The recent regulatory crackdown on stablecoins has sent shockwaves through the cryptocurrency market. Following actions against Kraken's staking services, the U.S. Securities and Exchange Commission (SEC) has now turned its attention to stablecoin issuers. Paxos, a major player in this space, finds itself under investigation by both the SEC and the New York Department of Financial Services (NYDFS).
Paxos is responsible for issuing its native stablecoin Paxos Dollar (USDP) and Binance USD (BUSD). It also manages PAXG, a gold-backed cryptocurrency that stores physical gold in London's Brinks Vault for investors.
NYDFS has ordered Paxos to stop minting new BUSD tokens. This stablecoin is backed by short-term Treasury bonds and cash-equivalent assets. The regulatory scrutiny comes after the catastrophic collapse of TerraUSD (UST) in 2021, which triggered widespread bankruptcies across the crypto ecosystem.
Regulatory Pressure Intensifies
The SEC recently filed a lawsuit against Terraform Labs and its co-founder Do Kwon. According to legal experts, this action could serve as a roadmap for regulators to target other stablecoins. In response to the Terra collapse, NYDFS published new guidelines for stablecoin issuers, while the SEC identified crypto asset oversight as a key priority for 2023.
Paxos announced it would stop issuing BUSD tokens on February 21. Existing tokens "have been and will always be" backed 1:1 with U.S. dollar reserves, with redemption available until February 2024. The company also stated it would terminate its relationship with Binance.
NYDFS told CNN that the order resulted from "several unresolved issues related to Paxos' oversight of its relationship with Binance." The agency is monitoring Paxos to ensure orderly redemptions with enhanced compliance protocols.
The investigation began after Paxos applied for a full banking charter. The New York-based blockchain infrastructure company already holds NYDFS' BitLicense and has established a leadership position in the industry. It also obtained a Major Payment Institution license from Singapore's regulator to expand its Asian presence.
Despite rumors that the U.S. Office of the Comptroller of Currency might ask Paxos to withdraw its application, the company has denied these claims.
Industry Responds to Regulatory Actions
Coinbase has argued that stablecoins are not securities and actually benefit the U.S. if the dollar remains the most reliable reserve asset. However, this can only be achieved "if we foster stablecoin development within our borders," the exchange stated. It warned that imposing securities laws through enforcement rather than guidance would push innovation overseas and weaken the U.S. global role.
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Stablecoin Market Realignment
News of the regulatory action triggered significant withdrawals, reminiscent of the FTX collapse in November. Coinbase's stablecoin balances fell 53%, while Bitfinex saw a 57% decrease. Binance experienced the largest absolute loss at over $1.5 billion, though this represented only an 8% decline.
This uncertainty has created opportunities for two major stablecoin players: Circle's USDC and Tether's USDT. According to Kaiko researcher Conor Ryder, USDT will likely emerge as the short-term winner as market makers and even Binance leverage it as the preferred trading alternative to BUSD.
USDT is the largest stablecoin and the third-largest cryptocurrency overall, with a market capitalization of nearly $70 billion. Since the Paxos news broke three days ago, USDT's market cap has increased by an additional $1.8 billion.
Meanwhile, USDC's market capitalization has added approximately $1 billion, currently standing at $41.7 billion. This places it fifth among cryptocurrencies, down from $44 billion earlier this year and a peak of $56 billion in June 2022.
During this period, BUSD has lost over $2.5 billion in market capitalization, now ranking eighth with $8 billion, down from its November peak of $23.5 billion.
Following the news, BUSD dropped to a two-year low of $0.9950. However, comments from Binance CEO Changpeng Zhao (CZ) about the exchange's connection to the Paxos-issued token helped BUSD recover to $0.9997. It currently trades at $0.9999.
"BUSD is not issued by Binance," Zhao stated during a Twitter Spaces session. "We have an agreement to allow them (Paxos) to use our brand, but it's not something we created."
According to a Bloomberg report earlier this year, Binance acknowledged that BUSD hasn't always been fully backed by reserves but has since resolved the issue. Occasionally in 2020 and 2021, the token lacked sufficient collateral. A Binance spokesperson told Bloomberg that this never affected user redemptions, attributing the problem to a "timing mismatch" in backing BUSD.
Exploring Beyond Dollar-Based Stablecoins
During a February 14 AMA on Twitter Spaces, CZ shared that stablecoins remain a crucial part of the crypto ecosystem. "Most people use U.S. dollar prices for cryptocurrencies because U.S. dollar-based stablecoins are the most popular and largest," he noted.
CZ suggested that recent regulatory actions might eventually reduce the dominance of U.S. dollar-backed stablecoins. "I think with the current stances taken by regulators on U.S. dollar-based stablecoins, the industry will likely move to non-U.S. dollar-based stablecoins and return to algorithmic stablecoins."
As multiple agencies "crack down" on these stablecoins, the market for dollar-based alternatives will shrink, CZ added. "This has led us to search for more options in different places."
Just days after reports about regulatory scrutiny of Paxos and BUSD emerged, Binance minted nearly $50 million worth of TrueUSD (TUSD). This stablecoin's market cap currently stands at $969 million, up from $915 million on February 16 and $756 million on January 1, 2023. TUSD reached its peak market capitalization of $1.68 billion in June 2021.
