Overview of the Whole Process: The Sudden Strangulation of BUSD by U.S. Regulators or Its Historical Path - What is the Reason?

Author: Wu Shuo

On the morning of February 13, Beijing time, The Wall Street Journal reported that the U.S. Securities and Exchange Commission (SEC) has informed the stablecoin company Paxos that it plans to sue the company for violating investor protection laws. The notice states that the digital asset Binance USD issued and listed by Paxos is an unregistered security. Companies that receive a Wells notice can respond in writing and tell the SEC why it should not proceed with the lawsuit. A Wells notice is not a final indication that the SEC will take enforcement action. The agency's five commissioners must vote to authorize any enforcement settlement or lawsuit. The SEC has not previously taken enforcement action against major stablecoin issuers.

https://www.wsj.com/articles/crypto-firm-paxos-faces-sec-lawsuit-over-binance-usd-token-8031e7a7?mod=businessminorpos4

On the afternoon of February 13, Beijing time, Bloomberg released news featuring a statement from Binance: The New York State Department of Financial Services (NYDFS) has instructed Paxos to stop minting new BUSD, which is a stablecoin wholly owned and managed by Paxos, and the market value of BUSD will only decline over time. Paxos will continue to service the product and manage redemptions. Paxos also assures that the funds are safe and fully backed by its bank reserves.

https://www.bloomberg.com/news/articles/2023-02-13/binance-says-stablecoin-partner-been-told-to-stop-minting-busd?srnd=cryptocurrencies-v2

Paxos stated that starting from February 21, it will stop issuing new BUSD tokens in accordance with NYDFS's instructions and in close cooperation with them. BUSD will continue to receive full support from Paxos and can be redeemed at least until February 2024; new and existing customers of Paxos will be able to redeem for U.S. dollars or convert their BUSD tokens to Pax Dollar (USDP).

https://www.prnewswire.com/news-releases/paxos-will-halt-minting-new-busd-tokens-301744964.html

On the afternoon of the 13th, CZ detailed in a post that regarding the so-called SEC lawsuit against Paxos, he has no relevant information other than public news articles. The lawsuit is between the U.S. SEC and Paxos. But personally, he agrees with Mile's logic (though it doesn't mean much): I know that technically, it doesn't need to pass the Howey test to be considered a security. If willing, the SEC can essentially define any investable asset as a security. However, this undoubtedly sets a terrible precedent. The SEC has labeled BUSD as "an unregistered security" and is suing its issuer Paxos. But how can it be considered a security when STABLECOIN clearly does not meet the Howey test criteria? No one ever had an "expectation of profit" when purchasing BUSD. CZ's old rival Xu Mingxing also stated that he believes the SEC may not win the lawsuit because BUSD definitely does not have an expectation of profit and should not be a security; however, the NYDFS can demand the cessation of BUSD or halt Paxos's license.

https://twitter.com/cz_binance/status/1625067484368740353

CZ expressed that if BUSD is ruled as a security by the court, it will have far-reaching implications for how the crypto industry develops (or does not develop) in jurisdictions where it is ruled as such. Binance will continue to support BUSD for the foreseeable future. We do foresee that users will migrate to other stablecoins over time. We will adjust our products accordingly. For example, we will no longer use BUSD as the primary currency pair for trading. Given the ongoing regulatory uncertainty in certain markets, we will review other projects in those jurisdictions to ensure our users are protected from any undue harm.

There are many speculations about the reasons, one viewpoint suggests that combined with the previous SEC fine on Kraken's staking yield products, Paxos's own stablecoin USDP was not within the SEC's warning scope, speculating that the U.S. SEC's crackdown on BUSD may be related to its staking yield products. Circle also has similar products and may therefore face similar crackdowns.

Another viewpoint suggests that "securities" is a broader category defined by the Securities Act of 1933, including notes, bonds, debt certificates, interest certificates, mortgage trust certificates, deposit certificates, etc., and does not necessarily have to strictly meet the Howey test. The stablecoin issuer holds underlying treasury bonds, making them very similar to money market funds, giving holders access to securities even if they do not profit from them.

TheBlock editor Frank stated that he would not be surprised if the U.S. SEC is reviewing USDC. A few days ago, a senior exchange executive told him that the SEC is implementing a "Night of the Long Knives" against cryptocurrencies. VanEck strategic advisor @gaborgurbacs stated that Coinbase offers a "reward" program for USDC users, using terms like "APY" and "yield," and given Paxos's recent developments and Gensler's statements on staking and yields, it is speculated that the SEC is investigating such issues. Paying forward yields could be regulated like some kind of fund. The Tether CTO also liked this tweet.

https://twitter.com/gaborgurbacs/status/1625139444326998016

At the end of 2022, Reuters reported that the U.S. Department of Justice's investigation into Binance began in 2018, focusing on whether Binance violated U.S. anti-money laundering laws and sanctions regulations. At least six federal prosecutors are involved, with some prosecutors believing enough evidence has been gathered to take action against Binance, while others believe more time is needed to review additional evidence. Binance has met with Justice Department officials in Washington in recent months. Both sides discussed possible out-of-court settlement options, including a plea deal or paying a fine.

However, it is worth noting that CZ emphasized that this incident is a lawsuit between the SEC and Paxos, not against Binance. In terms of outcomes, the redemption process has already begun, and the market value of BUSD, which is worth tens of billions, seems to have been completely abandoned, with little possibility of future settlement. Regarding the "suggestion for Binance to create their own decentralized stablecoin similar to DAI," CZ responded that at this point, we would prefer others to do it to make it more… decentralized. We cannot do everything. This statement seems to carry some unspoken implications.

Subsequently, the NYDFS's report with Bloomberg explained more reasons. The reason for NYDFS's demand to stop BUSD seems unrelated to the securities designation of stablecoins or staking. The real reason appears to be due to Binance-Peg BUSD, Circle's complaints, and Paxos's inadequate response.

The NYDFS statement indicated that it has ordered Paxos to stop minting BUSD issued by Paxos because there are several unresolved issues regarding Paxos's oversight of its relationship with Binance concerning BUSD issued by Paxos. NYDFS emphasized that it authorized Paxos to issue BUSD on the Ethereum blockchain, but the department has not authorized Binance-Peg BUSD on any blockchain.

https://www.dfs.ny.gov/consumers/alerts/PaxosandBinance

According to Bloomberg, Circle complained to NYDFS last fall about Binance's mismanagement of its own token reserves, indicating that Binance did not store enough crypto reserves to support its tokens. NYDFS determined that Paxos could not operate BUSD in a safe and sound manner "based on extensive regulatory involvement, recent examinations, and Paxos's failure to timely remedy significant issues related to BUSD issued by Paxos."

"Paxos failed to address critical deficiencies, necessitating the department to take further action to order Paxos to stop minting BUSD issued by Paxos. The department is closely monitoring Paxos to verify whether the company can facilitate redemptions in an orderly manner and comply with enhanced, risk-based compliance protocols."

https://news.bloomberglaw.com/securities-law/stablecoin-issuer-circle-warned-ny-watchdog-about-binance-token

Lawyer Collins Belton interpreted that NYDFS's true motivation seems to be the Binance Pegged BUSD, believing it is not fully backed by reserves. It was not until the end of last year that the relationship between Peg BUSD and Paxos was clearly disclosed. The SEC may handle this issue from the same perspective. Therefore, a better outcome would be to minimize the impact on other crypto stablecoins (which may not be affected by collateral consequences).