DeFi, Regulation

A War on Stablecoins

With regulators eyeing BUSD and Terra, could all stablecoins be at risk?
Jack Inabinet Jack Inabinet Feb 20, 20237 min read
A War on Stablecoins

Dear Bankless Nation,

The markets are booming despite an awful lot of regulatory noise, the most worrisome of which seems to be a potential stablecoin crackdown. Is there more to this saga than a targeted strike against UST? We take a look in today’s issue…

- Bankless team

Regulator enforcement and aggression has dominated the crypto news cycle as of late. The next possible target? Stablecoins.

Specifically, U.S. agencies are going after Binance’s (Paxos-issued) BUSD and Terra’s (formerly stable) UST.

On the heels of a combined SEC and New York Department of Financial Services (NYDFS) crackdown on BUSD, the CT rumor mill — and a Fox Business reporter — began churning out rumors last week that Circle’s USDC faced similar regulatory enforcement.

These rumors turned out to be unsubstantiated, with Circle’s Chief Strategy Officer Dante Disparte announcing that the stablecoin issuer had not received any notice of a regulatory inquisition from the SEC over USDC.

Still, the rumors that sent crypto circles spiraling betrayed a real concern — that federal agencies are only now making their first forays into an eventual all-out regulatory assault on stablecoins.

So, does the SEC want to declare all stablecoins as securities? Or are they simply striking against some unscrupulous entities?

Paxos Put on Notice

As noted, Paxos has been ordered to cease the issuance of BUSD.

Of note is the fact that this order did not extend to Paxos’s in-house Pax Dollar (USDP). Also, neither the domestically based USDC or the Hong Kong-based USDT were targets of this round of regulatory enforcement. Additionally, there is no indication that the SEC is looking into decentralized stablecoin providers like Maker (DAI) or Frax Finance (FRAX), both backed primarily by USDC, at this time.

Have Binance and CZ become fixtures on regulators’ naughty lists? Maybe 🤷‍♂️…

While I am not one to shout fire in the theater, it is certainly worth paying attention to how the BUSD debacle plays out, especially as concerns continue to emerge about Binance’s usage of BNB on their balance sheet.

Reports questioning the relationship between Binance and Binance US are beginning to emerge, with Reuters reporting Thursday that, “Binance had secret access to a bank account belonging to its purportedly independent U.S. partner and transferred large sums of money from the account to the trading firm, Merit Peak Ltd.”

Merit Peak Ltd. operated as a market maker on Binance US and is chaired by CZ. Binance transferred over $400M from Binance US to Merit Peak via Silvergate Bank, another crypto-oriented firm in regulators’ crosshairs, between January and March of 2021. Company messages reviewed by Reuters indicate that Binance US executives were concerned about these outflows from the Silvergate account, as they took place without their knowledge.

Despite claims that Binance US is “fully independent,” the Silvergate transfers raise fresh questions regarding Binance’s relationship with its subsidiary despite not being licensed to operate within the United States.

Regarding BUSD, regulators seemed to fancy a two-pronged approach for striking at the stablecoin.

One prong came in the form of a (fare)Wells notice on February 3, informing Paxos that the SEC was considering recommending an action that BUSD is a security and that the firm should have registered the offering under federal securities laws. To no one’s surprise, Paxos issued a statement that the stablecoin issuer “categorically disagrees with the SEC staff because BUSD is not a security under the federal securities laws.”

Additionally, NYDFS stepped in, ordering “Paxos to cease minting Paxos-issued BUSD as a result of several unresolved issues related to Paxos’ oversight of its relationship with Binance.”

Did regulators suddenly RICO the $16B that was backing BUSD? Thankfully, no.

The SEC’s Wells notice informs Paxos that the SEC is considering bringing a case against the firm, alleging that BUSD is a security and that they are requesting additional information on why a BUSD is NOT a security.

NYDFS has informed Paxos that they are to cease minting additional BUSD.

The stablecoin remains regulated by the NYDFS and Paxos is still required to maintain a 1:1 backing, processing redemptions for all customers in “good standing.” Additionally, this action does not impact the listing or exchange of BUSD by any NYDFS-licensed entities. BitLicense recipient Coinbase continues to offer BUSD to US consumers.

Paxos has stated that while they no longer issue new BUSD tokens, all existing tokens will remain fully backed and redeemable until AT LEAST February 2024.

Do Kwon and the Terra Bunch

For 9 long months, crypto has awaited some form of US regulatory enforcement action against the perpetrators of crypto’s largest… dare I say ponzi?

On Thursday, the SEC finally filed a complaint against Do Kwon and Terraform Labs.

