Do USDT and USDC Stand to Benefit From the Potential Demise of BUSD?

After forcing crypto exchange Kraken to close its staking facilities, the US Securities and Exchange Commission (SEC) is now turning to stablecoins. Last week, Paxos, a prominent player in the stablecoin market, came under investigation by both the SEC and the New York Department of Financial Services (NYDFS).

The company is responsible for issuing its native Paxos stablecoin USDP as well as Binance USD (BUSD). It is also behind the real-world asset (RWA) token PAXG, Paxos' gold-backed cryptocurrency that stores gold in Brinks Vault, London, for investors.

NYDFS said that it directed Paxos to stop issuing new tokens of BUSD, which is backed by short-term Treasurys and cash-like assets.

Ever since the collapse of the Luna ecosystem in 2021 because of its algorithmic stablecoin TerraUSD which resulted in many bankruptcies, the crypto sector has been facing increased regulatory scrutiny. On Thursday, the SEC sued Terraform Labs, the company behind TerraUSD, and its co-founder Do Kwon. According to Delphi Lab's general counsel Gabriel Shapiro, this move could be seen as an SEC “roadmap” to taking down other stablecoins.

In the aftermath of this implosion, the NYDFS also published guidelines for stablecoin issuers to follow, while the SEC said overseeing crypto assets is a key priority for 2023.

Paxos said that it would stop issuing BUSD tokens on Feb. 21, and the ones already circulating “have and always will be” backed one-to-one with US dollar reserves that customers will be able to redeem through February 2024. Paxos also said in a statement that it would “end its relationship” with Binance.

The order to the stablecoin issuer was “a result of several unresolved issues related to Paxos' oversight of its relationship with Binance,” NYDFS told CNN, adding that the agency is monitoring the company closely to verify that it can “facilitate redemptions in an orderly fashion subject to enhanced, risk-based, compliance protocols.”

The investigation into Paxos occurred after the company applied for a full banking charter. The New York-based blockchain infrastructure company has obtained BitLicense from the NYDFS and established a leadership position in the industry. It has also gained a Major Payments Institution license from the Singaporean regulator to boost its presence in Asia.

And while there have been rumors that the US Office of the Comptroller of the Currency (OCC) was contemplating requiring Paxos to withdraw its application — the OCC provided a provisional banking charter to Paxos in 2021 — the company has denied any such claims.

In light of the regulatory action against Paxos, Coinbase argued that stablecoins are not securities and that they actually benefit the US if the dollar remains the most trusted reserve asset for stablecoins.

However, this can only be achieved “if we foster the development of stablecoins within our borders,” said the exchange, adding: “Imposing securities law onto stablecoins through enforcement instead of guidance or dialogue with the industry will simply push innovation offshore and weaken our global role.”

Stablecoin Market Reshuffling

In response to this news, there has been a ramping-up of the withdrawals, much like seen during FTX's collapse in early November. Coinbase's stablecoin balances have dropped by 53% and Bitfinex's balances by 57%, with Binance seeing the most loss at more than $1.5 billion, although that's only an 8% decrease.

Amidst all this uncertainty, the embattled stablecoin is creating an opening for two big names in stablecoin markets: Circle's USDC and Tether's USDT. According to Kaiko researcher Conor Ryder, USDT will likely be the short-term winner as market makers and even Binance tap that as the trader favorite over BUSD.

USDT is the largest stablecoin and the 3rd largest cryptocurrency, with a market cap of almost $70.3 billion, according to CoinGecko. And ever since Paxos news became public three days ago, USDT's market cap has increased by an additional $1.8 billion.

USDT started 2023 at just above $66 bln and reached its peak of $83.4 bln in May 2022. In fact, Tether actually leads the crypto market in terms of trading volume, far ahead of Bitcoin (BTC) and Ethereum (ETH).

Meanwhile, about $1 bln has been added to USDC stablecoin's market cap, which currently sits at the fifth spot with a market cap of $41.7 bln, after down from $44 bln at the beginning of this year and a $56 bln peak in June 2022.

During this period, the third-largest stablecoin BUSD has lost more than $2.5 bln of its market cap and now stands at the 8th spot with a $13.7 bln market cap, down from its $23.5 bln peak in Nov. 2022.

In response to the news, BUSD also fell to a two-year low of $0.9950. However, Binance CEO Changpeng Zhao's comments on the crypto exchange's connection to the popular Paxos-issued token on Tuesday helped BUSD recover to $0.9997, and today it is trading at $0.9999.

“BUSD is not issued by Binance,” Zhao said during a Twitter Space. “We have an agreement to let them (Paxos) use our brand, but that's not something we created.”

According to a report from Bloomberg earlier this year, Binance acknowledged that its BUSD stablecoin hasn't always been backed fully with reserves but has now fixed the problem.

The token was, at times, undercollateralized in 2020 and 2021. However, a Binance spokesperson told Bloomberg that the issue never impacted user redemptions. Following the report, Binance explained that there was a “timing mismatch” in backing BUSD.