In September, Binance automatically converted TUSD, along with other stablecoins like USDC and USDP, to BUSD to increase liquidity and capital efficiency for users. This move increased BUSD's market share from 10% to 15% within weeks.
Launched in March 2018 by TrustToken, TUSD exists on Ethereum, Polygon, Tron, and Avalanche networks. The minting process is straightforward: buyers send USD to a third-party collateral account using Prime Trust, and upon receipt, an equivalent amount of TUSD is transferred to their designated ERC-20 or BEP-2 wallet address.
While CZ stated that Binance would provide more support for competing stablecoins USDT and USDC now that BUSD is "phasing out and slowly reducing over time," he shared that they're also exploring euro, Japanese yen, and Singapore dollar-based stablecoins.
Regarding existing BUSD, CZ has assured that the circulating supply is safe and will be burned (permanently removed from circulation) as more people redeem their tokens.
During his AMA, CZ admitted he was never overly optimistic about BUSD's success: "To be honest, BUSD was never a big business for us. When we started, I really thought the BUSD project might fail, so we actually don't have very good economics in that collaboration."
Filling the Void in DeFi
Paxos' decision to stop issuing BUSD amid U.S. regulatory pressure is affecting the decentralized finance (DeFi) world, where people trade, lend, and borrow without intermediaries.
Since BUSD has a relatively small presence in DeFi, most concerns focus on the Binance-sponsored BNB Chain, which has the highest BUSD usage in DeFi. This means the DeFi ecosystem must transition to a different stablecoin as a liquidity source.
For example: DEX Curve Finance has approximately $10 million in BUSD in its largest liquidity pool. According to founder Michael Egorov, regulatory actions against the stablecoin appear to be "a fairly safe extinction process" for its holders. However, he noted that DAO members managing the protocol might eventually vote to reduce rewards in the BUSDv2 pool as it incentivizes users to provide BUSD liquidity.
A similar discussion is underway on the DeFi lending protocol Aave, according to a governance proposal from community member Marc Zeller. The proposal considers freezing reserves and switching to another stablecoin as the "most reasonable path" for Aave.
However, BUSD's shutdown raises questions about the fate of other stablecoins, particularly Circle's USDC, which is the most widely used stablecoin in DeFi. Any regulatory action against USDC would be much more damaging to the DeFi ecosystem.
While payment giant PayPal has reportedly halted work on its upcoming stablecoin offering amid increased regulatory scrutiny, the crypto sector remains focused on building and innovation.
This week, Seattle-based Web3 payments infrastructure company Stably Corporation announced the launch of its Stably USD ($USDS) stablecoin on the Polymesh blockchain. The company claims USDS is a regulated, fully collateralized stablecoin backed 1:1 with USD held in bank deposits managed by a custodian.
Meanwhile, Stratis, a flexible blockchain development platform designed for enterprise and financial service needs, has been working on a regulated GBP stablecoin. The platform's proposal for a GBP stablecoin is currently in the application process to be submitted to the Financial Conduct Authority (FCA), Stratis CEO and founder Chris Trew stated earlier this year.
For the Great British Pound Token (GBPT), Stratis intends to use the Open Banking standard. This will allow both businesses and individuals to deposit fiat currency through a simple web page to mint GBPT, which can then be easily sent across borders using a digital wallet. The official announcement noted that the stablecoin would be 100% backed by low-risk, highly liquid fiat assets.
Earlier this week, Trew said the technology enabling the GBPT offering has already undergone internal testing. If Stratis obtains FCA registration, the company can provide an end-to-end solution.
While regulators focus on stablecoins, numerous projects stand ready to fill the void left by BUSD, as demonstrated by the increasing market share of USDT and USDC and new projects emerging to meet customer needs. However, the future performance of stablecoins in the coming months remains uncertain as additional regulations emerge.
Frequently Asked Questions
What is happening with BUSD?
Paxos has been ordered to stop minting new BUSD tokens by the New York Department of Financial Services. Existing tokens will remain redeemable until February 2024, and the company is ending its relationship with Binance.
Which stablecoins might benefit from BUSD's decline?
USDT (Tether) and USDC (USD Coin) are positioned to capture most of BUSD's market share. TrueUSD (TUSD) has also seen increased minting activity following the news.
Are stablecoins considered securities?
The regulatory classification remains unclear. Coinbase argues they are not securities and benefit the U.S. financial system, while the SEC appears to be taking a more aggressive enforcement approach.
What does this mean for DeFi platforms?
DeFi protocols using BUSD must transition to alternative stablecoins for liquidity. Curve Finance and Aave are already discussing reducing BUSD rewards and potentially switching to other stablecoins.
Will this affect other stablecoins like USDC?
The regulatory scrutiny on BUSD raises questions about other stablecoins. However, USDC's stronger regulatory compliance and transparency might position it better than algorithmic or less-regulated alternatives.
Is this the end of dollar-dominated stablecoins?
While U.S. regulatory pressure might reduce dollar-based stablecoin dominance in the long term, they currently remain the most popular option. The industry is exploring alternatives including euro, yen, and Singapore dollar-based stablecoins.