Compared to the Wells notice sent to Paxos, which acts as a request for comment, an SEC complaint is an official filing to a court that marks the commencement of the US judicial process. It’s highly likely that Terraform Labs and Do Kwon received Wells notices prior to this filing, but it’s unclear whether Terraform Labs had anyone on staff to respond and we all know that Kwon hasn’t always been the easiest to track down…

The complaint categorized LUNA, along with Mirror Protocol’s governance token, MIR, and mAssets, synthetics designed to track the performance of US equities, as securities and security-based swaps. The SEC applied the Howey Test to conclude that these Terra ecosystem assets all met the definition for an investment contract.

An asset must meet the following four criteria, or prongs, to be classified as an investment contract:

  1. Investment of Money
  2. Common Enterprise
  3. Reasonable Expectation of Profits
  4. Derived from the Efforts of Others

While various flavors of securities exist, Howey and the resulting “investment contract” label is the most applicable to the majority of crypto assets.

Broadly speaking, the consensus view on stablecoins is that they ARE NOT INVESTMENT CONTRACTS!


Stablecoins generally fail to meet prong number three of Howey: no reasonable person expects profits when they purchase dollar pegged stablecoins. There is no upside: one dollar is paid pro rata per stablecoin redeemed!

But the SEC’s enforcement action against Terra, and specifically UST, makes it clear that they believe some stablecoins are indeed investment contracts.

They argue that Terra’s role in developing the Anchor Protocol and subsidizing yields translates to purchasers of UST holding reasonable expectations of profits, derived from the efforts of others.

As stated in the SEC’s complaint, Anchor Protocol was engineered, developed, and supported by Terraform Labs and Do Kwon, with, “defendants tout[ing] these efforts to investors in their monthly investor updates, including, among other things, their efforts to built out its front-end user access and back-end features, facilitating user access to the protocol through third-parties’ crypto asset financial services, and funding and managing the Anchor Protocol ‘yield reserve,’ which was used to pay investors interest on their UST.”

When Anchor revenues fell below what was required to pay the advertised return on UST, “Terraform and Kwon sought to ensure that the Anchor Protocol had enough reserve assets to pay investors the promised interest and continue attracting UST/Anchor Protocol investors.”

The SEC highlights multiple instances where Terraform props up these Anchor yields, including:

  • $70M of UST provided in July 2021 by Terraform
  • $450M of UST provided in early 2022 by the Luna Foundation Guard (LFG)

Additionally, Do Kwon even Tweeted about his efforts to support the yield on Anchor Protocol 😵‍💫

Remember when Terra gifted the LFG billions of dollars in UST to defend the peg?

I think it is fair to say that the subsidization of yields on Anchor in combination with the aggressive LFG defense of the UST peg looks a lot like evidence of a reasonable expectation of profits based on the managerial efforts of others…

Where’s the Beef?

At this time, it is truly unknown why the SEC and NYDFS are keen to investigate Paxos for the issuance of BUSD.

Regulators have appeared to be searching out an inroad against Binance, and this could be their best foot forward. Binance and Binance US have both fallen under the ire of other regulators, including the DOJ and CFTC for various alleged concerns ranging from money laundering to tax evasion to sanctions evasion to the improper offering of crypto derivatives to US citizens.

What is known, however, is that (at least for now) US regulators have not taken direct actions against USDC, USDT, TUSD, USDP, GUSD, or any other centralized stablecoin provider! They also appear to be ignoring DAI, FRAX, and other (less noteworthy) decentralized stablecoins.

A distinction between something like UST and these products is the involvement of a centralized management company in the success of the products. Investors in UST were literally depending on some combination of Do Kwon, Terraform Labs, the Luna Foundation Guard, and subsidized yields on Anchor Protocol AT EVERY STEP!

Luna may be an easier target for regulators with many of the crimes seeming to be carried out live on Twitter, but to strike at BUSD, regulators either must have expectations something is gravely amiss or are simply moving to the next most vulnerable target as they aim to strike at stablecoin issuing authorities.

While in this writer’s opinion, FUDing all stablecoins is a step too far, there are certainly some unsavory smells coming from certain corners of the industry. As always, it is EXTREMELY IMPORTANT to continue to DYOR, especially in such a ~dynamic~ market. Crypto assets in general are risky, and you too, anon, can make a best practice out of avoiding ones that regulators are actively targeting!

Jack Inabinet

Written by Jack Inabinet

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Jack Inabinet is a Senior Analyst with a passion for exploring the bleeding edge of crypto and finance. Prior to joining Bankless, Jack worked as an analyst at HAL Real Estate where he conducted market research and financial analysis for commercial apartment development and acquisition activities in the Seattle region. He graduated from the University of Washington’s Michael G. Foster School of Business and remains based out of the Seattle area.

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