case of BUSD or what specifically it might claim. But, investors need to keep a close eye on both scenarios. These could have an impact on not just cryptocurrency businesses but also more broadly on financial technology and banking. Stablecoins are more than just a new type of token with a catchy name. They are regarded as a crucial medium within the digital asset space, not only for trading on exchanges but also possibly as a form of payment or savings, as they are instruments meant to be redeemed for a fixed quantity of fiat money.

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Stablecoins may be the most significant of the various offshoots of cryptocurrency. Stablecoins have been criticized as posing financial dangers by some in the banking sector, and a group of Biden administration officials has suggested that banks issue them. The administration has also looked into the possibility of creating a stablecoin-like digital dollar that would be issued by the government itself.

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Many in the cryptocurrency community may take legal solace in the way securities are frequently defined, but they argue that stablecoins, which are designed to be a fixed store of value, are missing at least one essential component: the expectation of profit. The so-called Howey test, which typically consists of three prongs: the investment of money, joint enterprise, and the expectation of rewards obtained from the efforts of others, is where the significance of profit originates from others.

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Regulators could also take inspiration from previous precedents. At a speech in April of last year, Mr. Gensler made reference to chinchillas, which were considered securities before Howey. When contending that crypto-lending products entail securities, the SEC has also cited another Supreme Court judgment from 1990 called Reves v. Ernst & Young, which dealt with whether so-called "notes" can be considered securities.

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According to Arthur Wilmarth, emeritus professor at the George Washington University Law School, how regulators perceive a certain stablecoin's function may be significant, particularly if it is thought to primarily facilitate profit-seeking investment. He noted that Mr. Gensler 2021 referred to stablecoins as "acting almost like poker chips at the casino right now" and that stablecoins offer "features similar to...bank deposits and money-market funds." "The no-interest stablecoin doesn't fit neatly within either the Howey test or Reves test unless you take this indirect approach," he said.

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Howey was mentioned in part by the SEC in its lawsuit over TerraUSD. A large number of US retail investors are said to have "bought [TerraUSD] for the sole purpose of receiving a return" on the yield-bearing Anchor Protocol, according to the lawsuit, which claims that the defendants created and maintained "profit-bearing opportunities" for TerraUSD.

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Yet, as they develop, there may be issues with some currencies that aren't generally applicable. The value of algorithmic stablecoins like TerraUSD is distinct in that it isn't derived from a reserve of assets. According to Mr. Wilmarth, investment considerations could be balanced against other elements, such as whether a stablecoin is utilized for both the buying and sale of things. In a framework released in 2019, the SEC identified certain potential mitigants to a digital asset's security status, such as whether it is intended to maintain a constant value or whether it may be "used to make payments in a wide variety of situations."

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All of this highlights a persistent problem for American financial innovators: analogy-based reasoning by legislators, regulators, and courts. Even if stablecoins are neither fish nor chicken nor chinchilla, the situation might not seem resolved until a decision is made.