PayPal Stablecoin Operations Scrutinized by SEC. What is Next?

The U.S. Securities and Exchange Commission (SEC) recently turned its regulatory focus towards PayPal and its stablecoin, PYUSD. It reflects a growing interest in the stablecoin sector which could potentially shape the ventures of major financial players.

Backtrack to Regulatory Request

Rewinding to August 2023, the SEC requested documents concerning PayPal’s stablecoin initiative. PayPal, in its quarterly report, revealed its compliance with this request. This move marks an extension of a broader regulatory sweep against the crypto sector by the SEC, led by Chairman Gary Gensler. Notably, the SEC lodged a lawsuit against the Binance-branded BUSD stablecoin issued by Paxos in March, a stablecoin co-managed by Paxos much like PYUSD.

SEC’s Selective Scrutiny towards PayPal

Observers interpret the latest subpoena, which may or may not culminate in a lawsuit, as the SEC’s selective validation in the burgeoning crypto space. PayPal ventured into stablecoins as a major fintech pioneer, soon followed by VISA. This initiative, amidst the “crypto winter”, stood as a robust endorsement for the technology, perceived as beneficial for U.S. interests due to the U.S. dollar denomination of most stablecoins.

However, PYUSD’s launch stirred controversy with Rep. Maxine Waters voicing deep concerns, reflecting broader contention among U.S. lawmakers and regulators towards stablecoins. Despite this, PayPal, under the vigilant eye of the New York Department of Financial Services (NYDFS), adhered to the prevailing rules during PYUSD’s inception.

The crux revolves around whether stablecoins, engineered to maintain a monetary peg, can be classified as securities. The SEC argues that the collaborative commercial endeavor between PayPal and Paxos in crafting PYUSD, aimed at issuing (not selling) the stablecoin to individuals, embodies a collective enterprise for profit, hence qualifying as a security. This interpretation, however, challenges existing securities norms, particularly concerning the source of “profits” in such arrangements.

Industry Reaction and PYUSD’s Code Flaws

The narrative shifted positively post Ripple Labs’ victory over the SEC in July 2023, reigniting traditional financial institutions’ interest in the crypto domain. Yet, PayPal’s PYUSD launch, intended as a TradFi adoption milestone, faced resistance from crypto natives due to inherent flaws in PYUSD’s smart contract code. If left unaddressed, these issues may embolden other institutions to bypass crypto rules, potentially reshaping the industry to their advantage.

Potential Vulnerabilities and Centralization Concerns for PayPal

A scrutiny of PYUSD’s code unveils vulnerabilities, common to smart contracts, capable of freezing or erasing account balances, thereby undermining trust and adoption. Another concern emerges from the “wipeFrozenAddress” function in PYUSD’s code, allowing the erasure of tokens from a frozen account, akin to incinerating dollar bills. Moreover, a “pause” functionality implies PayPal’s ability to halt token transfers or trades universally, resembling a scenario where a button’s push renders physical dollar bills unusable, with sole discretion resting with PayPal, a firm with a history of unilateral account actions.

This unfolding scenario underscores the juxtaposition of traditional financial institutions venturing into the crypto realm, against a backdrop of evolving regulatory frameworks and inherent trust issues related to centralization, paving the way for further dialogues among regulators, financial entities, and the crypto community.