Welcome to another edition of the DeFi Frontier, a weekly newsletter about DeFi innovation for the real world! This has been a wild last week in the crypto world, full of drama 😱, treachery 🔪, and intrigue 👀. Grab some popcorn — let’s dive right in.

News Wire

The Stablecoin Wars

• Feb 13 — Paxos ordered to end support for Binance USD (BUSD) by New York regulators. Paxos is the issuer of three stablecoins — BUSD, USDP, and PAXG (gold-backed) — as well as the white-label crypto custodian for PayPal, Venmo, and Mercado Pago. In its consumer alert regarding BUSD, the New York Department of Financial Services, the issuer of Paxos’s digital asset license, alluded to problems related to Paxos’s relationship with Binance. Namely, the NY DFS highlighted the lack of authorization for Binance-Peg BUSD. (link)
• Feb 13 — USDC-issuer Circle reportedly warned New York regulators about BUSD discrepancies. According to a report in Bloomberg, Circle alerted the New York Department of Financial Services to discrepancies in on-chain data that suggested improper collateralization for wrapped tokens on Binance Smart Chain and other chains. In addition to BUSD, these collateralization issues also reportedly affected BSC-based USDC. At one point, Binance allegedly had just $100mn in stored collateral for $1.7bn BSC-based USDC. (link)
• Feb 12 — Paxos could face SEC lawsuit regarding BUSD and potential securities law violations. Paxos received a Wells notice from the SEC, which informs of a possible enforcement action and allows recipients to contest any allegations. Paxos issued a public statement in response, saying that it “categorically disagrees with the SEC staff because BUSD is not a security under the federal securities laws.” (link)

Commerce

• Feb 13 — Wirex to launch Visa crypto debit card for Asia Pacific region. The London-based fintech has over 5 million customers, most of whom are based in the UK. Through a new partnership with Visa, Wirex will be permitted to issue its crypto-enabled debit cards in 40 Asia Pacific countries. (link)
• Feb 11 — Shopify launches suite of blockchain commerce tools for merchants. The e-commerce giant announced the launch of enhanced crypto wallet connect features, as well as the ability to tokengate marketplace features. These features will permit merchants to reward users and provide exclusive experiences through the verification of brand NFTs. (link)
• Jan 19 — Revolut to launch native rewards token RevCoin in “coming months.” The European fintech giant has some 25 million users worldwide and already permits users to buy, hold, and sell 90+ cryptocurrencies. RevCoin will reportedly be used to reward users, including for expenditures via Revolut cards. (link)

Public sector innovation

• Feb 13 — Brazilian bank to permit tax payments via crypto. Banco de Brazil, the country’s second-largest bank by assets, announced a partnership with crypto payments processor Bitfy to permit crypto-denominated tax payments. (link)
• Feb 2 — California DMV commissions blockchain-based vehicle titling solution. The California Department of Motor Vehicles commissioned Oxhead Alpha to develop a proof-of-concept blockchain-based alternative to the agency’s existing vehicle titling system. Oxhead Alpha’s solution is built on the Tezos blockchain. (link)

Analysis

The Wild West era of crypto has come to an abrupt end. Sheriff Gary Gensler is in town, with guns a-blazing. After years of light-touch crypto regulation, the United States government has in recent weeks begun cracking down on the U.S. crypto industry (here is a helpful overview from Castle Island’s Nic Carter). Gary Gensler has long believed that “the vast majority of [cryptocurrencies] are securities,” and he is now leading a whole-of-government effort to regulate them as such.

The demise of Binance USD (BUSD) represents a dramatic escalation in this War on Crypto, potentially threatening stablecoins and the vital use cases they enable. This week, BUSD was targeted by both state and federal regulators in the U.S. At the state level, the New York Department of Financial Services ordered Paxos to cease minting BUSD, citing improper supervision of Paxos’s relationship with Binance and issues related to Binance-peg BUSD. We don’t know all the details yet, but there seems to have been something fishy going on. Ethereum-based BUSD was issued by Paxos, with verifiable 1-for-1 reserves. On other blockchains, however, this backing was evidently less consistent: Reportedly, BUSD on Binance Smart Chain was undercollateralized by at least $1bn three times in the last 3 years. Binance attributed these discrepancies to “operational delays” in peg maintenance, but in the post-FTX world, any such inconsistencies in CEX ledgers must be regarded with extreme suspicion. Perhaps NYDFS went too far in shutting BUSD down outright, but if there was indeed risk to user funds, decisive intervention was likely warranted.

At the federal level, the story is very different: The SEC’s Wells notice to Paxos alleged that BUSD is an unregistered security. The SEC’s reasoning stems from the fact that stablecoins like BUSD are often backed not by cash but rather by interest-bearing financial instruments like U.S. Treasuries. In Gensler’s interpretation, this makes stablecoins akin to shares in a money market fund, which would be subject to securities law regulation. From a legal standpoint, this argument seems a bit shaky, given that stablecoins would presumably fail Prong #3 (“a reasonable expectation of profit”) of the Howey Test; no one who buys a stablecoin expects it to appreciate in value or generate dividends. But from a pragmatic standpoint, an attack on stablecoins makes even less sense. Stablecoins provide real, powerful utility, expanding access to stable money in every corner of the globe. If people in emerging markets could easily buy shares of a USD-denominated money market fund, they very well might. But they most often cannot, Gary. Furthermore, attacking the most compliant stablecoins threatens to push dollar demand towards less transparent, potentially riskier tokens.

We are in favor of reasonable regulation of crypto, especially in the creation of strong consumer protections. However, any such regulatory regime should still leave room for innovation and impact. Burning the industry to the ground out of fear will result in countless missed opportunities for a safer, more transparent financial system.

DISCLAIMER: The views and opinions expressed herein are those of the speakers and do not necessarily reflect the views or positions of any entities they represent. The information provided does not constitute investment advice, financial advice, trading advice, or any other sort of advice, and you should not treat any of this content as such. Do conduct your due diligence and consult your financial advisor before making any investment decisions.