Shifting Away from USD, Time to Explore Other Currencies

On Feb. 14, Binance CEO Changpeng Zhao, aka CZ, hosted a Twitter Spaces AMA where he shared that stablecoins are an important part of the crypto ecosystem. And that “most people use US dollar prices for crypto because US dollar stablecoins are the most popular and the largest.”

According to CZ, this recent regulatory action by the US SEC and NYDFS may lead to a fall in the dominance of USD-backed stablecoins over the long term.

“I think with the current stances taken by the regulators on the US dollar-based stablecoin, the industry will probably move away to a non-U.S. dollar-based stablecoin, back to algorithmic stablecoins.”

With multiple agencies “putting applied pressure” on these stablecoins, it is going to shrink the market of USD-based stablecoins, said CZ, adding: “This has prompted us to look for more options in different places.”

Just days after reports of regulatory scrutiny of Paxos and BUSD and CZ's comments on diversifying stablecoin holdings, Binance minted nearly $50 million worth of TrueUSD (TUSD). The market cap of the stablecoin currently sits at $969 million, up from $915 million on Feb. 16 and $756 million on Jan. 1, 2023. In June 2021, the market cap of TUSD hit its peak at $1.68 billion, as per CoinGecko.

Back in September, TUSD, along with other stablecoins like USDC and USDP, was auto-converted to BUSD by Binance to increase liquidity and capital efficiency for users. This resulted in BUSD's market share rising from 10% to 15% within a few weeks.

Launched in March 2018 by TrustToken, TUSD exists on Ethereum, Polygon, Tron, and Avalanche networks. The way TUSD minting works is quite simple. It starts with the buyer wanting to get TUSD. They then send USD to a third-party escrow account that Prime Trust uses. And once the USD is received, TUSD will be transferred to the buyer's nominated ERC-20 or BEP-2 wallet address in the same amount.

While CZ said that Binance would be providing more support for competing stablecoins, USDT and USDC, now that BUSD is “gone” and “slowly winding down over time,” he shared that they're now looking to explore more into euro-, Japanese yen, or Singapore dollar-based stablecoins.

As for BUSD, CZ has said that the existing circulating supply of BUSD is safe and will be burned — permanently removed from circulation — as more people redeem it.

During his AMA, CZ also said that he was never too bullish on the success of its BUSD stablecoin: “To be honest BUSD was never a big business for us, when we started I actually thought the BUSD project may fail, so we actually don't have very good economics on that collaboration.”

Filling the Gap

Paxos's move to halt issuing more of the BUSD amid pressure from US regulators is trickling down into the world of decentralized finance (DeFi), which lets people trade, lend and borrow without intermediaries.

With BUSD having a relatively small presence in DeFi, most of these concerns are, of course, centered around the Binance-sponsored BNB Chain, which has the most BUSD usage in DeFi. This means the DeFi ecosystem has to move to a different stablecoin as its source of liquidity.

For instance: DEX Curve Finance has about $10 million BUSD in its biggest liquidity pool. According to its founder Michael Egorov, regulatory actions against the stablecoin look like “quite a safe sunset process” for its holders. However, he said that members of the DAO managing the protocol might eventually vote to reduce the rewards in the BUSDv2 pool as it incentivizes users to provide BUSD liquidity.

A similar discussion is currently being held on DeFi lending protocol Aave, according to a governance proposal by a community member, Marc Zeller. The proposal sees freezing the reserves and switching to another stablecoin as the “most reasonable path” for Aave.

The shutdown of BUSD, however, raises questions about the fate of other stablecoins, such as Circle's USDC, which is the most used stablecoin in DeFi and, as such, would be far more damaging to DeFi.

But while payments giant PayPal has reportedly paused work on its forthcoming stablecoin offering amidst this increasing regulatory scrutiny, the crypto sector remains unperturbed with the market green and the focus on building.

This week, a Seattle-based Web3 payment infrastructure company Stably Corporation announced the launch of its stablecoin Stably USD ($USDS) on the Polymesh blockchain. The company claims that USDS is a regulatory-compliant stablecoin and is fully collateralized 1-to-1 with USD held in bank deposits managed by the custodian.

Meanwhile, Stratis, a flexible blockchain development platform designed for the needs of real-world financial services and businesses, has been working on a regulated GBP stablecoin. The platform's proposal for a GBP stablecoin is currently in the application process to be submitted to the Financial Conduct Authority (FCA), said Stratis CEO and founder Chris Trew, CEO earlier this year.

For the Great British Pound Token (GBPT), Stratis aims to use the Open Banking standard. This will allow both companies and individuals to deposit fiat via a simple webpage to mint GBPT, which then can be sent cross-border easily using a digital wallet. The official announcement noted that the stablecoin would be 100% backed by fiat and low-risk, highly liquid assets.

Earlier this week, Trew said that the technology that makes the GBPT offering possible has already undergone internal testing. And if Stratis attains an FCA registration, the company can provide an end-to-end solution.

While regulators are focusing on stablecoins, many projects are ready to fill the gap that will be left by BUSD, as seen by the increase in USDT and USDC's market share and new projects emerging to fulfill customer needs. But it remains to be seen just how the stablecoins will fare in the coming months as more regulations come along.