Stablecoins have been getting a lot of attention recently with the collapse of Terra’s algorithmic stablecoin UST and with the recent depegging of the stablecoin USDC. Stablecoins are digital currencies either backed by assets or by an algorithm which regulate their supply. They supposedly hold stable value and are therefore designed to reduce volatility and to facilitate trading in other digital assets. With a market capitalization of almost $130B today, stablecoins are getting more and more adopted and are under growing scrutiny by the regulators.
This article is part of the miniseries about stablecoins in which we will present the 4 main stablecoins: Tether, USD Coin, Binance USD, and Multi Collateral Dai.
Binance USD, or BUSD was launched in September 2019 by Binance in collaboration with Paxos. It is now the 7th biggest cryptocurrency and the third largest stablecoin with a market capitalization of $8.40B.
Binance Holdings Ltd or more commonly Binance was launched in 2017 by Changpeng Zhao, known as CZ. With a revenue of $20B in 2021, Binance is the largest cryptocurrency exchange in the world where customers can exchange over 350 digital assets everyday, 24/7.
Binance was incorporated in George Town, GY, Cayman Islands but is now based in UAE. It has its own native blockchain BNB Chain, forked from Ethereum and its own stablecoin, Binance USD or BUSD.
According to Reuters, Binance has been under investigation by the US Department of Justice (DOJ) since 2018 for potential violations of US anti-money laundering laws and sanctions. The investigation has reportedly involved discussions about potential plea deals related to charges of unlicensed money transmission, money laundering conspiracy, and criminal sanctions violations. Reuters has also reported on Binance’s alleged weak anti-money laundering controls, processing of over $10 billion in payments for criminals and companies seeking to evade US sanctions, and plotting to evade regulators in the US and elsewhere.
Binance’s CEO, Changpeng Zhao, has declined to disclose the location or entity behind his own exchange. Additionally, Binance has reportedly hired several former officials from the IRS Criminal Investigation division to enhance its financial crime compliance efforts.
Binance has hired a former chief of Money Laundering and Asset Recovery Section (MLARS), Kendall Day, to engage in discussions with the Justice Department, and officials have reportedly discussed a possible resolution to the case out of court, including potential guilty pleas or fines.
Changpeng Zhao, also known as CZ, is a businessman, investor, and software engineer. He is the co-founder and CEO of Binance, which is currently the world’s largest cryptocurrency exchange by trading volume. As of December 2022, he is ranked the 136th-richest person in the world, with a net worth of $13.1 billion, according to Bloomberg Billionaires Index. Zhao was born in China’s Jiangsu province and later immigrated to Canada with his family. He attended McGill University in Montreal, where he majored in computer science. After graduation, he worked for several companies, including Bloomberg Tradebook, before moving to Shanghai in 2005 to establish his own technology startup company, Fusion Systems. In 2017, he launched Binance, which quickly grew to become the world’s largest cryptocurrency exchange.
Paxos Trust Company, LLC is a stablecoin issuer and blockchain solutions company founded in 2012 by CEO and co-founder Charles Cascarilla. It is based in New York (US) while its holding, Kabompo Holdings, Inc. is domiciled in Cayman Islands. Paxos offers digital assets tokenization, custody, trading, settlement and exchange for enterprise clients like Paypal, Bank of America or Credit Suisse. They also issue stablecoins like BUSD.
Paxos is a New York regulated financial institution and has an impressive record when it comes to regulation.
Paxos is a Limited Purpose Trust Charter approved by the New York Department of Financial Services (NYDFS). Companies that gets this charter go through a long process in which every little details are scrutinized by the NYDFS (company’s anti-money laundering, consumer protection, capitalization and cyber security standards, directors’ fingerprints taken, directors interview, business plan reviewed, etc). You can find an exhaustive list here. The New York State is one of the most heavily regulated state in the United States. Being regulated by the NYDFS is a great achievement and provide great trust to potential customers.
What is a Trust ?
In the US, trust companies are legal entities which offer fiduciary services and services related to their fiduciary services. Fiduciary activities require you to do everything in order to protect the interests of the beneficiary, whose assets you’re holding/maintaining.
