The SEC Is Taking Aim at Paxos and (Annoyingly) It’s Good for Bitcoin

While the largest cryptocurrency has not been a direct focus for regulators, bitcoiners should not become cheerleaders.

AccessTimeIconFeb 15, 2023 at 2:32 p.m. UTC
Updated Feb 15, 2023 at 10:27 p.m. UTC
AccessTimeIconFeb 15, 2023 at 2:32 p.m. UTCUpdated Feb 15, 2023 at 10:27 p.m. UTC
AccessTimeIconFeb 15, 2023 at 2:32 p.m. UTCUpdated Feb 15, 2023 at 10:27 p.m. UTC

Chalk up another point for the regulators as the crypto onslaught continues. I hate to make this about Bitcoin, but I will. Because in a way, this is about Bitcoin.

The U.S. Securities and Exchange Commission (SEC) reportedly plans to sue crypto firm Paxos for violating investor protection laws because the firm issues, maintains and white labels Binance USD (BUSD). The SEC alleges that BUSD, a U.S. dollar stablecoin with Binance branding, is an unregistered security.

And while it seems bad for BUSD and Paxos, it’s good for Bitcoin. Leave it to the Bitcoin maximalist, I guess.

Never mind if it makes a shred of sense that something with no expectation of profit can be deemed a security (U.S. dollar stablecoins are not interest-bearing and they are pegged at $1), Paxos still decided to stop minting the stablecoin starting Feb. 21 at the direction of the New York Department of Financial Services (NYDFS). Paxos has since said it “categorically disagrees” with the SEC on the point that BUSD is a security and is “prepared to vigorously litigate if necessary.”

Points were also recently awarded to the regulators following crypto exchange Kraken’s settlement with the SEC last week on charges it was offering unregistered securities through a staking-as-a-service platform, and after Wyoming-based Custodia Bank was denied membership to the Federal Reserve System in late January for being a risk to the banking system since it aims to serve crypto clients.

Again, nevermind if the regulation makes a shred of sense. It is regulation nonetheless.

No regulation for you, Bitcoin

What’s missing from the regulators’ recent push is anything that represents a direct attack on Bitcoin. Sure, there are warnings of market volatility, and a lot of Bitcoin’s most-used trading pairs feature the stablecoins regulators are focused on. But putting Bitcoin in a chokehold isn’t a priority. That’s mostly because it would be quite difficult to do so.

For all the issues Bitcoin’s decentralized design presents, there isn’t a central company or individual that a government can pinpoint for a targeted regulatory push as it can for stablecoins (e.g., Paxos, Circle) or staking providers (e.g., Kraken, Coinbase). And for the Bitcoin-related companies or individuals it could pick out and somehow buffet, the network is decentralized enough that it would take the battering in stride. It would take a widespread, highly coordinated and expensive attack to meaningfully slow down the Bitcoin network.

As such, Bitcoin as a network will be largely uninhibited by this regulatory push.

No one should be surprised that regulators are regulating

That said, maybe Bitcoin regulation isn’t completely off the table after the Biden administration published a call to action to regulate the industry thoroughly, titled “The Administration’s Roadmap to Mitigate Cryptocurrencies’ Risks” on Jan. 27. Looking back at this, no one should have really been surprised with new crypto regulatory action.

The White House’s relatively short online post notes stablecoins twice: In the first instance it is enclosed in what must be scare quotes in reference to terraUSD, which collapsed; and in the second instance it linked to a (very long) Financial Stability Oversight Council (FSOC) October 2022 report on digital asset financial stability risks and regulation. The FSOC report specifically makes the case for robust regulation of stablecoin issuers’ reserve assets and banks’, credit unions’ and trust companies’ interactions with crypto – using the term “stablecoin” over 170 times in its 124 pages.

Now the regulators are taking direct action against the providers of stablecoins they deem to have opaque reserve practices – the custodial staking service providers like Kraken and the banks looking to service crypto companies like Custodia before they get too big and intertwined with the noncrypto financial system.

Yet, even though the keen observer shouldn’t be surprised by the recent regulatory moves they need not be happy with or satisfied with the regulation.

No one should be satisfied, even if you’re a Bitcoiner

From the same White House blog post:

“Safeguards will ensure that new technologies are secure and beneficial to all – and that the new digital economy works for the many, not just the few.”

I want to put aside the staking provider conversation to focus on the consequences of policies aimed at Paxos and stablecoins instead. With stablecoins as the focus, the White House’s sentiment encapsulated in the above quote is perfect, and you’d be hard-pressed to find anyone who could argue against it in good faith. Expanding access to sound financial services empowers people, which raises the quality of life across the board. But sentiment needs to be met with action to mean anything.

Forcing stablecoin issuers like Paxos to operate with almost unsettling transparency would be a good thing as long as it doesn’t become onerous for the issuer.

Right now, we generally have to trust that stablecoin issuers like Paxos (USDP, BUSD), iFinex Inc. (tether) and Circle (USDC) maintain adequate U.S. dollars or dollar equivalents in reserve to survive a spike in withdrawals by looking at “Trust and Transparency” blog posts or one-page .pdf uploads when we should have some other means in which we could verify their claims. If it’s not clear, this is where a blockchain is supposed to have value.

So policy which edges the stablecoin ecosystem away from where it is now with its “Don’t Verify. Trust.” dogma toward the exact opposite would be a net improvement for the aforementioned “many.” Especially because it is those “many” who can most benefit from stablecoins.

Just ask the Lebanese citizens who are opting to use U.S. dollar stablecoin tether to pay for groceries as their country’s sovereign currency tanks and the economic crisis continues to unfold. Regulation that decreases the likelihood of yet another bank run experience for people is a good thing. And don’t think for a second the plight of the Lebanese person doesn’t at least loosely resemble that of some Americans.

If the U.S. government instead intends to regulate stablecoins harshly in an attempt to introduce its own central bank digital currency (CBDC) with the same or worse transparency and strong-arm people into choosing it from a menu with only one option, then what have we actually achieved here? The attitude that “Uncle Sam knows best” is exactly why our institutions are the way they are now. U.S. stablecoins wouldn’t exist if the current banking infrastructure expanded access to financial services like permissionless stablecoin protocols rather than excluding half the world's population.

Don’t get me wrong, I maintain that stablecoin regulation is good for Bitcoin. Bitcoin is the escape hatch. In a world where the regulators continue to pile on stablecoins and other crypto-related things to the point where they’re rendered toothless, Bitcoin will be there.

Borderless, censorship-resistant, peer-to-peer money will be open for you then as it is now. Even if payments aren’t your thing and you live in the world of crypto trading, Bitcoin can fill in admirably as the base of trading pairs as it did in the early days of crypto if U.S. dollar stablecoins are regulated out of existence.

Still, although this can be good for Bitcoin, cheering for it by urging on regulation is unsavory and in exceedingly poor form. Freedom of choice is central to the Bitcoin ethos. Even though Bitcoin is the best choice, regulation shouldn’t force anyone to have to make that best choice.

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George Kaloudis

George Kaloudis was a research analyst and columnist for CoinDesk.