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Welcome to The Node. This is Daniel Kuhn, here to take you through the latest in crypto news and why it matters. In today’s newsletter:

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Paxos Puts Up

Stablecoin issuer Paxos acknowledged it received a Wells Notice from the U.S. Securities and Exchange Commission, which claims the Binance USD token Paxos used to issue is an unregistered security and has threatened suit. The firm “categorically disagrees” with the SEC’s charges and is “prepared to vigorously litigate if necessary,” adding the notice does not impact any other part of its business and that BUSD was “always backed.” This follows rumors that competing stablecoin issuer Circle tipped off the New York Department of Financial Services in late 2022 that Binance did not always keep complete reserves for BUSD. Circle denied the accusation. Meanwhile, Binance has seen some $831 million of net outflows in the past 24 hours, decentralized stablecoin exchange Curve is seeing a boost of activity and Morgan Stanley wrote a report saying a drop in stablecoin capitalization and liquidity will damp the crypto industry’s prospects.

Hard Times

The U.S. SEC is reportedly planning rules to make it harder for hedge funds, private equity firms and pension funds to work with crypto firms. This includes more stringent rules for crypto firms to become “qualified custodians" (that hold client assets for money managers), according to Bloomberg’s sources. Meanwhile, Grayscale’s Bitcoin Trust (GBTC), the world’s largest publicly traded bitcoin fund, has seen its discount increase to about 47% – the widest level since Dec. 29, according to TradeBlock. This comes as the firm’s parent company, Digital Currency Group (which also owns CoinDesk), has started selling assets from Grayscale investment vehicles at a steep discount, securities filings show. Finally, Solana’s largest NFT marketplace, Magic Eden, will lay off 22 employees as part of a "company-wide restructuring." In a Twitter post, CEO Jack Lu explained the company’s updated goals amid a decline of activity on Solana.

Court Docs

The U.S. SEC’s case against FTX founder Sam Bankman-Fried will be put on hold until related charges brought by the Department of Justice are dealt with, a judge ruled on Feb. 13. U.S. prosecutors last week said a pause would save time and resources. On Tuesday, the U.S. Commodity Futures Trading Commission’s civil suit against Bankman-Fried was also delayed. SBF has pleaded not guilty in all cases. In other court documents, U.S. prosecutors claim SBF used a virtual private network, or VPN, to access the internet, which may prompt another update of his bail conditions. SBF’s lawyers said he used the location-masking web service to watch the Super Bowl. Elsewhere, Washington D.C.-based crypto lobbyists at the Blockchain Association have filed a “friend of the court” brief arguing the SEC is engaging in “absentee enforcement” in its case against a former Coinbase employee accused of front-running trades on the exchange. The SEC has unilaterally declared nine tokens are unregistered securities, which “is irreconcilable with due process” and creating a “chilling effect” on the blockchain industry, the filing reads.

"Because the SEC has been pursuing regulation of crypto almost entirely through enforcement actions … it leaves a lot of questions about what form of staking service would be acceptable to the SEC."

– Bain Capital crypto partner and head of regulatory and policy TuongVy Le, on CoinDesk TV's "First Mover"

The Takeaway: Shoring Up Stability

Last week Consensus Magazine published an editorial from senior policy analyst at Americans for Financial Reform Mark Hays, who argued the recent regulatory action against crypto should only be accelerated. Stablecoins, in particular, are "not worth the risk," Hays wrote. Since then, it has been revealed that the SEC and NYDFS have taken aim at Paxos' Binance-branded BUSD stablecoin, citing registration slip ups and potential damages to consumers.

In response two Columbia Business School adjunct professors have written columns defending stablecoins as a way to not only safely expand financial access but increase the U.S. government's "soft power." Omid Malekan, who is also the author of “Re-Architecting Trust: the Curse of History and the Crypto Cure for Money, Markets and Platforms," wrote that open, permissionless platforms expand the demand for U.S. dollars "at a time of high inflation and high deficits." Potentially trillions of dollars are at stake.

Meanwhile, Jesse Austin Campbell, who until December oversaw the BUSD portfolio at Paxos, wrote that stablecoins not only resemble existing, regulated financial products like money market funds but can be safer alternatives. "Stablecoins are arguably on better rails and are less risky than traditional mutual funds. Their reserves, the assets kept to back the stablecoin, are rarely leveraged out and consist of safer backing instruments than any bank in the United States," he wrote.

Given that Paxos is willing to go to the mat and potential fight the SEC or NYDFS in court, we may get a more clear view into the agencies' rationale that has been lacking from the public debate. On the face of it, unlike other "security-like" crypto assets, stablecoins do not promise a return on investments – exactly why they're useful in the world of trading. They're supposed to maintain their value. But there may be other justifications. Dragonfly Capital's Haseeb Quereshi said in recent podcast that regulatory enforcement against Paxos may be a way to get at the offshore crypto exchange Binance.

U.S. regulators may or may not be able to bring the world's largest crypto exchange under their remit, but they can make it increasingly unattractive and unviable for U.S. businesses to do business with Binance. All of this is unfolding at the U.S. Department of Justice reportedly readies a case against the exchange, and as other U.S. regulators seem intent on cleaving crypto from the traditional banking sector. Some have gone as far as calling the recent spate of regulatory advancements "Operation Choke Point 2.0," referencing the Obama-era program to debank legal but unsavory industries.

For his part, Campbell argued that authorities see crypto as a risk not just to consumers but their own power. "Reading between the lines, the real risk stablecoins pose is creating a system less amenable to government efforts of control." he wrote. There are existing channels to bring blockchain-based privately-minted dollar alternatives into the regulatory system – and good reason to do so. Because, as Campbell wrote, "technological progress is not going to stop." The question is whether it happens on U.S. shores or not.

– D.K.

@danielgkuhn

[email protected]

Fat Chains

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