What’s a Limited Purpose Trust Charter
In 2014, the NYDFS started working on a new regulation, BitLicense or the limited purpose trust company provisions of the New York Banking Law, aimed at providing a clearer regulatory frame for virtual asset companies, after the collapse of Mt. Gox.
The Virtual Currency Regulation is quite restrictive but highly protective of the consumers. The section a) provides the beneficiary with a kind of insurance from the qualified custodian, here a bank. Note here that trusts are not insured with the FDIC, even though section 200.19 a) (10) states that it could not be enough to cover all the losses.
Section b) implicitly prohibits the licensee to operates with fractional reserve but instead with 100% reserve, kept in the asset the beneficiary bought in the first place.
According to the part 200.9 c) of the regulation custody and protection of customer assets, the licensee (here Paxos) is forbidden to lend, sell or do any action on those assets it is custodian of unless the beneficiary (consumer) directs the licensee to do so.
In part 200.19 Consumer protection of the Virtual Currency Regulation, it explicitly states that the licensee are not covered by the FDIC.
Paxos directly benefited from this new regulation and was the first to get the Limited Purpose Trust Charter license in May 2015.
For the NYDFS, “the term limited purpose trust company refers to institutions chartered under the bank and trust company provisions of the New York Banking Law but without the power to take deposits or make loans.”
Recent chartering documents include this standard clause:
“The corporation is to exercise the powers conferred by Section 100 of the Banking Law. The corporation shall neither accept deposits nor make loans except for deposits and loans arising directly from the exercise of the fiduciary powers specified in Section 100 of the Banking Law.”
They also differ in that they don’t need to be insured by the Federal Deposit Insurance Corporation (FDIC), and don’t have a capital requirement like banks do. It’s because they are not depository institutions and therefore are not allowed to lend or invest the beneficiary’s assets. In other words, trusts don’t use fractional reserve like banks do, keeping only a percentage of their reserve and lending/investing the rest.
The NYDFS then adds that the applicant “…must demonstrate to the satisfaction of the Banking Board that public convenience and advantage would be promoted by the new facility.” Approvals are conditioned upon any restrictions on doing business that the Department of Financial Services deems necessary.”
National/State Level Regulation
In the US, banks and financial services companies can be regulated both at the state and/or federal level. Paxos, being regulated by the NYDFS since 2015, is therefore regulated by the state of New York but is not regulated in any other US states. A shortcut for Paxos would be to get a National Bank Charter which would allow the company to be regulated at a national level and therefore to instantaneously get regulated in all the US states. The application for a National Trust Bank Charter has been submitted in December 2020 to the national banking regulator, the Office of the Comptroller of the Currency (OCC) which gave its preliminary conditional approval in April 2021.
Note that Paxos would treat the two charters like two different affiliates and not one entity being regulated at both a state and federal level.
Paxos’ National Trust Bank Charter Submission
In April 2021, Paxos received a preliminary approval to be chartered as a National Trust Bank.
The OCC gives clear indication as to what Paxos would be able to do with this license in its Preliminary Approval Letter; one of the condition being to limit Paxos’ activities to those of a trust:
- Why is it a preliminary conditional approval?
The OCC hasn’t given a final approval and has put some conditions for the final approval of the charter. One of them is to obtain a Federal Reserve’s membership, which is a legal requirements for national banks in the US.
”The OCC stated that its decision to grant preliminary conditional approval was made with the understanding that Paxos will apply for Federal Reserve membership.” OCC Preliminary Approval, 23th April, 2021
Paxos’ conditions for final approval by the OCC:
- Where is the regulation process at?
In April 2021, the OCC gave Paxos 18 months to fulfill its requirements in order to get the final approval for getting the National Trust Bank Charter.
The approval has therefore expired and when checking the lists of trust banks on the OCC website, we can’t find PAXOS. You can check here.
The OCC could be on the way to give a precedent to current legislation but hasn’t granted yet the final approval for Paxos to become a National Trust Bank Chartered. We can’t wait to see what happens here.
A recent update from Paxos on Twitter made clear that the process is still going on.
