Notes 2/13: BUSD In Trouble

Following its settlement with Kraken on Friday, the Securities Exchange Commission (SEC) dropped another bombshell last night. According to a WSJ report, the agency has served a Wells Notice to Paxos Trust Ltd., issuer of Binance’s stablecoin BUSD. A Wells Notice is an informational notice that is sent before the agency commences litigation. In this case, it plans to sue Paxos for selling unregistered securities.

As of this writing, BUSD is the world’s seventh-most valuable cryptocurrency and has a market capitalization of almost $16 billion. It is among the top three coins against which Bitcoin is traded, based on data from Coinmarketcap – a Binance-owned company. The stablecoin’s derivative Paxos – issued BUSD (PBUSD) circulates on decentralized finance (DeFi) chains.  

The New York Department of Financial Services (NYDFS), which regulates BUSD, is also getting in on the action against BUSD. The agency told Reuters that Paxos had “violated its obligation to conduct tailored, periodic risk assessments and due diligence refreshes of Binance and Paxos-issued BUSD customers to prevent bad actors from using the platform” and added that the token was not issued and administered in a “safe and sound manner”.

Binance or BUSD?

There is not much detail available about the SEC’s notice against Paxos. But observers say that the agency may be targeting Binance, instead of Paxos, with its latest action because its problems are with BUSD’s derivative offshoot PBUSD, that mainly circulates on Binance Smart Chain (BSC), rather than with the stablecoin issued by Paxos.

As I have written earlier, it is difficult to track or ascertain BUSD’s derivative’s circulation numbers in DeFi apps. That has a cumulative effect on regulated reserves for BUSD because Binance claims that each PBUSD is backed by an equivalent BUSD locked at Ethereum. BUSD’s numbers on the blockchain are, in turn, is backed by reserves consisting of a mix of securities, bonds, and cash.

In the past, Binance has admitted to inconsistencies in maintaining adequate reserves equal to BUSD’s circulating numbers. Paxos’s issue of BUSD, and indeed that of other stablecoins headquartered in the U.S., could also be classified as a security under the Reves test.

What Happens if BUSD Collapses?

Paxos has agreed to stop minting BUSD in response to the news yesterday. PayPal has also halted work on developing a stablecoin with the help of Paxos. Meanwhile, DeFi platform Aave is reportedly reconsidering its use of PBUSD.

For all the big numbers associated with it, however, BUSD functions in a limited operational perimeter. Its main markets and trading volumes are at Binance. Its two biggest trading pairs are against Bitcoin and Tether. Last September, Binance claimed to have auto-converted other stablecoins and products associated with them on its platform to BUSD. That list of stablecoins included the likes of Circle-issued USDC and Tron’s USDD, to BUSD.

A result of these actions is that the fallout from BUSD’s regulatory problems, or a possible collapse, will be limited to Binance’s ecosystem. Actually, “limited” is the incorrect word in this context since Binance is the world’s biggest cryptocurrency exchange.

The larger problem relating to BUSD’s travails concern the broader stablecoin ecosystem’s future. This is because stablecoins are the only assets that promise predictability and a fixed value in a volatile crypto ecosystem.

Their seeming stability has convinced regulators to search for possible use cases for such coins, including as a payment mechanism and as a bridge to central bank-issued digital currencies. In fact, the US Congress has made stablecoin regulation a priority in its upcoming session.

The SEC’s actions may have made the certainty of that future unstable.

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