Paxos ordered to cut ties with Binance, will stop minting BUSD stablecoin

Paxos Trust has halted the minting of its BUSD stablecoin and is cutting ties with the Binance exchange after state and federal regulators fired warning shots across Paxos’ bow.

On Monday, the New York-based Paxos announced that it will halt the issuance of BUSD effective February 21, but BUSD “will remain fully supported by Paxos and redeemable to onboarded customers through at least February 2024.” Customers have the option of redeeming BUSD in U.S. dollars or converting them to the Pax Dollar (USDP) stablecoin.

The announcement came after New York’s Department of Financial Services (NYDFS) issued a consumer alert stating that it had ordered Paxos to halt minting BUSD “as a result of several unresolved issues related to Paxos’ oversight of its relationship with Binance.” Paxos’ announcement stated that the company “will end its relationship with Binance for the branded stablecoin BUSD.”

NYDFS noted that it had “authorized Paxos to issue BUSD on the Ethereum blockchain,” but it had not authorized so-called “Binance-Peg BUSD on any blockchain.” The ‘Binance-Peg’ version of BUSD is issued by Binance itself on its own Binance Chain, and the controversial exchange recently confirmed reports that it had not always held sufficient assets to support the redemption of Binance-Peg BUSD at a rate of 1:1 with the U.S. dollar. This shortfall topped $1 billion on at least three separate occasions.

Reuters quoted an NYDFS spokesperson saying Paxos was unable to administer BUSD in a “safe and sound” manner. The spokesperson added that Paxos “violated its obligation to conduct tailored, periodic risk assessments and due diligence refreshes of Binance and Paxos-issued BUSD customers to prevent bad actors from using the platform.”

Monday’s announcements came one day after the Wall Street Journal reported that the U.S. Securities and Exchange Commission (SEC) had sent Paxos a Wells notice based on the regulator’s opinion that BUSD is an unregistered security. On Monday afternoon, Paxos confirmed receiving the SEC’s notice that the regulator was considering recommending action against it for failing to register BUSD as a security.

Paxos said it “categorically disagrees with the SEC staff because BUSD is not a security under the federal securities laws.” Paxos stressed that the notice was limited to BUSD and “there are unequivocally no other allegations against Paxos.” Paxos added that it “will engage with the SEC staff on this issue and are prepared to vigorously litigate if necessary.”

How’d we get here

Paxos struck a deal with Binance in 2019 to issue BUSD, with Binance publicly insisting that its involvement was limited to ‘branding support.’ But Binance quickly took advantage of the situation by launching Binance-Peg BUSD, evidently eager for consumers to enjoy a sense of confidence from the perceived association with Paxos’ New York-approved stablecoin.

Bloomberg reported Monday that Paxos’ New York-based rival Circle—which issues the USDC stablecoin—reportedly alerted the NYDFS “last autumn” about blockchain data showing Binance-Peg BUSD was insufficiently backed by reserves.

Recall that Binance boss Changpeng ‘CZ’ Zhao announced last September that his exchange would begin forcibly converting customers’ USDC to BUSD (a policy that also impacted Paxos’ USDP).

At the time, Circle boss Jeremy Allaire called this policy “problematic” for Binance customers, who had little recourse but to immediately move their USDC off Binance if they didn’t wish to relinquish them for Binance-issued tokens. It now seems that Allaire didn’t take kindly to CZ’s sharp-elbowed bid for the stablecoin market share.

Nothing to see here, folks, keep moving

CZ issued a Twitter thread regarding Monday’s developments, offering assurances that Paxos-issued BUSD was “fully covered by reserves in their banks.” (Tellingly, he made no reference regarding the safety of Binance-Peg BUSD.) But CZ warned that the “BUSD market cap will only decrease over time” as customers redeemed their BUSD for dollars.

#BUSD. A thread. 1/8

In summary, BUSD is issued and redeemed by Paxos. And funds are #SAFU!

— CZ 🔶 BNB (@cz_binance) February 13, 2023

CZ said Binance would “continue to support BUSD for the foreseeable future,” but with customers expected to shift their support to other stablecoins, the exchange would “make product adjustments according. e.g., move away from using BUSD as the main pair for trading, etc.”

CZ warned that any court ruling that finds BUSD to be a security “will have profound impacts on how the crypto industry will develop (or not develop) in the jurisdictions where it is ruled as such.” Binance will also be “reviewing other projects in those jurisdictions to ensure our users are insulated from any undue harm.”

A Binance spokesperson told Bloomberg that the exchange will stop minting new Binance-Peg BUSD but will maintain its auto-conversion policy when customers deposit USDC and certain other stablecoins. This doesn’t really add up, so basically, any Binance customer would be crazy to deposit USDC at this point.

It’s worth noting that (a) the NYDFS and SEC actions against Paxos solely target Binance-related products, and (b) Circle’s Allaire isn’t the only industry peer that CZ has antagonized. CZ played a prominent role in last November’s downfall of former business partner Sam Bankman-Fried’s FTX exchange, and with SBF facing 115 years in prison, dishing dirt on CZ’s questionable practices may be the only card SBF has to play (or has already played).

Binance halted U.S. dollar bank transfers this month after New York-based Signature Bank blocked Binance from accessing the bank’s Signet digital payments platform. That, in turn, followed Binance being publicly shamed as the top receiving party of the crime-friendly Russia-based Bitzlato exchange.

