By Anndy Lian
In the case of the stablecoin, BUSD, which is issued by the cryptocurrency exchange, Binance. In February 2021, Binance was reportedly under investigation by the CFTC (Commodity Futures Trading Commission) to determine whether it had violated U.S. rules by allowing Americans to buy and sell derivatives that are linked to digital tokens. Shortly after, it was reported that the SEC was also investigating Binance, specifically with regard to the issuance of the BUSD stablecoin.
This conversation started again this week. According to a press release on Monday, Paxos, the issuer of the stablecoin Binance USD (BUSD), has acknowledged receiving a Wells Notice from the U.S. Securities and Exchange Commission (SEC), indicating a possible enforcement action. The SEC’s charge is that BUSD constitutes an unregistered security, despite Paxos claiming it is not. BUSD is a stablecoin pegged to the U.S. dollar, and Paxos has stated that it is always backed 1:1 with U.S. dollar-denominated reserves, held in segregated accounts, and bankruptcy remote. Paxos also emphasized that the Wells Notice only pertains to BUSD and not any other part of its business. It is mentioned that they are prepared to litigate if necessary. Paxos also announced earlier that it would stop issuing new BUSD tokens at the direction of the New York Department of Financial Services (NYDFS), which CoinDesk reported on. The NYDFS is currently investigating Paxos.
Stablecoins are a type of cryptocurrency that is designed to maintain a stable value relative to another asset, such as the U.S. dollar. They are often used to facilitate transactions on cryptocurrency exchanges or to provide a stable store of value for users of cryptocurrency wallets. In the case of BUSD, the SEC is reportedly investigating whether the stablecoin qualifies as a security under U.S. law. If the SEC determines that BUSD is a security, the issuer could be subject to regulatory requirements under federal securities laws.
The BUSD case highlights U.S. authorities’ continued regulatory scrutiny of the cryptocurrency industry, as well as the potential for stablecoins to be considered securities under the Howey test. I honestly think that BUSD is not a security. This should be a firm stand from all parties as nobody would expect a profit from having BUSD. I will walk you through my thoughts.
Howey Test in 1946
The Howey Test is a legal test used in the United States to determine whether a transaction qualifies as an “investment contract,” which is a type of security that is subject to regulation under federal securities laws. The test is named after the 1946 U.S. Supreme Court case SEC v. W.J. Howey Co., which established the framework for evaluating whether an investment contract exists.
Under the Howey Test, a transaction is considered an investment contract if it involves:
1. An investment of money
2. In a common enterprise
3. With an expectation of profits
4. That are derived solely from the efforts of others
If a transaction satisfies all four prongs of the Howey Test, it is considered an investment contract and subject to federal securities laws, including registration requirements and antifraud provisions.
It’s worth noting that the “common enterprise” prong of the Howey Test has been broadly interpreted by courts to include various arrangements, including cryptocurrency and other digital asset offerings. In recent years, the SEC has applied the Howey Test in several high-profile cases involving digital assets, including initial coin offerings (ICOs) and various types of token sales.
The Howey Test is an important tool for determining whether a transaction qualifies as a security and is used by regulators, investors, and businesses alike to navigate the complex and evolving world of securities laws.
Debate on cryptocurrencies are securities
The question of whether cryptocurrencies are securities under U.S. law has been a topic of much debate and uncertainty. The Securities and Exchange Commission (SEC) has taken the position that some cryptocurrencies may be considered securities if they meet the criteria established by the Howey Test.
In 2017, the SEC issued a report stating that the offering of certain cryptocurrencies and initial coin offerings (ICOs) may be subject to federal securities laws. The report emphasized that whether a particular investment transaction involves the offer or sale of a security depends on the facts and circumstances of that transaction, and the application of the Howey Test.
The SEC has also brought enforcement actions against certain cryptocurrencies and ICOs that it considers to be securities. Another example, in 2018, the SEC charged two cryptocurrency companies with conducting unregistered securities offerings. The companies had offered and sold digital tokens that were deemed to be securities because they met the Howey Test’s criteria.
Despite this, the application of the Howey Test to cryptocurrencies is still a matter of debate, with many in the cryptocurrency industry arguing that it is not applicable to digital assets. Some have argued that cryptocurrencies should be considered a new asset class that does not fit within the traditional definitions of securities, commodities, or currencies.
In response to the uncertainty, some countries have sought to establish clearer regulatory frameworks for cryptocurrencies. In 2019, the Swiss Financial Market Supervisory Authority (FINMA) published guidelines that outlined the regulatory framework for digital assets in Switzerland. The guidelines aimed to provide clarity on the classification and treatment of digital assets for financial institutions and other market participants in the country.
According to the FINMA guidelines, digital assets are divided into three categories: payment tokens, utility tokens, and asset tokens. Payment tokens are defined as digital assets that are primarily used as a means of payment, such as Bitcoin or Litecoin. Utility tokens, on the other hand, are digital assets that provide access to a specific product or service, such as a digital ticket or a token that grants access to a particular platform. Finally, asset tokens are digital assets that represent assets such as real estate, company shares, or other physical or financial assets.
