Hunting down securities: Are stablecoins standing outside the securities' circle?

Circle takes a stand

Before the key hearing on 12 October in the ongoing SEC vs Binance case, the USDC stablecoin issuer Circle filed a court motion on 29 September. Circle argued that assets pegged to the US dollar, such as USDC, cannot be deemed an investment contract and therefore, securities. 

If you're new to the stablecoins' space, take a look at this article to learn more: 'What is a Stablecoin?'.

Circle stated that payment stablecoins do not possess the features of an investment contract since users don’t expect profit from these standalone purchases. Interestingly, Circle Chief Legal Officer Heath Tarbert is a former chair of the Commodity Futures Trading Commission (CFTC) which is another federal body that is suing Binance. 

As stated by Circle, the brief was not submitted to support any of the involved parties yet to aid the court’s consideration of the Securities and Exchange Commission’s (SEC) allegations about Binance and its asset sale. Circle didn’t argue whether Binance sold or offered a security, yet the stablecoin issuer made three main points in the amicus brief.

Three main points of Circle's filing

Circle primarily stated that payment stablecoins, specifically those tied to the US dollar such as USDC, present a vital part of the digital ecosystem and that they differ from any other digital token previously asserted by the SEC as securities.  

According to its legal action, payment stablecoins differ from other fungible digital assets because they are redeemable at a constant value and have a unique risk profile; since they are primarily used as a store of value, they cannot be a tool for anticipated profit. Circle added that people cannot use a stock certificate to buy pizza; when choosing a payment method, security is hardly what comes to people’s minds.

Secondly, Circle noted that payment stablecoins cannot be considered as an investment contract or any other type of security. This means that the federal regulator doesn’t have the authority over standalone sales of such tokens.  

The USDC issuer pointed out that, even though non-security assets can be seen as part of an investment scheme, it does not convert them into securities. The brief highlighted that several courts have recognised that digital tokens standing alone are assets instead of securities. In fact, it says that decades of case law support that view.  

Finally, Circle said that the court should reject any imprecise or too broad assertion of jurisdiction over payment stablecoins in the SEC case. In simple terms, Circle thinks that the SEC should back down; at least, while stablecoins remain the subject of regulatory debate. 

Circle’s filing adds that the United States, unlike other countries, has failed to pass clear legislation to regulate the industry of digital assets at the federal level. To fill that void, regulators have been using existing federal laws in relation to the crypto space. The result is that the SEC gained a wide regulatory authority over the crypto industry. 

The USDC issuer noted that SEC didn’t gain the authority through new rulemakings yet by alleging that many companies and individuals have breached the securities laws by offering and selling unregistered securities. In other words, Circle said that the whole system failed to provide clarity to industry participants and consumers.

The background of SEC's case against Binance

The SEC made a move against Binance, stating that the Binance stablecoin BUSD has been a security since its inception. These legal proceedings took place several months after the New York Department of Financial Services ordered Paxos, a crypto exchange, to stop administering BUSD. 

The regulator laid down allegations that Binance and a trust company issued the stablecoin; allegedly, Binance agreed to take customer funds from the purchase of BUSD, and the trust company would place the money into other money-generating opportunities. The SEC didn’t get into the meaning of money-generating opportunities, yet based its allegations on the fact that these were profit-generating streams. 

Binance asserted that the SEC, in an attempt to claim authority over the crypto space, distorts the text of securities laws by reading the word contract out of the statutory phrase investment contract.

Furthermore, the allegations stated that Binance made post-sale promises based on interest to people who were just buying BUSD on the American soil, along with those who deployed the stablecoins into yield activities through Binance's reward programs.

Why did Circle back up Binance?

Circle Internet Financial LLC, referred to as Circle, is a global tech company that issues a stablecoin named USDC. Similar to other dollar-backed stablecoins, USDC is designed for making payments or settlements with a value pegged to the US dollar at a 1:1 ratio. 

The answer is evident – Circle has an interest in this case because SEC stated that Binance’s BUSD was an unregistered security. The solution of this case may have crucial implications and consequences for the regulatory future of payment stablecoins. 

The brief followed the public statement of Circle's chief strategy officer, Dante Disparte, cautioning about US bank failures affecting local stablecoin issuers and causing investors to turn to less regulated digital currencies abroad.

Circle argued all of this in its filing, and offered to assist the court in assessing the SEC’s allegations. It laid down a thorough legal analysis regarding why payment stablecoins shouldn’t be under the SEC oversight, and that financial trading laws shouldn't spread to crypto assets whose value is tied to other assets.

Are stablecoins securities?

For a stablecoin to be deemed a security, it needs to meet the three-part Howey test of an investment contract – an investment of money, a common enterprise and profits dependent solely upon the efforts of a third party. 

Circle argues, along with a bunch of other legal experts, that stablecoins provide no profits or expectation of profits, and therefore cannot be securities. It has been explained that due to stablecoins’ essential features of being crypto assets backed by other assets, they lack profit.

What do experts say?

If a stablecoin provided at least 1% of the underlying asset returns to investors, it would be a security according to Howey; however, if the percentage is zero, it cannot be a security. 

This is not as simple as it sounds because it requires a lot of legal definitions and interpretations. For example, if we interpret the term profits as ‘profits or losses’, stablecoins serve to minimise losses and preserve values through the efforts of a third party. However, not all investments that make no profit become securities. 

The third component of the Howey test is the most discussed one, and the part where stablecoins are likely to diverge from other crypto assets. A few other experts believe that stablecoins backed by assets other than fiat money could be analysed to assess whether potential growth in the value of the underlying asset is sufficient evidence. In other words, if such stablecoins were backed by a security, it could be stated that they are a derivative of a security. However, here we’re talking about fiat-backed stablecoins. 

On the other hand, the Howey test is embedded in the SEC’s allegations. The regulator stated that retail buyers invested money in BUSD by buying it from Binance which went into a money-generating machine or the common enterprise run by the trust company. Since Binance allegedly promised money to BUSD holders, buyers expected profits.

Final thoughts

Circle doesn’t say that it shouldn't be regulated, yet that the regulator should have provided clear guidelines instead of claiming authority. The stablecoin regulation has been bouncing around the Congress for some time now, and stablecoin issuers have been left without a roadmap to comply with. 

Other countries have not been waiting for the US to regulate stablecoins. For example, the EU enacted the Markets in Crypto Assets Act (MiCA) which encompasses provisions for the issuance of stablecoins such as auditing and collateral requirements. 

Circle is generally on board with regulation, but believes that SEC isn’t the right regulator for stablecoins. Taking into account that stablecoins fall under the payment activity category rather than being investment contracts, its opinion indicates that there should be a more appropriate regulator for stablecoins.