If PayPal's Stablecoin Is a Security, Anything Could Be

The U.S. Securities and Exchange Commission (SEC) is requesting documents related to PayPal’s relatively new stablecoin, PYUSD. The payments giant is reportedly complying with the request, it disclosed in a quarterly report.

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This marks the latest in a series of regulatory actions against the crypto industry taken by the securities regulator led by Chairman Gary Gensler. Notably, the SEC filed suit against the Binance-brand BUSD stablecoin issued by Paxos in March. PayPal’s stablecoin is also a product co-managed by Paxos.

To many observers, this latest subpoena, which could but does not necessarily have to lead to an official lawsuit, reeks of the SEC “picking winners” in the emergent world of crypto. In a sub-sector dominated by crypto natives, PayPal was the first major fintech to launch a stablecoin, followed shortly after by VISA.

At launch, in the depths of “crypto winter,” PayPal’s entrance signaled a strong show of support for the technology, which many see as beneficial to U.S. interests. Stablecoins are primarily denominated in U.S. dollars, and so arguably increase global demand for and access to greenbacks, which could be said to bolster U.S.’ monetary hegemony.

Though the PYUSD launch was also a controversial move. Rep. Maxine Waters (D-CA), who until recently led the important House Financial Services Committee (from 2019 to 2023), said she was “deeply concerned” about the stablecoin in August. Stablecoins are a significant point of contention for U.S. lawmakers and regulators, and one of the few areas of crypto where progress is being made on the legislative front.

Waters has said the “issuance of a new form of money” requires “federal guardrails.”

But this may not actually be true. As Jesse Austin Campbell (who goes by his middle name) said, there is a massive exception to the so-called “Howey Test,” the guideline used by the SEC to determine what falls under its remit, which will likely be cited to argue that PYUSD is an “investment contract” under existing securities laws if the SEC decides to file suit.

“The problem is … if you are already in a more restrictive regulatory regime,” Campbell said. “That is to say, you know what's not captured by Howey? Banking activities and insurance — your JPMorgan checking account is not a security even if it pays you interest.”

By all accounts, PayPal followed the rules when launching PYUSD, a product that is overseen by the New York Department of Financial Services (NYDFS), one of the foremost financial regulators in the world.

Then there’s the open question of whether stablecoins, a type of blockchain-based asset meant to keep a monetary peg, could even be said to resemble securities. I asked Campbell for a good faith interpretation of the SEC’s argument:

“I think what the SEC would say to these things is “guys, we believe this is a securities arrangement,” because if you look at Howey as a coherent whole (not the specific four-prong test), the principles-based thrust of it is that if a ‘collective enterprise’ exists to make money than that is a securities arrangement. I think you really have to simplify it down to that level.

“PayPal and Paxos have a joint commercial arrangement to create this stablecoin — that they’re going to issue, not sell, to people — so as a result of that issuance there is a collective enterprise to make profits, and therefore it’s security.”

The only problem with that reading, Campbell said, is that under existing securities rules, the “profits” in question would need to come from a “collective enterprise” where the “expectation of profits” primarily comes through the “efforts of others.”

It seems almost silly to say this, but PayPal and Paxos are in this arrangement together. The effort is theirs. “This kind of asks the question, ‘where's the outside money coming from,’” Campbell said.

The obvious response here would be, well, people who send money to PayPal to receive stablecoins that they can use on- and off-platform. That money is then supposed to be stored by PayPal and Paxos in a reserves fund, which may or may not reinvest the capital to earn interest — the same type of arrangement that had made Tether and Circle, the two largest stablecoin issuers, into cash cows.

The only trouble is — whether or not these types of enterprises pay out a portion of those reinvested returns to stablecoin users or minters, which to my knowledge isn’t being discussed for PYUSD anyway, but would complexify the idea of a “collective enterprise’s profits” — this same type of arrangement would apply to any number of financial tools that are decidedly NOT securities.

See also: What's Wrong With PayPal's Stablecoin? | Opinion

Stablecoins, in this sense, resemble checking accounts, giftcards, reward points and … PayPal’s primary product — the cash-equivalent tokens used for online money transfers.

Campbell referred to this situation as a “reductio ad absurdum.” Effectively, the SEC can say anything is a security as long as they say it is. To be fair, others like crypto-focused lawyers Brian Frye and Lewis Cohen have made similar remarks, in part because the Howey Test is vague enough, technically, where any purchase that could lead to a profit — from fine art to collectible sneakers — could be considered a securities offering.

The question is: where to draw the line.

“If everything is a security so long as the SEC wants to define it that way, then from a legal perspective you could argue nothing is a security, because this undermines the entire premise of securities law,” Campbell said.

CORRECTION (NOV. 2, 2023 19:30 UTC): Original version of this article erroneously referred to the SEC's subpoena as a "Well's notice."