In a further sign United States regulators are planning to get tough on digital asset businesses, the Securities and Exchange Commission (SEC) has sent a “Wells notice” to Paxos Trust over its use of Binance USD (BUSD). While Paxos’ BUSD is “approved and regulated by the New York State Department of Financial Services,” according to the company, the SEC appears to regard it as an unregistered security.
A Wells notice warns of potential enforcement action, though as a cybersecurity compliance consultant and attorney John Reed Stark wrote, this almost always means an enforcement action will follow:
Newsflash: SEC issues Wells Notice to Paxos informing Paxos of possible enforcement action. In my 18 years at SEC enforcement division, I can’t recall a time when I sent a Wells Notice and an enforcement action did not follow. SEC’s crypto-sweep continues! https://t.co/kItzSEcCUF
— John Reed Stark (@JohnReedStark) February 13, 2023
Upon receiving a Wells notice, a recipient has the chance to issue a written response to the SEC justifying itself before any enforcement action takes place.
BUSD is an ERC-20 1:1 USD stablecoin token issued by Paxos, but which carries the Binance “branding.” According to Paxos, it is “100% backed by reserves held in either or both (i) fiat cash in dedicated omnibus accounts at insured U.S. banks and/or (ii) U.S. Treasury bills (including through repurchase agreements and/or money-market funds invested in U.S. Treasury bills).” Binance and Paxos announced a partnership to issue the asset in 2019.
Neither Paxos nor the SEC has commented any further on the matter. Though news reports suggested the Wells notice was related to BUSD, it’s unclear whether any action would concern Paxos’ issuing the asset, listing it…or both. The SEC claimed in 2022 it would be paying particular attention to stablecoins and their issuers, but any action against Paxos over BUSD would be the first against a major issuer.
Explaining BUSD
As well as BUSD, Paxos also issues its own in-house stablecoin called Pax Dollar (USDP). The company also says PUSD is fully backed by cash and “cash equivalent” reserves.
Binance also supports a version of BUSD separate from Paxos’ Ethereum token, which it issues under the compatible BEP-2 protocol on Binance Chain (aka Binance Smart Chain). Binance’s own version of BUSD is sometimes called “Binance-peg BUSD” and is actually backed by reserves of Paxos’ BUSD assets rather than actual U.S. dollars.
This connection allows Binance to claim Paxos’ regulated-coin reputation. However, in January 2023, Binance issued an “oops” statement admitting it hadn’t always maintained fully-backed reserves for its token (one ChainArgos analyst suggested it was as much as a US$1 billion difference in 2020-21). However, Binance also said the issue had only happened in the past, and that it currently maintains fully-backed BUSD reserves—as well as the standard claim that no user redemptions were impacted by the discrepancy (so, no big deal).
The SEC tends to care more if laws are being broken than about whether or not any users were inconvenienced. It’s interesting that the agency has chosen Paxos-issued BUSD as its first target for a potential stablecoin action. Paxos’ response, and any subsequent legal activity, may set the scene for future regulatory interest in stablecoin issuers—of which there are many.
Paxos Trust, from 2012 to 2015, was known as itBit, a long-time BTC and digital asset exchange. ItBit stated at its launch that it planned to bring real financial industry expertise and responsibility to the digital asset trading industry. In 2015 it became the first exchange to gain a license from the New York State Department of Financial Services (NYSDFS) and thus be allowed to legally act as a digital asset custodian for U.S. customers.
The SEC under chair Gary Gensler, has repeatedly promised to get tough on certain sectors of the blockchain and digital asset industry, primarily stablecoins and exchanges. Stablecoins are of particular concern to financial regulators, given their status as dollar substitutes makes them effectively the same as “real” digital USD from the Federal Reserve and a past tendency for stablecoin issuers to stretch the meaning of “fully backed by reserves.” What we’re seeing now is the earliest stages of the SEC’s threats being carried out, and it’s likely to be a bumpy ride for some of blockchain’s most lucrative businesses.
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