Why is all this important? Because Paxos is the company that issues BUSD on the Ethereum Blockchain. Well, …was. In February 2023, New York regulators have directed Paxos Trust Co. to stop issuing more BUSD, which is a stablecoin wholly owned and managed by Paxos. The move comes after reports that the NYDFS is investigating Paxos over whether it was meeting rules around custody of client crypto assets. Additionally, the SEC is planning to sue Paxos Trust for violating investor protection rules in relation to Binance stablecoin, as the SEC claims that BUSD is an unregistered security. Paxos has stated that it will continue to manage redemptions of BUSDs until February 2024, but its market cap will only decrease over time.
Charles Cascarilla is the CEO and co-founder of Paxos, then known as ItBit. He is a certified financial analyst and holds a Bachelor of Business Administration from the University of Notre Dame. Cascarilla’s career began in 1999 as an analyst at Bank of America and he later worked with other notable companies such as Goldman Sachs, Claiborne Capital Management, Cedar Hill Capital Partners, Liberty City Ventures and the Association for Digital Asset Markets. The NYDFS would have also done extensive research about his financial and professional past, which shows green lights.
Andrew is an American businessman and was Paxos’ COO until 2021; he is now a part time advisor.
Investor, operator, consultant and senior executive in web3 projects, Andrew has a great record.
General Counsel at Paxos since 2019, Daniel Burstein has a background in legal and compliance and worked at the NYDFS for 4 years (can it get any better?).
Amongst the board members: Sheila Bair, former Chairman of the Federal Deposit Insurance Company (FDIC), Scott Malpass, Board Member at The Vanguard Group, Inc. and Brian Stern, former Head of Private Markets at BlackRock.
Overall impressive team, we will agree.
Let’s now talk about the peg, the most crucial information for a stablecoin. That’s when it starts being confusing.
For most people BUSD is a stablecoin pegged 1 to 1 with US Dollars which are held in PAXOS US-banks or in cash equivalent.
Paxos BUSD is apparently backed with cash, overnight loans secured only by US Treasuries, and US Treasuries with a less than 90 day maturity. As a Trust Company chartered by the NYDFS, Paxos needs approval by the latter in order to change the composition of this peg.
Do not mistaken this with a bank. A bank is allowed to take deposits and therefore in the category of depository institution, which have reserve requirement.
Well…that’s not entirely true. BUSD has 2 faces: Paxos’ BUSD (ERC-20 token) issued by Paxos on Ethereum blockchain and held in US FDIC insured-banks and Binance-Peg BUSD (BEP20 or BEP2 token) issued by Binance on other chains like BNB Beacon Chain, Avalanche or BNB Smart Chain.
When looking for information on CoinMarketCap regarding BUSD, this is what we find.
When clicking on BNB Smart Chain (BEP20), a message appears at the top providing clear information regarding BUSD issuance and the regulation it’s backed by. It reads:
“BUSD is issued on Ethereum by Paxos and regulated by the NYDFS. Binance provides the pegged token service, which locks BUSD on Ethereum and issues an equivalent amount of Binance-Peg BUSD on corresponding other networks (BNB Chain, Avalanche and Polygon, etc). Please note that Binance-Peg BUSD is a Binance product. It is not issued by Paxos nor regulated by the NYDFS.”
On Binance’s website, a recent article put lights on the difference between the 2 types of BUSD tokens (November 15th, 2022).
Paxos’ BUSD is issued as ERC-20 token on Ethereum blockchain and are collateralized 1 to 1 by US Dollars held by Paxos Trust Company, LLC in FDIC-insured, U.S.-domiciled banks. Paxos’ BUSD is issued and destroyed by Paxos. Paxos publishes monthly reports of proof of reserves in order to prove the peg and also follows NYDFS guidance and requirements.
Attestations are made by WithumSmith+Brown, PC, one the of top 25 American accounting firms, “in accordance with attestation standards established by the American Institute of Certified Public Accountants (AICPA)” (Paxos.com).
You can find the latest attestations here.
“BUSD is designed with three key areas in mind: high-quality reserves, audits, and regulation” states Binance on their website.
