On Monday, the New York-based Paxos announced that it will end its partnership with the crypto giant Binance and halt minting BUSD, a Binance-branded stablecoin created in collaboration by the two companies, effective Feb. 21.
The decision comes after reports that the Securities and Exchange Commission plans to sue Paxos, and in light of an order from the New York Department of Financial Services instructing Paxos to stop creating the token.
The partnership between Binance and Paxos saw the BUSD become the third largest stablecoin by market cap and a formidable challenger to its two main competitors, Tether and USD Coin. With Monday’s announcement, the future of BUSD—and the stablecoin market in the U.S.—is in flux.
At a time of soaring interest rates, dollar-backed stablecoins have also served as a source of steady revenue for crypto companies, including Binance and Paxos, during a broader bear market.
“Paxos continues to maintain strong regulatory capital to protect customers, as well as a strong corporate balance sheet to support our long-term business goals,” the company said in a statement. "This action does not impact our ability to continue serving new or existing customers."
A tale of two companies
Paxos has long had a reputation for heeding regulatory guidance. In 2015, it became the first company to receive a New York limited purpose trust charter for digital assets from NYDFS. In 2019, Paxos received authorization from NYDFS to issue the first virtual currencies approved by the agency—the gold-backed PAX Gold, as well as BUSD, a stablecoin pegged to the U.S. dollar.
For the latter, Paxos partnered with Binance, then a quickly expanding crypto exchange with a renegade streak that was looking to benefit from the former's reputation for following the rules. Primarily an infrastructure company that white-labels products for other firms, Paxos benefited from the partnership as well, with Binance likely becoming one of its largest clients. As a private company, Paxos does not release publicly available financial reports.
As Binance grew into the world’s largest exchange, it sought to challenge the dominance of the two biggest stablecoins, Tether and USDC. In September 2022, the company announced it would start automatically converting three major stablecoins, including USDC, into BUSD for the exchange’s customers. BUSD’s market share quickly soared.
Binance also came under fire for its management of BUSD, despite the reputation of its partner, Paxos. Because Paxos was only authorized to issue BUSD on the Ethereum blockchain, and not Binance’s proprietary blockchain (BNB Chain), Binance issues a synthetic token called Binance-peg BUSD, where users can deposit BUSD and receive a BNB Chain-compatible equivalent in return.
In January, researchers at the blockchain analytics company ChainArgos found that Binance did not always hold sufficient collateral of BUSD for the synthetic Binance-peg BUSD token, which the company attributed to “operational delays.” Binance also later admitted to storing BUSD collateral with customer funds in error.
There is speculation that issues with the Binance-pegged BUSD token have resulted in the crackdown from regulators. In a consumer alert issued on Monday, NYDFS said that it has not authorized Binance-pegged BUSD on any blockchain, citing “several unresolved issues related to Paxos’ oversight of its relationship with Binance” for its decision to order Paxos to cease minting BUSD.
"DFS determined that Paxos was unable to maintain and administer Paxos-issued BUSD in a safe and sound manner based on extensive supervisory engagement, a recent examination, and failure of Paxos to remediate material issues related to Paxos-issued BUSD in a timely manner," a DFS spokesperson told Fortune.
The future of stablecoins
Paxos said that it will continue to support BUSD that customers will be able to redeem their funds in U.S. dollars or convert to Paxos’ other stablecoin, Pax Dollar, through at least February 2024. A spokesperson for the company did not respond to a request for further comment from Fortune. The DFS spokesperson told Fortune that the department will continue monitoring Paxos to verify that it can facilitate redemptions.
Binance founder and CEO Changpeng Zhao said on Twitter that BUSD's market cap will decrease over time—it had already fallen from a high of over $23 billion in November 2022 to around $16 billion in February amid questions over Binance's stability.
#BUSD. A thread. 1/8
— CZ 🔶 Binance (@cz_binance) February 13, 2023
In summary, BUSD is issued and redeemed by Paxos. And funds are #SAFU!
The DFS action may just be the beginning of regulatory headaches for Paxos. The company has a pending application with the U.S. Office of the Comptroller of the Currency to become a national trust bank. There have been rumors that the application will be rejected, although Paxos has denied the allegations.
On Sunday, the Wall Street Journal reported that the SEC told Paxos it plans to sue the company for violating investor protection laws, alleging that BUSD is an unregistered security.
The SEC has been aggressive in moving against major crypto companies in the wake of the collapse of FTX, but this would be its first lawsuit targeting a stablecoin, which does not fall under the traditional “Howey Test” for the definition of a security.
Gabriel Shapiro, the general counsel for the crypto firm Delphi Labs, speculated on Twitter that the SEC was targeting the most compliant stablecoin in BUSD due to Paxos’ oversight by NYDFS, but that the SEC would still likely prevail in an ensuing lawsuit.
FWIW the SEC picked the hardest stablecoin to go after in BUSD, as Paxos is NYDFS regulated and uses a trust structure
— _gabrielShapir0 (@lex_node) February 13, 2023
Paxos therefore has at least a slight chance of beating the SEC, especially under the so-called "Reves test" for debt securities (no expectation of profit… https://t.co/F72DqAx5Jw
The lawsuit would also threaten the future of other U.S.-based stablecoins, including the Circle-issued USDC.
“Facts and circumstances in any time of regulatory action like this are all different,” said Circle’s chief strategy officer, Dante Disparte, in a statement to Fortune. “Circle maintains that USDC is a regulated dollar digital currency issued as stored value under U.S. money transmission law.”
