Notes 12/31: Binance’s BUSD: An Unstable Stablecoin

Binance USD (BUSD), Binance’s stablecoin, is among the few regulated parts of the exchange’s sprawling and mostly unregulated operations. It is issued by Paxos – a registered Trust company in New York that was a cryptocurrency exchange in its earlier avatar – and regulated by the New York Department of Financial Services (NYDFS). That stamp from authorities allays investor fears about BUSD’s reserves – deposits meant to make investors whole if there is a run on the token.

The stablecoin’s regulatory cred are a point of pride for both its issuer and customer.

On its website, Paxos touts BUSD as one of the only three regulated stablecoins in the market. Binance CEO Changpeng Zhao (CZ) also mentioned BUSD’s regulated status during a CNBC interview recently in response to questions about his company.

Like most things crypto, however, BUSD’s veneer of stability is false. It conceals a shaky edifice constructed out of crypto derivatives that use the stablecoin. The use of derivatives inflates its risk profile and makes a mockery of stablecoin regulations at the New York Department of Financial Services (NYDFS).

BUSD: An Unstable Stablecoin

The biggest problem with BUSD is its restricted regulatory perimeter. The stablecoin is issued as an ERC-20 token on Ethereum and NYDFS has restricted the scope of its BUSD regulation to that blockchain.

Binance also mints another token called Binance-Peg BUSD on other blockchains. This token, available on three networks, falls outside the bounds of NYDFS’s regulation. Binance’s promise is that each Binance-Peg BUSD corresponds to a BUSD token held in reserve by Paxos.

At least on paper, the math on the Proof of Collateral page for BUSD on the Binance website adds up.

As of this writing, there are 17.1 billion BUSD in circulation. Out of this figure, there were 5.3 billion Binance-peg BUSD circulating on three blockchains – Avalanche, BNB Chain, and Polygon. Each token on these chains has a corresponding collateral in Paxos’s reserves based on Proof of Collateral statistics, according to Binance.

But BUSD’s use as a derivative makes it difficult to determine the exact circulating supply of the token on platforms that are outside the scope of regulation. Their assets are not audited or attested by independent accounting firms. Their unregulated status also means that the platforms are not legally liable to redeem Binance-Peg BUSD coins, meaning investors are left holding the bag if they crash. This makes Paxos’s claim of BUSD being a regulated stablecoin a sham.

A Mockery of NYDFS Stablecoin Regulations

The idea behind NYDFS’s stablecoin regulations (and of BUSD on the Ethereum blockchain) is to restrict the scope and reach of such coins in risky ecosystems and inspire investor confidence in the asset. But Binance’s derivative bridge sidestep existing regulations and expand BUSD’s reach well beyond the regulated zone.

The Binance-Peg BUSD Derivatives Complex  

Binance-Peg BUSD’s circulating supply is a muddle. The stablecoin functions as a seeming twin of its stablecoin counterpart and has a wide reach on the three blockchains outside of NYDFS’s purview. On these platforms, it is extensively used in liquidity pools, decentralized exchanges, and lending platforms that are proliferating across its supported blockchains.  

There are no official statistics to determine Binance-Peg USD’s use or supply on these blockchains. Announcements or news about new BUSD tokens available in the market are also infrequent.

Complicating the matter further are the obfuscations employed Binance and its partners to advertise the stablecoin. They frequently refer to BUSD’s derivative version as the actual stablecoin. Here’s an example. Here’s another one.

Anecdotally, at least, the Binance-Peg BUSD token casts a long shadow. For example, the top two apps on the BNB Chain – Pancake Swap and Venus – support it. The apps are supposed to have generated $1 billion and $14 billion in total transaction volume last year. On the Venus app, Binance-Peg USD has the second-highest liquidity among tokens.   

At the Avalanche blockchain, a lending protocol called Meshswap enables users to lend out the stablecoin. On the same platform, a yield farming derivative consisting of the same token and wrapped Ethereum offers an APR of 8.56%. [A wrapped token is a derivative contract whose price is pegged to that of a underlying coin]. Trader Joe – a ‘one-stop-shop’ decentralized finance platform on Avalanche – also supports the Binance-Peg BUSD token across its services.

A Systemic Risk

Binance-Peg BUSD is used extensively on DeFi platforms. A trader might use the stablecoin to arbitrage on the interest rates being offered at different platforms. They could also build entire structures consisting of Binance-Peg BUSD and its derivatives. For example, they could stake Binance-Peg BUSD on an app and use the staked token (given to customers after they deposit the coin) to take out a loan or purchase another token with higher yields.  

Apart from the systemic risk of such a structure, it may also result in double counting or, even, triple counting of the same token across the transaction list. There is precedent of decentralized finance (DeFi) analytics sites indulging in such practices to inflate the Total Value Locked (TVL), an error prone DeFi metric, at protocols.

Where’s My BUSD?

The unregulated status of Binance-Peg BUSD on other chains means that holders of Binance-Peg BUSD on these chains do not have legal claims on the token.

From Paxos’s website: Binance-Peg BUSD, which is not issued by Paxos and is not regulated by NYDFS, is a separate product. Binance independently mints Binance-Peg BUSD on other blockchains (e.g., BNB Chain, Polygon and Avalanche) and pegs the tokens to BUSD on a one-to-one basis. This allows holders of both tokens to swap tokens between Ethereum and other blockchains.

What does this disclaimer mean?

It means that the trust company is not legally bound to make investors in Binance-Peg BUSD whole, if there is a run. Given that it is difficult to determine the actual circulating supply, a run on the token might also result in multiple claims for the same Binance-Peg BUSD hypothecated at different places. In that sense, the disclaimer is smart strategy to avoid legal responsibility.

Hacking BUSD

Paxos is not the only one evading claims for Binance-Peg BUSD. On its website, Binance advertises attractive interest rates for staking BUSD. But it does not specify the token’s blockchain location. An archived version of the same page shows that it advertised Binance-Peg BUSD on BNB Chain’s Venus app as BUSD for its staking program. The BNB chain is unregulated, meaning investors in the Binance-Peg BUSD token do not have legal claims to the asset.  

Binance also disclaims responsibility for hacks on the chain. The exchange states that it does not bear “any liability for losses incurred as a result of on-chain contract security.”

The chain, by the way, is home to Binance’s BNB token and has “deep ties” to the exchange. A bridge connecting to the chain was hacked in October this year. The hacker, reportedly, minted $570 million BNB and made away with $100 million worth of the token.

What does this mean for BUSD? If the hacker were to follow a similar strategy for Binance-Peg BUSD, they could inflate or deflate its supply and force Paxos to burn or mint tokens and make the stablecoin lose its peg.  

A False Attestation Report

The difficulty in determining the actual Binance-Peg BUSD circulating supply also means that the attestation reports peddled out by Paxos each month as proof of its reserves for the stablecoin are false. The figures for Binance-Peg BUSD’s presence on other blockchains are self-reported by Paxos and not based on verification by an independent third-party auditor or attestations at these apps or chains.

The accounting firm responsible for producing them has refused to provide assurance for the final section of these reports.

That section contains the following innocuous-looking sentence:

BUSD is an ERC-20 token, which is built on the Ethereum public blockchain and as such, the total number of BUSD tokens in circulation is fully and transparently viewable at all times by anyone through any publicly available Ethereum block explorer (e.g. Etherscan). It is an anomaly in a report that includes token numbers held as reserves by Paxos for Binance-Peg BUSD circulating on other platforms.

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