Paxos faces SEC lawsuit over BUSD
On February 13, the U.S. Securities and Exchange Commission’s (SEC) Enforcement Division issued a Wells notice to Paxos, ordering the company to stop minting the Binance USD (BUSD) stablecoin.
The notice follows an SEC investigation into Paxos and its relationship with Binance, whose stablecoin it issued, which found the company violated securities laws. However, a Wells notice does not necessarily mean the SEC will take enforcement action against Paxos. For the SEC to pursue this issue further, its five commissioners must vote to authorize any enforcement litigation or settlement.
According to notice, the Department of Financial Services (DFS) ordered Paxos to stop minting BUSD due to “several unresolved issues related to Paxos’ oversight of its relationship with Binance.” There was no further explanation for these issues — Binance CEO Changpeng Zhao, said he was only aware of the enforcement actions through the media.
Paxos is expected to submit a response to Wells’ notice and present his case as to why he should not be sued. In the meantime, the company should stop minting new BUSD and allow all customers to exchange their BUSD for US dollars. Paxos has maintained that it has and will always back all BUSD 1:1 tokens with US dollar-denominated reserves.
BUSD is the only stablecoin backed by assets with long maturities
These dollar-denominated reserves are far from the norm, however. Unaudited BUSD holdings of Paxos report shows that the stablecoin is mostly backed by long-lived assets. On February 10, the company’s report showed 16.14 billion BUSD tokens in circulation and an equal or greater balance of assets held in custody.
Just under $3.1 billion is held in short-term US Treasury debt, which will mature by mid-April 2023.
On February 10, $12.5 billion of Paxos’ $16.4 billion BUSD reserves were held in US Treasury reverse repurchase agreements. Only two repurchase agreements expire in 2023 and 2024 – the rest of the $12.5 billion have expiry dates ranging from 2026 to 2052.
$1 billion worth of stablecoins leave Ethereum
The intense scrutiny of BUSD has caused unprecedented FUD in the market. This was evident in the massive outflows of stablecoins from exchanges – since February 13, more than $1 billion worth of various stablecoins have left the Ethereum network.
The majority of this loss can be attributed to BUSD, which saw the total number of tokens in circulation decrease about 700,000 between February 10 and February 14.
This is the fifth largest stablecoin release on Ethereum in the past two years. And while the $271 billion in outflows recorded on February 16 is only a fraction of the $830 billion recorded on December 13, it still shows the impact of the SEC’s Paxos investigation on the market.
The BUSD sees its dominance diminish
Being the third largest stablecoin by market capitalization, any change in the volume of BUSD experiences is bound to have a profound impact on the rest of the stablecoin industry. The coin decreased its dominance from 17%, recorded in November 2022, to 12% on February 14.
The same goes for the top-ranked stablecoins, USDC and DAI, both of which have seen their market dominance dwindle since the start of the year.
An opposite trend can be seen in USDT. The Tether stablecoin has seen its dominance increase since November 2022, surpassing 53% on February 15, 2023.
Changpeng Zhao, CEO of Binance, said that the SEC order to Paxos will cause the market capitalization of BUSD to decrease over time. While Paxos will continue to service the product, the market expects redemptions to continue to further deplete the supply of BUSD until an SEC decision is made.
Until then, we could see the market capitalization and sector dominance of USDT increase further. The largest stablecoin by market capitalization, USDT, has already seen a notable influx since the SEC investigation into Paxos.
The Tether stablecoin saw a significant increase in liquidity on Binance last September when the exchange removed USDC, USDP, and TUSD-denominated pairs from the platform. The move was aimed at improving price discovery and the overall liquidity of the exchange. However, many saw this as an attempt to vertically integrate Binance, as most of its trading pairs – and the most liquid ones – were tied to BUSD.
The share of BUSD pairs on Binance has grown steadily since its launch in late 2019, but has seen notable increases since the exchange retired USDC, USDP, and TUSD.
As the market capitalization of BUSD declines, we can expect the share of BUSD pairs on the exchange to decline even further. And while there hasn’t been a noticeable increase in the share of USDT pairs on the exchange, there is a chance that it will rise by the end of the quarter.
Binance’s problems with maintaining the stablecoin pool
The SEC’s enforcement action against Paxos is expected to have a negative effect on Binance. The SEC notice cited Paxos’ relationship with the exchange as the reason for the application. And while Binance is not based in the US and therefore not subject to US regulation, targeting BUSD has certainly shaken market confidence in the exchange.
Since witnessing historic pullbacks in November 2022 following the collapse of FTX, Binance has come under intense scrutiny. In January this year, the exchange acknowledged that it had failed to maintain the reserves of Binance-peg BUSD, a stablecoin it issues on other blockchains whose value is pegged to the BUSD issued by Paxos. on Ethereum.
Data compiled by blockchain analytics firm ChainArgos and analyzed by Bloomberg showed that Binance-peg BUSD was frequently under-collateralized between 2020 and 2021. On three occasions, the gap between BUSD reserves held by Binance and Binance-peg BUSD supply exceeded $1 billion. .
The exchange acknowledged its past issues in maintaining the reserve for Binance-peg BUSD and said it has since improved the process with improved divergence checks to ensure the token is backed 1:1 with BUSD. .
The BNB begins a slow recovery
Binance’s native token, BNB, has not been immune to the Paxos news.
The token saw its price drop more than 11% in less than 24 hours as investors pondered the prospect of increased regulatory scrutiny from Binance. However, the dip in confidence appears to have been short-lived as BNB recouped most of its losses on Feb. 16, jumping more than 9% since the Feb. 13 news.
The full effects of the SEC investigation into Paxos have yet to be felt.
If the SEC decides to take enforcement action against Paxos and sue it for violating securities laws, the market could enter a period of unprecedented volatility. Many analysts have argued that BUSD fails the Howey test, a set of criteria defined by the SEC to determine whether an asset is classified as a security. If the Commission continues to pursue the matter in court, it could set a precedent for the rest of the crypto industry and threaten all other major stablecoin issuers.
Increased regulatory uncertainty could destabilize the market, which has just begun a slow recovery from the collapse of FTX. It could also drastically change the crypto landscape in the United States, as many companies may seek to establish themselves in a more regulatory-friendly environment.