The Breakdown - The Latest Front in the Crypto Wars Is Binance-Paxos and BUSD

Episode Date: February 14, 2023

Last week, rumors swirled that Paxos was the next target for regulatory action. On Sunday, the Wall Street Journal reported the Securities and Exchange Commission was preparing a suit accusing the company of issuing an unregistered security. Then on Monday, the New York-regulated company announced it would cease issuing Binance USD after the state banking regulator said Paxos couldn’t do so in a safe and sound manner.  - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: ZU_09/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.  

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDesk. What's going on, guys? It is Monday, February 13th, and today we are talking about the latest salvo in the Crypto Wars. A quick note before we dive in, there are two ways to listen to The Breakdown. You can hear us on the Coin Desk podcast network feed, which comes out every afternoon and features other great CoinDesk shows. Or you can listen on The Breakdown Only Feed, which comes out a few hours later in the evening. Wherever you listen, I was so appreciated if you would take the time to leave a rating or review,

it really makes a big difference. All right, friends, well, the thunder on the horizon has officially become a storm. The U.S. government is on the march, and the next front of the crypto wars has officially been opened up around Paxos and their relationship with Binance. Now, obviously last week's biggest news was Cracken Settlement with the SEC. It was big for Crackin themselves, obviously. The company had to shut down their staking. as a service program and pay a $30 million fine, but the implications for the rest of the industry

were really the biggest significance. Some noted the SEC's hypocrisy. Lawyer Jason Gottlieb tweeted, I find the SEC's all crypto projects have to do is come in and register line, unbelievably insulting. It assumes that there's this vast quantity of sophisticated securities lawyers advising clients, nah man, screw the SEC, yolo baby, do whatever you want. Tons of projects and their lawyers desperately want to come in and register. But when they do, they're just told no. Or worse, they draw a Wells notice, or as Hester Perce said, a court date. There is simply no path to registration for many crypto products. The SEC says just register. We say cool, but as what? Because the regs just don't fit. In response, we get blank stares, apologies, and mumbles that

they're not going to give us legal advice. If the new de facto rule as crypto equals no, that rule has to come from Congress, or at least through an APA process, not through enforcement. Going on CNBC to say that registration is just a form on our website is a painful misrepresentation of the registration process. Again, it's just insulting. It brands the whole industry and its lawyers as scofflaws who don't bother following easy rules instead of the reality. People desperately trying to figure out how to offer a product legally and getting zero guidance

other than no. If registration were possible, we'd do it. Give us a pathway, show us it can be done efficiently or at all, and watch the flood of registrations. Or don't, and watch the industry move offshore and watch America get left behind. in the next wave of fintech. End thread. Now for others, where they honed in on the Cracken news was wondering what the implications for other staking programs might be.

Coinbase's chief legal officer Paul Gruel made it clear that the company believed that their staking program was fundamentally different because it didn't offer additional rewards on top of whatever the protocol mandated. Cracken founder Jesse Powell said he wasn't really sure the SEC was going to be okay with any custodial staking program, but that he sincerely hoped someone would be willing to actually have a legal battle around it. It does appear that Brian Armstrong and Coinbase seem to be willing to have that fight. Gruwall, in fact, wrote a blog post called Coinbase's staking services are not securities, and here's

why. He basically says that staking isn't a security under the U.S. Securities Act, nor under the Howey Test, and that, quote, staking fails to meet the four elements of the Howey Test, investment of common enterprise, reasonable expectation of profits and efforts of others. He says that it doesn't constitute an investment because people retain full ownership. He said it doesn't meet common enterprise because they're staking on a decentralized network. He said it doesn't mean reasonable expectation of profits because staking rewards are not a return on an investment, but instead, quote, a payment for validation services provided to the blockchain.

Now, in any case, it seems like Coinbase is willing to fight. Brian Armstrong tweeted the piece and added, Coinbase's staking services are not securities. We will happily defend this in court if needed. Bringing it back to Cracken, though, the same day that they announced their settlement with the SEC, the IRS also announced that they were seeking court approval to enforce a 2021 summons against Cracken to get information about their users.

Basically, everything was feeling like there was a big, increasing, and coordinated fight. And on Sunday night, the next attack began. On Sunday, the Wall Street Journal reported that the SEC is planning to file a lawsuit against Paxos for violating securities laws. According to the report, Paxos had received a Wells notice claiming that Binance, U.S.D, BUSD, is an unregistered security. A well's notice is a formal notification of the SEC's intent to bring enforcement actions regarding violations of securities law. Firms are allowed to respond in writing to argue why the SEC should not bring a lawsuit over the infractions disclosed, so a lawsuit is not certain to go ahead, but in practice, it's pretty rare that it doesn't happen after that Wells notice