In the report, it confirms the amount of BUSD on Ethereum blockchain on 14th November 2022.
When checking CoinMarketCap today, we find over 16.636 billion BUSD in circulation.
The attestation report also confirms the nature of the peg: US Dollars and US Treasury Bills held at insured US banks.
The report also notes that the NYDFS rules regarding stablecoin issuance are respected.
The confusion starts here. The Binance-Peg BUSD is a wrapped BUSD token issued by Binance and backed one to one with locked Paxos’ BUSD tokens. Binance-Peg BUSD runs on other chains than Ethereum like BNB Beacon Chain and BNB Smart chain.
It is therefore pegged by tokens held in Binance wallet.
In order to issue Binance-Peg BUSD, Binance must first “lock” native BUSD on Ethereum and then create “wrapped” BUSD tokens. Wrapped tokens means in crypto terms that we increase the interoperability of the token which now can go onto other blockchains.
Those two tokens have the same name, BUSD, but one is the wrapped version of the other.
Recently, Bloomberg cited an analysis made by Jonathan Reiter, co-founder of blockchain analytics company ChainArgos, put lights on the fact that the peg for Binance-Peg BUSD was not always maintained 1 to 1. At a certain time, Reiter says that the calculation shows a 1 billion gap between the “locked” BUSD and the Binance-Peg BUSD in circulation.
On Messari, BUSD is presented as an ERC-20 token and therefore as Paxos’ BUSD.
Recently, Binance made efforts in order to bring clarity to Binance-peg BUSD. As shown below, you can now see on Binance’s website their addresses and link to those addresses to follow the peg.
Binance is looking to bring more transparency but is struggling to find partners to help it do so; according to Bloomberg, Mazars had been hired to provide transparency report but withdrew before publishing the report in December 2023.
Binance USD (ERC-20) is regulated by the New York Department of Financial Services. It is one of the toughest regulatory body in the US.
The NYDFS has Guidance on the Issuance of Stablecoin. The requirements are the following (you can find the whole Guideline here ):
– Redeemability: clear redemption policies with redemption no later than 2 days after customer’s request and redemption at 1:1. redemption in US Dollars,
– Reserves: 1:1 fully backed reserves in US Dollars or US Bonds. Reserves must be segregated from company’s account,
– Attestation: being attested every month by a Public Accounting Firm “licensed in the United States and applying the attestation standards of the American Institute of Certified Public Accountants (“AICPA”)”. The process examines the last business day of the month, plus a randomly picked business day,
-Annual attestation report: regarding the “effectiveness of the internal controls, structure, and procedures for compliance”.
According to data provided by Into The Block, there appears to be a high level of centralization for BUSD. Approximately 80% of the total supply of BUSD is controlled by just four addresses, all Binance’s wallets. This represents around 80% of all BUSD coins.
Binance wants to be the leader in the stablecoin market. In order to accelerate things, it had recently added a new auto convert feature on its exchange. Stablecoin like USDC, USDP and TrueUSD are now automatically auto-converted to BUSD on the Binance platform since September 2022. With Binance claiming that it will increase liquidity, and be beneficiary to BUSD holders.
Binance didn’t realize that this move would really trigger the US regulators, as BUSD is pegged to the US dollars. The regulators were already scrutinizing the every move of Binance and its CEO but with this announcement, the regulators had to start making moves faster. Hence Paxos’ ban on BUSD issuance.
In light of Paxos being directed to stop issuing BUSD tokens, the question remains whether Binance will seek out another partner or will start issuing BUSD itself. While current BUSD holders have a year to redeem their tokens. It’s worth noting that this government action is aimed at Binance and its stablecoin rather than Paxos, a US-based company that follows regulations by the book. Given Binance’s position as the world’s largest crypto exchange and the backing of BUSD by US dollars, it’s clear that the US government wanted to stop or at least reduce the power and influence Binance is getting. BUSD’s market cap once $23 billion, it’s now $8 billion.
DISCLAIMER: The information contained in this article is for educational purposes only and does not constitute any form of advice or recommendation by Wheatstones, and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.