BUSD sunsetting: the Facts, the Insights, and the Consequences

The facts

On Feb 9th, news broke that the NYDFS was investigating Paxos for undisclosed reasons. Four days later, we learned that the regulator had ordered Paxos to cease issuing BUSD “as a result of several unresolved issues related to Paxos’ oversight of its relationship with Binance.” According to the regulator, Paxos “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,” in a possible reference to problems with AML or KYC.

NYDSF’s statement also pointed out that one of those unsolved issues had to do with the fact that BUSD was multichain, while Paxos’ license was only subject to issuance on the Ethereum blockchain. “It is important to note that the Department authorized Paxos to issue BUSD on the Ethereum blockchain.”

More recently, we learned months ago the Circle Consortium, the group of companies in charge of issuing USDC, had warned the New York Regulator that oversees both Circle and Paxos (New York State Department of Financial Services) that Paxos was misrepresenting its reserve balance.

Parallel to the NYDSF’s enforcement action, the SEC announced a lawsuit against Paxos for selling unregistered securities. The move was met with surprise: how can a stablecoin, whose main trait is to have a stable value, be considered a security?

Again, the SEC’s complaint is that Paxos did not adequately warn investors of the risks involved in investing in BUSD, nor did it make proper financial disclosures. Forbes

Paxos subsequently announced they would cease to issue new BUSD on behalf of Binance.

The insights

Are all stablecoins securities?

The SEC has this habit of banging their hammer on the head of projects without warning or explanation. So although Gary Gensler keeps claiming that projects are welcome to register in the SEC’s online forums to avoid prosecution, crypto keeps wondering what they should register as and why.

Circle’s USDC is a highly compliant stablecoin, and its issuer collaborates with US authorities regularly. And, as it turns out, they were the ones who first pointed their finger in Paxos’ direction. So if the US government were ever to see the expansion of stablecoins with good eyes, USDC would be their bet because it could serve as an extension of the country’s power inside crypto.

USDT, on the other hand, claims that it does not operate in the US, which has been a defensive legal moat so far. Even though Tether has had to settle with US regulators in the past, it is unclear how they could approach a ban on USDT. Tether has always been very opaque in its location and operations.

Are US authorities chasing Binance?

Some have pointed out that what we’re seeing today is the backlash of the collapse of FTX. Sam Bankman-Fried’s platform brought attention to the crypto ecosystem and gave a boost of urgency to Biden’s administration plans to regulate crypto. Binance, the number 1 crypto exchange operating outside of the USA, seems like a double threat to US regulators: it threatens economic stability through its increasing influence in traditional finance and the potential US hegemony over crypto.

Is this a coordinated effort from US authorities against crypto?

There’s been enough activity from Washington lately to take this as more than a conspiracy theory. In weeks, the Department of Justice increased pressure on Silvergate for their relationship with FTX. Binance suspended USD transfers, and Kraken settled a lawsuit by halting their staking services. Nic Carter makes a more extended list in his much-shared post “Operation Choke Point 2.0.”

It’s a natural response for governments to try to asphyxiate a financial system that’s beyond their scope of control.

The consequences

BUSD sunsetting

The most obvious one is that the BUSD supply will start to decrease. Paxos has announced that they will continue to support the stablecoin and honor redemptions, but they’ve ceased to create new coins. So the only way at the moment is out. Other stablecoins, centralized and decentralized, emerge as alternatives since DeFi generally seems unaffected (DeFi’s TVL increased ~2% in the last 24h).

Three roads

In broad terms, the SEC actions leave three different roads for crypto projects:

• Compliance. the long and winding road of complying with regulators is often too heavy a burden. Moreover, regulation is often unclear, sometimes inexistent, and generally fits poorly with crypto. As a result, only a few companies will be able to comply.
• Offshoring. Unspecific regulation pushes entrepreneurs away from US borders and customers. This prevents US citizens from getting exposure to DeFi risks and its benefits. There are vocal critics of this option, as the most likely outcome is for companies and institutions to move to greener pastures looking for clearer regulation. The EU, surprisingly, has become a beacon of hope for some (for example, CZ).
• Decentralization. As we saw with Kraken’s staking services crackdown, decentralized alternatives become the preferred solution when centralized ones are very vulnerable to regulators. Harsh regulation is a catalyst of innovation in decentralized solutions.
  We must not forget that decentralization has many layers, though. Even projects theoretically decentralized like MakerDAO rely heavily on centralized stablecoins. Decentralization is an extremely challenging path too.

So this means war?

If the SEC ends up yielding its hammer against Circle, we might see a legal battle begin. Coinbase has already asserted that they will fight to defend their staking services to the last drop of sweat. We can fairly assume they’d go even the extra mile for USDC. This could be a net positive for crypto since it could end up getting some clarity from the SEC.