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Overview

Stablecoins provide investors with “safe haven” assets that grant protection from periods of high volatility. This expands upon the utility of an asset like Bitcoin, limiting volatility by functioning on a pegged value to stabilize the price. The pegged value is determined by the corresponding collateral behind the stablecoin. The most common type of stablecoin is a tokenized (fiat-collateralized) asset that's pegged 1:1 with the USD. There are other types of stablecoins that use other collateral, including commodity-collateralized stablecoins, such as PAX Gold.

Stablecoins effectively serve as a hybrid between cryptocurrencies and fiat currencies, providing the best of both worlds: the price stability of the USD and the reduced friction of blockchain payment rails. They also enable crypto traders to maintain exposure to USD without needing to exit the crypto ecosystem. Stablecoin transactions, like in the case of USDT, can be sent in minutes, without KYC, and without any banks or middlemen. Additionally, a dollar peg enables USDT as a functional form of collateral in crypto-finance, along with opening arbitrage opportunities where asset prices differ across exchanges. 

BUSD

BUSD is a 1:1 USD-backed stablecoin issued by Paxos Trust Company, a New York-regulated trust company that also holds a provisional charter from the Office of the Comptroller of the Currency, in partnership with Binance. It is a 100% centralized, fiat-backed stablecoin. 

If that wasn’t bad enough, it (obviously) has a heavy reliance on the success and efforts of Binance, which has a very questionable track record when it comes to regulations, keeping their word, security, or putting customers first.

BUSD market cap. Source

BUSD Design: Fiat-backed and 100% Centralized

However, not all stablecoins are created equal. There are several different approaches projects have taken to keep their stablecoin "stable.” By far, the easiest approach (and therefore most popular) is backing a crypto stablecoin 1:1 with fiat dollars in a bank. This is the approach market leaders USDT, USDC, and BUSD have taken. For every USDC in circulation, there's $1 (or dollar equivalent) in reserves with the Circle Consortium. While these are the current market leaders, fiat-backed stablecoins inherit all of the issues that come with fiat plus require trust in a centralized custodian. This isn't exactly the revolution crypto promised!

BUSD is a regulated, fiat-backed stablecoin issued by Paxos on the Ethereum blockchain, pegged to the US dollar. Both the stablecoin and its reserves are subject to strict regulatory oversight by the New York Department of Financial Services. BUSD is backed by reserves held in either fiat cash in dedicated omnibus accounts at insured US banks or US Treasury bills, including through repurchase agreements and/or money-market funds invested in US Treasury bills.

From the Binance website, “BUSD is 100% backed by reserves held in either or both (i) fiat cash in dedicated omnibus accounts at insured U.S. banks1 and/or (ii) U.S. Treasury bills (including through repurchase agreements and/or money-market funds invested in U.S. Treasury bills).”

Binance-Peg BUSD, on the other hand, is a separate product that is not issued by Paxos and is not regulated by the NYDFS. Binance independently mints Binance-Peg BUSD on various blockchains, such as BNB Chain, Polygon, and Avalanche, and pegs the tokens to BUSD at a one-to-one ratio. This allows holders of both tokens to swap tokens between Ethereum and other blockchains.

Want more on BNB? Check out the Full CORE report!

A Fiat-backed Stablecoin…. Without the Fiat?

In December 2022, news broke about a potential lack of collateral backing the Binance-peg BUSD on the Binance Chain. Binance eventually came forward and admitted that it had not always fully backed the Binance-peg BUSD version of the stablecoin. 

Source: Bloomberg

The root of the issue has to do with which blockchain (Ethereum or Binance) the BUSD lives on. Paxos very clearly states that they are only responsible for BUSD issued on Ethereum. Any other form, wrapped or not, cannot be accounted for by Paxos.

The recent issue, unsurprisingly, involved wrapped or Binance-peg BUSD on the Binance Chain. The ~$1B accounting hole that made the news was 100% an issue internal to and solely attributable to Binance, not Paxos. As mentioned previously, Binance has a long (and we mean very long) history of indiscretions, questionable actions, and security flaws. They should not be looked to as competent custodians of billions of dollars.

As a result of this revelation, BUSD temporarily lost its peg in December 2022, despite Binance assuring customers that the issue had been fixed. 

