US SEC takes action against BUSD, and the impact of stablecoin regulation uncertainty continues

Stablecoins appear to be the next target of U.S. regulators in the crypto ecosystem.

Stablecoin issuer Paxos acknowledged on Monday that it had received a Wells Notice from the U.S. Securities and Exchange Commission ( SEC ) on February 3, 2023. The Wells Notice stated that SEC staff was considering recommending action alleging that BUSD is a security and that Paxos should register the issuance of BUSD under federal securities laws.

Paxos issued the following statement in response: Paxos categorically disagrees with the SEC staff's view that BUSD is not a security under the federal securities laws. This SEC Wells Notice applies only to BUSD. To be clear, there are no other allegations against Paxos, and Paxos always puts the security of customer assets first. BUSD issued by Paxos is always backed 1:1 by USD-denominated reserves, fully segregated and held in dedicated accounts. We will engage with the SEC staff on this matter and are prepared to aggressively litigate if necessary.

BUSD is a stablecoin issued by Paxos under the Binance brand, pegged to the value of the U.S. dollar and wholly owned and managed by Paxos. Earlier in the day, Paxos said it would stop minting new BUSD in accordance with the instructions of the New York Department of Financial Services ( NYDFS ).

BUSD encounters massive redemption, and the pressure on Binance reserves increases sharply

After Paxos announced that it would stop minting new BUSD, the token’s redemption volume surged, with CoinGecko data showing that investors redeemed 286,720,127 BUSD in about 8 hours.

During this period, BUSD trading volume also climbed 18%. Three months ago, BUSD had a market cap of approximately $23.24 billion, and more than 30% of its supply has been redeemed in the past 90 days. Monday's redemptions caused slight price fluctuations, with BUSD falling to a low of $0.992245 on February 13.

According to statistics from CryptoCompare.com on Monday, most of BUSD's trading that day was paired with Tether (USDT ), followed by the Turkish lira, the DAI stablecoin and the U.S. dollar. Before the Paxos announcement on Monday morning, BUSD's trading volume was about $15 billion, but by around 3:15 PM New York time, trading volume had increased 18% to $17.6 billion.

The regulator’s actions put Binance’s reserves to the test again.

Nansen data shows that there are about $13.4 billion of BUSD on the Binance platform, which is the largest asset in Binance's reserves after Tether's USDT, accounting for 22% of Binance's $60 billion in assets. BNB, the native token of Binance's BNB Chain , worth $3 billion, accounts for about 5% of all assets on the exchange.

Walter Teng, vice president of digital asset research at market analysis firm Fundstrat , commented that the withdrawals put Binance and its reserve assets to the test. He said: "If Binance does not hold customer deposits at a 1:1 ratio, they may face withdrawal pressure. BUSD's on-chain liquidity has dried up. Redeeming BUSD for US dollars or alternative stablecoins to meet customer withdrawals is the only viable option."

Kaiko research analyst Conor Ryder believes that given that Binance only grants its brand to BUSD, Paxos' decision is expected to have limited financial impact on the exchange, but it may find another issuer for BUSD or find a different solution. Ryder said: "There are still many variables at play, but at present we can expect traders to slowly start to cash out their BUSD holdings."

Binance CEO Changpeng Zhao also warned that if BUSD is deemed a security, it would have a significant impact on the crypto industry. He pointed out that when Paxos stops minting new BUSD tokens, the market value of the BUSD stablecoin "will only decline over time," and he assured investors in a tweet that customer funds are safe.

Wider Implications for Crypto Markets

Stablecoins have grown to a $135 billion market in the crypto space and are the backbone of the crypto ecosystem, seen as the “killer use case for the crypto industry.” The action against Paxos is significant because the company is regulated, bills itself as the “first regulated blockchain company,” and has former FDIC Chair Sheila Bair and retired Senator Bill Bradley on its board of directors.

Crypto market observers expect the SEC to intensify its investigation into stablecoins and introduce new regulations, which pose risks that were not previously considered and could continue to have a negative impact on prices.

Bitpush previously reported that SEC Chairman Gary Gensler said at a legal conference in Washington last September: "Stablecoins have similar characteristics to money market funds, other securities, and bank deposits, and may compete with them and raise important policy issues."

The Financial Stability Oversight Council, a super committee of U.S. regulators chaired by Treasury Secretary Janet Yellen and charged with preventing a repeat of the 2008-style financial crisis, included stablecoins in a comprehensive report on digital assets published last October, which warned that “stablecoins could pose financial stability risks if they grow rapidly without compliance and appropriate regulation.”

Aaron Kaplan, co-CEO of fintech company Prometheum Inc., said in a tweet that the U.S. government has "legitimate reasons to be concerned," arguing that stablecoins could pose systemic risks to the financial system if not properly managed. He said: "If BUSD is considered a security, then other fully pegged dollar stablecoins - including Circle 's USDC - may also be securities, and there is no way to avoid it."

Richard Mico, CEO and chief legal officer of fintech platform Banxa, sees Circle's USDC as a potential next regulatory target, but he believes both Paxos and Circle can win against the SEC in court. He said: "One reason for this concern is that there is not enough guidance. It does provide more evidence and more data points as to why we need clear regulation in the United States, and frankly, it should be done through legislation through Congress."

Leena ElDeeb, research assistant at digital asset firm 21.co, said in a report: "This headwind will lead to a consolidation of the stablecoin market towards blue-chip stocks such as Tether and USDC. The winner is likely to be Tether as we see millions of dollars flowing into USDT on Binance. We may also witness the rise of decentralized stablecoins such as DAI to resist censorship."