hits. Now, information about Paxos being targeted had started to leak out late last week, but this morning we got even more news. Early Monday morning, Paxos tweeted, this morning Paxos announced it will halt minting new BUSD tokens effective February 21st. Existing BUSD tokens are fully back, and redeemable through Paxos trust company through at least February 24. Paxos will continue to manage all outstanding BUSD reserves, ensuring all BUSD are always backed one-to-one with U.S. dollar denominated reserves held in bankruptcy remote accounts. Paxos remains dedicated to the development of stablecoins, tokenization, and blockchain technology. We'll continue serving the world's most respected and established companies to create a more open financial system. Now, CZ from Binance tweeted,

we were informed by Paxos that they have been directed to cease minting new BUSD by the New York Department of Financial Services. Paxos is regulated by NYDFS. BUSD is a stable coin wholly owned and managed by Paxos. As a result, BUSD market cap will only decrease over time. Paxos will continue to serve the product and manage redemptions. Paxos also assured us the funds are Safu and fully covered by reserves in their banks, with their reserves audited many times by various audit firms already. On the alleged SEC versus Paxos lawsuit, I have no information about it other than public news articles. The lawsuit is between the U.S. SEC and Paxos. If BUSD is ruled as a security by the courts, it will have profound impacts on how the crypto industry will develop or not develop

in the jurisdictions where it is ruled as such. Finance will continue to support BUSD for the foreseeable future. We do foresee users migrating to other stable coins over time, and we will make product adjustments accordingly, e.g., moving away from BUSD as the main pair for trading, etc. Given the ongoing regulatory uncertainty in certain markets, we will be reviewing other projects in those jurisdictions to ensure our users are insulated from any undue harm. Now, I'll admit, it was a little hard to keep track of all the different things happening at once, but the specific consumer alert issued by NYDFS gave us just a little bit more info. In that alert, they write, DFS has ordered Paxos to cease minting Paxos-issued BUSD

as a result of several unresolved issues related to Paxos' oversight of its relationship with Binance in regard to Paxos issued BUSD. In response on February 13, 2023, Paxos notified customers of its intent to end its relationship with Binance for BUSD. It is important to note that the department authorized Paxos to issue BUSD on the Ethereum blockchain. The department has not authorized Binance PAYG BUSD on any blockchain, and Binance PECD is not issued by Paxos. There is currently no restriction on the listing or exchange in New York of existing Paxos issued BUSD by DFS licensed entities. Now, the key part to me is really this part about the difference between BUSD and

Binance Pegg USD. BUSD is actually not just one product. There's the Paxosd. There's the Pax Xos version of it that is regulated in New York, and then there is the Binance Peg-BUSD version, which is on the Binance smart chain. It's supposed to be backed one-to-one, with a reserve of Ethereum BUSD custodied by Binance, but, remember, in January, revelations emerged that the Sablecoin's reserves had been at times under-collateralized by more than $1 billion during 2020 and 2021. Binance admitted that their processes hadn't always been top-notch, but they had already solved this problem. At the time, CZ dismissed all of it as FUD, although others in the community weren't so sure. Travis Kling tweeted, please explain to the market how it is fud when a

Binance spokesperson confirms to Bloomberg that BUSD had over a $1 billion hole in its collateral value. Now, as I was recording this, there's also now reporting that Circle, USD, one of Binance BUSD's big competitors, had actually brought this issue up with NYDFS last year. From the DB News feed, Circle alerted NYDFS to issues its team had surfaced in blockchain data that showed Binance did not store enough crypto in reserve to support tokens it had issued, according to a person familiar with the matter. Now, this definitely got the community's attention. DB at Tier 10K also added context to their own tweets, saying,

Circle alerted the watchdog last autumn to issues its team had surfaced, around the time when Binance stopped support for USDC and started auto-converting into B-USD, question mark? Definitely an interesting subplot to watch. Now, on top of this reserves issue, there also may be KYC and AML, issues. This is from an article in Reuters this morning, quote, an NYDFS spokesperson later told Reuters via email that Paxos violated its obligation for tailored periodic risk assessments and due diligence checks on Binance and Binance USDA customers

needed to stop bad actors from using the platform. Now, all in all, this is a fairly big blow for Paxos business model. And remember, last week, Bloomberg had also reported that PayPal had put its stable coin plans on hold due to regulatory uncertainty, and they had also been working with Paxos. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3, happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, founders, entrepreneurs, and more.

Use code Breakdown to get 15% off your paths. Visit Consensus. Or check the link in the show notes. Now, I think right now as the dust starts to settle, the big question for many is what the SEC complaint will actually look like. And specifically, will they try to make the case that stable coins are definitionally securities? They've given some hints in the past that this might be their view.

Speaking at the American Bar Association in July of 2021, Gary Gensler said, make no mistake. It doesn't matter whether it's a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These platforms, whether in the decentralized or centralized finance space, are implicated by securities laws and must work within our securities regime. Now, when it comes to this logic, most of crypto-twitter had a pretty similar reaction to Tree of Alpha, who wrote, how on earth does BUSD register as a security? Where is the expectation of profit? Are you all buying BUSD because it's going to $2?