Source: Kaiko

Since then, BUSD has experienced a significant decrease in its circulating supply, with a reduction of ~$7 billion over the past three months. This reduction in supply can be attributed to withdrawal surges from concerned customers following the lack of collateral news, as well as the most recent regulatory news concerning Paxos (discussed below).

BUSD circulating supply has decreased from ~$22B to ~$15B. Source

SEC Wells Notice

According to a recent report by the Wall Street Journal, the US Securities and Exchange Commission (SEC) issued Paxos a Wells Notice, indicating their plans to sue Paxos over the issuance of BUSD. The SEC alleges that BUSD is an unregistered security, although the commission has declined to comment on the potential investigation. This news comes in the wake of a recent report by CoinDesk that Paxos is also under investigation by the New York Department of Financial Services, although the scope of this investigation remains unclear. 

The regulatory landscape and stablecoin economy continue to evolve, with Paxos announcing their decision to no longer issue BUSD following the Wells Notice. The impact of this decision on the stablecoin market is expected to be significant, as BUSD is widely used on Binance's exchange and in its DeFi ecosystem.  Paxos has pledged to honor all BUSD redemptions through at least February 2024. 
 

Regulation

List of Notable SEC Enforcements

The SEC has recently taken a strong stance on enforcing securities regulations within the cryptocurrency industry, as evidenced by several high-profile cases.

In December 2020, the SEC sued Ripple (XRP) for conducting an unregistered $1.3 billion securities offering. This marked the beginning of the SEC's more aggressive approach toward cryptocurrencies.

In February 2022, BlockFi agreed to pay $100 million for offering an unregistered lending product. The exchange later filed for bankruptcy in November after being implicated in the collapse of FTX.

In October 2022, the SEC fined celebrity Kim Kardashian $1.26 million for promoting securities without disclosing her personal holdings. SEC Chair Gary Gensler emphasized that celebrity endorsements do not necessarily indicate that investment products are suitable for all investors.

In December 2022, the SEC charged Sam Bankman-Fried, the founder of FTX, with defrauding equity investors through the failed exchange. The SEC also announced an investigation into whether Bankman-Fried violated other securities laws.

Other tokens created by large centralized companies have recently run into opposition from the US regulators, such as Telegram abandoning its project entirely after a multi-year battle with the SEC. Several landmark cases by the SEC set a precedent for them to evaluate ICOs as securities retroactively, while a recent ruling in November 2022 against LBRY tokens further strengthened the SEC’s case against many altcoins. 

In January 2023, Genesis and Gemini were charged with offering and selling unregistered securities to retail investors through the Gemini Earn crypto asset lending program. Genesis filed for Chapter 11 bankruptcy shortly after.

Crypto lender Nexo agreed to pay $45 million and cease operations in the US after the SEC accused it of offering an unregistered crypto lending product.

In February 2023, Kraken was ordered by the SEC to discontinue its US-based staking service and pay $30 million in disgorgement, prejudgment interest, and civil penalties. Stablecoin issuer Paxos disclosed receiving an SEC notice alleging that the Binance USD (BUSD) stablecoin is a security. Paxos responded by ending its relationship with Binance and ceasing the minting of the BUSD stablecoin.
 

Stablecoins in the Crosshairs

The very idea of stablecoins or “crypto dollars” has come under attack from US regulators as the STABLE Act was proposed in December 2020. The STABLE Act was written with “the intent to prevent abuse, opacity, and the potential rise of a stablecoin-based shadow-banking system.” However, the obligations that stablecoin issuers would have to abide by in order to avoid breaking the law are incredibly cumbersome and/or restrictive.

Firstly, any stablecoin issuer would be required to obtain a federal banking charter. In addition, any stablecoin issuers would be required to obtain the approval of both the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) six months before issuance. Finally, the stablecoin issuers would either need to obtain FDIC insurance or deposit dollar reserves directly at the Federal Reserve.

Additionally, in November 2021, the President’s Working Group (PWG) on Financial Markets released a report outlining its position on stablecoins. The report stated the key use cases for stablecoins are trading, lending, and borrowing other digital assets in high-value payments/transfers.