Each of these three categories of digital assets is subject to different regulatory requirements in Switzerland. Payment tokens, for example, are not considered to be securities under Swiss law, and as such, they are not subject to the same regulatory requirements as securities. However, financial institutions that provide payment services with payment tokens must comply with the country’s anti-money laundering regulations.
Utility tokens are not considered to be securities if they meet certain conditions, such as being redeemable for services or products on a platform, but not tradable on secondary markets. If these conditions are not met, utility tokens may be considered securities and subject to Swiss securities regulations.
Asset tokens are generally considered to be securities under Swiss law, and as such, they are subject to the country’s securities regulations. This includes complying with rules around prospectus requirements, disclosure obligations, and registration with the authorities.
The guidelines provided by FINMA have helped to clarify the regulatory treatment of digital assets in Switzerland. By defining clear categories of digital assets and outlining the corresponding regulatory requirements, the guidelines have provided greater certainty and stability for market participants in the country’s digital asset industry.
Such clarify is essential. To me, the application of the Howey Test to cryptocurrencies is still a matter of debate, it is clear that the SEC has taken the position that some cryptocurrencies may be considered securities if they meet the criteria established by the Howey Test. As such, cryptocurrency issuers and investors must be aware of the potential implications of the Howey Test and ensure that their transactions are compliant with applicable securities laws.
Modern-day application of Howey Test on Cryptocurrencies
As the cryptocurrency industry has evolved, questions have arisen as to whether the Howey Test is still applicable in the modern-day context of cryptocurrencies. To address this issue, some experts have proposed a modern-day version of the Howey Test that takes into account the unique characteristics of digital assets.
The proposed modern-day version of the Howey Test for cryptocurrencies would include several factors. The first factor would be whether there is an investment of money. If a digital asset issuer has not sold any assets issued to build its project, it is unlikely to be considered a security.
The second factor would be whether there is an expectation of profits from the investment. If the digital asset is utility-based, such as being used for voting purposes, it is unlikely to be considered a security.
The third factor would be whether the investment of money is in a common enterprise. If the project is decentralized and not controlled and operated by a centralized entity, it is unlikely to be considered a security.
Finally, the fourth factor would be whether any profit comes from the efforts of a promoter or third party. If the profit primarily comes from the community, which has nothing to do with the issuance of the digital asset, it is unlikely to be considered a security.
Adapting Howey Test to better fit Cryptocurrencies
Adapting the Howey Test to fit the unique characteristics of cryptocurrencies better is a complex issue, and there is an ongoing debate among legal experts and regulators on how to do so. However, some potential ways to improve the test’s application to cryptocurrency include:
Examining the underlying technology: One potential approach is to look at the underlying technology of a cryptocurrency and evaluate whether it is sufficiently decentralized and functional to qualify as a utility token rather than a security. For example, suppose a token is used primarily to access a particular blockchain network or platform, and its value is tied to its utility rather than speculation. In that case, it may be less likely to be considered a security.
Considering the role of promoters and third parties: Another potential approach is to examine the extent to which promoters or third parties play a role in the development and promotion of a cryptocurrency. If a token’s value is primarily driven by the efforts of a centralized entity or individual, rather than the broader community of users, it may be more likely to be considered a security.
Focusing on the economic reality of the transaction: Rather than relying on a strict application of the four-pronged Howey Test, some legal experts have suggested that a more flexible approach may be needed to assess whether a particular cryptocurrency is a security. This could involve looking at the economic reality of the transaction and considering a range of factors, including the nature of the token, the purpose of the transaction, and the expectations of the parties involved.
In conclusion, while the Howey Test has been a useful reference point for determining whether an investment qualifies as a security, it is not a perfect fit for the unique characteristics of cryptocurrencies. Cryptocurrencies, especially those that are decentralized, often have features that do not align with traditional securities, and thus may not meet the criteria outlined in the Howey Test. As the cryptocurrency industry continues to evolve, there is a growing need for regulatory frameworks that are tailored specifically to the unique nature of digital assets. While the Howey Test can serve as a starting point, it is important to adapt and refine the rules to better reflect the realities of the cryptocurrency market. It is clear that cryptocurrency is a new and rapidly developing asset class that requires careful consideration when applying traditional securities laws. A more nuanced and flexible approach is needed to ensure that innovation is not stifled while at the same time protecting investors from fraudulent activities.
Coming back to my first point- BUSD is not a security. BUSD is primarily used as a means of payment, rather than as an investment vehicle, and it is not designed to generate profits for investors in the same way that traditional securities do. The price of BUSD is intended to be stable and is tied to the value of the US dollar, rather than being subject to the speculative forces that often drive the prices of other cryptocurrencies. Let’s stick to this.
The author is an intergovernmental blockchain expert