However, Binance’s supposedly ‘independent’ U.S.-licensed offshoot Binance US continues to enjoy access to U.S. dollar payment rails. Given the fiscal mingling the two entities have displayed in recent months, how much longer will U.S. regulators and banks be willing to tolerate any entity bearing Binance branding?

It’s been only two months since Binance was forced to deny insolvency rumors as panicked customers withdrew between 25-30% of the exchange’s total assets in the wake of FTX’s collapse. On Monday, Nansen data showed Binance suffered a net outflow of over $830 million in the past 24 hours, the largest since that November crisis.

While the broader ‘crypto’ market was negative on Monday, Binance’s in-house BNB token took a pounding, falling 8% at one point. Given Binance’s reliance on its ability to print BNB out of thin air—much like FTX’s doomed FTT token—how much longer can CZ maintain the façade of solvency? (And that BNB/BUSD’ industry recovery fund’ suddenly looks in need of its own rescue.)

Go ahead: make Gary’s day

The Securities and Exchange Commission (SEC), under Chairman Gary Gensler, has become increasingly aggressive in its stance toward ‘crypto’ firms’ dealings with U.S. customers. Last week, the SEC imposed a $30 million penalty on the San Francisco-based Kraken exchange, which agreed to permanently halt its ‘crypto asset staking services’ and ‘staking programs’ due to the SEC’s view that the products are unregistered securities.

The SEC is reportedly eyeing similar products at other crypto firms, including the Coinbase (NASDAQ: COIN) exchange. Last Friday, Coinbase’s chief legal officer Paul Grewal posted yet another tone-deaf blog post, this one titled “Coinbase’s staking services are not securities. And here’s why.” The post can basically be summarized as ‘we need the money we make from staking so we can’t acknowledge that they’re unregistered securities.’

Coinbase CEO Brian Armstrong offered a similarly defiant response to the SEC’s action against Kraken, tweeting his agreement with Grewal’s blog post and vowing that Coinbase “will happily defend this in court if needed.” (Bet on this court appearance being a matter of ‘when’ not ‘if.’)

With the SEC now targeting both staking services and stablecoins, Coinbase is effectively fighting for its life. Its most recent financial report card showed an unhealthy revenue reliance on staking and USDC custody interest, meaning if they both get struck off, Coinbase is likely to follow suit. That must be why Grewal dumped another $140,000 worth of his Coinbase shares last week.

Interestingly, Armstrong also tweeted Monday morning that he was “in Washington D.C. and had a meeting canceled,” so he offered to meet “anyone” to “come chat about crypto.” Does anyone get the sense legislators are suddenly wary of posing for a photo they might come to regret?

Tether untethered

Questions are also mounting regarding a possible action against the Tether stablecoin by either the SEC or New York. Under a 2021 settlement with the New York Attorney General’s office for lying about the reserves backing its USDT stablecoin, Tether and its parent company iFinex were explicitly ordered to “cease any further trading activity with New Yorkers.”

Reports emerged over the weekend that the U.S. Treasury bills allegedly backing Tether’s billions of USDT were being handled by the New York-based financial services firm Cantor Fitzgerald. Cantor’s equally NY-based offshoot BGC Partners was said to have “bought and sold large volumes of Tether.”

Tether minted another $1 billion of USDT on Monday, clearly expecting a flood of new business as stablecoin aficionados transfer their affections from rivals vulnerable to enforcement due to their presence on U.S. soil, including Circle’s USDC (which may be receiving its own Wells notice as we speak).

PayPal’s seen enough

Even before the news of New York’s BUSD crackdown had been confirmed, Bloomberg reported that payment processor PayPal (NASDAQ: PYPL) had paused efforts to issue its own stablecoin. A PayPal spokesperson subsequently told Fortune that the company was “exploring a stablecoin. If and when we seek to move forward, we will, of course, work closely with relevant regulators.”

PayPal’s stablecoin plans, which were announced over a year ago and in which Paxos was to play a major role, were likely much further along than the company is now willing to admit. PayPal began allowing its customers to deal in digital currencies over two years ago and last week reported holding $604 million in digital assets—overwhelmingly BTC and ETH—on behalf of its customers at the end of 2022.

Paxos, which in 2021 received conditional approval of its bid to split its operations to include a national trust bank charter, felt compelled to issue a public denial last week of reports that the Office of the Comptroller of the Currency (OCC) had asked Paxos to withdraw its application. Paxos said it continues to “work constructively with the OCC” but the OCC has yet to comment.

Those rumors followed last month’s unanimous rejection by the U.S. Federal Reserve Board of Governors of Custodia Bank’s application for membership in their financial club. The Fed rejected the Wyoming-based Custodia’s application because its crypto focus “presented significant safety and soundness risks.”

That rejection followed January’s joint statement by the Federal Reserve, OCC, and the Federal Deposit Insurance Corporation (FDIC) that basically suggested banks have no business dealing with crypto and those that choose to do so should expect to be watched extra closely.

The U.S. Senate Banking Committee will hold a hearing Tuesday morning with the not-at-all ominous title: ‘Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets.’ Any crypto bros in attendance may want to scope out the emergency exits in advance.

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