Gary Gensler is on an unhinged, unchecked crusade against crypto and will keep doing so as long as he is permitted to. This point about how a stable coin could possibly come with an expectation of profits was definitely front and center in the discourse. Neil Hartner and engineer at Ripple says, just as for all the people who bought Paxos' USD stable coin with an expectation of profit, but only broke even. Still, some said not so fast. Gabriel Shapiro, General Counsel at Delphi Labs, said, don't hate me, but custodial stable coins are probably all securities. I've said this consistently. U.S. securities laws are just insanely broad. They are basically shares of a money market fund, but are worse than normal shares because they only become activated when some people hold them.

fully censorable and backed by discretionarily managed black box portfolio of assets fully trustful. At one point, those assets included commercial paper and other securities, though now moved on to treasuries and cash to increased defense potential. Adam Cochran, who it should be noted isn't a lawyer, said this is what people don't realize. Howie test equals a precedent for investment contracts, but Securities is a much broader category defined by the 1933 Securities Act. Honestly, if the SEC wants to, with how vague the act is, it's fairly easy to put anything under it. If all the matter was the Howie Test, you wouldn't have an entire field of law dedicated to this one act. Unless otherwise exempt as a bank or regulated trust,

redeemable deposits in trust can easily fall under this. The fact that these assets hold underlying treasuries makes them a lot like a money market fund, exposing holders to a security even if they don't earn from it. Making an argument, not one I agree with, but a reasonable enough one that they can be a security. It's worth fighting tooth and nail, but everyone who is shrugging this off as lull the SEC got it wrong this doesn't pass the Howie test needs to reevaluate. The SEC, believe it or not, has knowledgeable securities counsel. But I don't earn from it. How can it be a security? Doesn't have to be a good or lucrative security to be a security. If someone is holding or otherwise securing value for you, and you are trusting them to do it and not

otherwise exempted, it's a security. So where we are with that is the question really remains if this is going to be finance-related or more general. J.P. Coning says the SEC suing paksos over its binance-Ustsd-Stablete but not USDP, suggest its coral may have something to do with a binance nexus and not stablecoins in general. But if not, and the SEC has a wider problem with stable coins, then the crypto industry is in a lot of trouble. USDP is Paxos' own managed Pax stablecoin, by the way. Now, obviously, another question that many are asking is whether Circle's USDC is in the targets as well.

AP Abacus Andrew said update, expect Circle and USC to be the next SEC stablecoin target to receive a Wells notice. Frank Chaparro from the block writes, SEC is on an absolute war path. I wouldn't be surprised if they were reviewing USDC specifically. Lex Moskovsky says, it's funny how USDC is. B-USD bear more risk than USDT right now, exactly because they have chosen to be compliant with U.S. regulations. And there does indeed seem to be a bit of a rotation. Since the beginning of the month, about a billion dollars has come out of USDC, while a few hundred million has flowed into tether.

Still for many, this is about something much bigger than stable coins. Masari's Ryan Selkis sounded the absolute war call, saying my goal in life is to end Gary Gensler's political career and make him the reason Biden loses re-election. I will spend every ounce of energy and financial and political capital I have fighting crypto's morally bankrupt and corrupt enemies. Smart regulation is important. De facto bans will be fought ruthlessly. And when it comes to the government, it's hard not to feel like part of this opportunity for Gensler was created by Congress's failure to pass stablecoin legislation last year. It was something Patrick McHenry and Maxine Waters worked on but couldn't get over the hump with, although we're not sure what the reason for that

was or how the balance of power might change now that the Republican Patrick McHenry is the chair and Maxine Waters is the ranking member. It is certainly the case that House Republicans are no fan of Gary Gensler. On Friday, Representative Bill Huizenga says since Gary Gensler won't abide by his own policies to come in and talk, the House GOP will hold him accountable. Today, as promised, our oversight of the SEC begins with a request for documents surrounding their interactions with Sam Bankman-Fried, F.TX, and the Justice Department. Basically, the House Financial Services Committee sent a letter to Gary Gensler saying, we want to know all of your interactions and investigations around FTX. The letter states, presumably the SEC's division of enforcement did a complete investigation into the actions

by Sam Bankman-Fried and presenting findings to the commission for its review into authorized charges. Yet the timing of the charges and his arrest raised serious questions about the SEC's process and cooperation with the Department of Justice. The American people deserve transparency from you and your agency. The letter demands records of all SEC communications regarding charges brought against SBF, dating back to the start of November. Over the weekend, Maxine Waters fired back saying that a more important action for McHenry to take would be to drag salmon for testimony. So if you were thinking we were going to get some more unanimity on where the House Financial Services Committee at least should focus its priorities, that may be a little bit of a pipe dream.

Anyways, guys, that is the latest from the Crypto Wars. I certainly don't think it's the last update we'll get this week. So strap in, get ready, and until tomorrow, be safe and take care of each other. Peace.