Once a top-three stablecoin, Binance USD (BUSD) looks to be in very real danger of vanishing altogether. But what happened and can it recover?

BUSD started in 2019 under the umbrella of Binance’s ‘Project Venus‘ — billed as “an initiative to develop localized stablecoins and digital assets pegged to fiat currencies across the globe.” The coin got off to a slow start and its market cap sat at less than $200 million for months before suddenly increasing in late 2020.

As Binance offered a series of contests and market-making rewards to clients who used BUSD and pushed the exchange to move away from competitors, the coin’s market cap rocketed to over $23 billion in 2022. Two years may be an extremely short amount of time for an asset to go from $800 million to $23 billion, but the speed of its ascent pales in comparison to how fast it collapsed.

BUSD begins to bleed

When FTX collapsed in November 2022, it spelled the end for BUSD. The coin’s market cap peaked on November 14 at roughly $23.5 billion but by the turn of the year had shed nearly 30%, plunging to $16.5 billion. Unfortunately, the bad news was just beginning.

In February, Paxos, the company that provided the infrastructure for BUSD to function within the US banking system, was issued a Wells notice. Before the end of the month, instead of “vigorously litigating” against the SEC, as promised in a statement, Paxos folded its hand and admitted it would no longer issue the stablecoin for Binance.

By this point, BUSD’s market cap was under $12 billion — meaning that within 90 days, the stablecoin had lost over half of its deposits.

Read more: Explained: How Binance’s stablecoin BUSD can be a security

Death by a thousand cuts

As bad as this was, the pain wasn’t over and the coin’s market cap continued to slowly bleed out. Then, in June, it once again found itself in the spotlight for all the wrong reasons: the SEC filed a suit against Binance and included a host of associated tokens, including Binance’s exchange token, BNB, and BUSD.

The coin’s market cap began to plummet again, at an even more accelerated pace. BUSD currently sits at a market cap of $4.5 billion — meaning that 80% of all BUSD ever created has been burned.

At this point, it doesn’t appear to be a matter of if BUSD will finally reach a market cap of zero, but when. If anything, the real win here is that, despite holders fleeing for the exits over a devastating seven-month period, the peg hasn’t faltered and users haven’t been left holding a worthless bag.

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The Securities and Exchange Commission (SEC) left many scratching their heads when it designated BUSD, a so-called stablecoin, as an unregistered security. The commission’s reasoning is complex yet intriguing — and raises questions about the classification of other stablecoins.

The SEC has explicitly classified dozens of digital assets as securities, including many ICOs like cardano (ADA), solana (SOL), ripple (XRP), algorand (ALGO), tron (TRX), and filecoin (FIL). 

Interestingly, commissioners also classified Terra (UST), the failed stablecoin associated with Do Kwon’s Terra Luna (LUNA), as an investment contract. Many observers dismissed this securities classification without much thought, due to UST’s obvious collapse and algorithmic dependence on the hyperinflationary LUNA token.

However, the SEC turned heads on Monday when it classified another stablecoin which still trades near $1 as an unregistered security: Binance’s BUSD. The stablecoin’s ecosystem is jointly operated with Paxos.

Read more: Binance controlled its US arm’s bank accounts for two years: Reuters

For context, the SEC recently filed a lawsuit against the companies operating Binance.com and Binance US, as well as its founder Changpeng Zhao (CZ). It alleges that Binance secretly operates many of the functions of Binance US and has violated a litany of US securities laws.

How a stablecoin can be a security

The SEC’s lawsuit alleges BUSD has been offered as an investment contract. It claims that Binance and its founder withheld information that a reasonable investor would need in order to make an informed decision about whether or not to invest in BUSD.

Like many stablecoin backers, Binance promised BUSD would always remain at, or close to, a specified value — in this case, one US dollar. By making that promise, it might seem as though Binance promised that investors would not profit by investing in BUSD.

However, according to the SEC, Binance sold BUSD as a security according to the US Supreme Court-affirmed Howey Test because it sold investors on the totality of the BUSD ecosystem. 

According to the SEC, “BUSD purchasers invested in a common enterprise with each other and with Binance — the BUSD ecosystem through which BUSD holders and Binance could and did earn returns through various forms of capital deployment.”

The SEC continued to explain the BUSD ecosystem which Binance offered “part and parcel” with its promotions of BUSD.

“The proceeds from investor purchases of BUSD were purportedly pooled in reserves, and Binance earned 50 percent of the investment returns on those pooled assets (which increased as more investors purchased BUSD),” its lawsuit read.

“Binance then used at least a portion of those returns to enable and promote the Binance ecosystem that gave BUSD its profit potential. Binance has, from the outset, marketed BUSD’s profit-earning potential and referred to the various ‘APYs’ (annual percentage yield) that investors may earn with respect to their BUSD holdings.”

Read more: Binance lawsuit adds another 10 cryptos to SEC securities list

Selling BUSD part and parcel with investment schemes

Rather than sell BUSD as a stand-alone stablecoin which would not increase in value, Binance allegedly marketed various interest-earning or profit-generating schemes which required the purchase of BUSD.

For reference, an offering passes the Howey Test as an investment contract if it meets the following conditions: 

1. An investment of money, 
2. into a common enterprise, 
3. with a reasonable expectation of profit, 
4. to be derived from the efforts of others.

An investment contract means an entity was selling assets in a securities offering. If the asset would only exist as part of an investment contract scheme — such as the various interest-bearing, reward-earning, or profit-generating BUSD schemes — then even the asset itself could be a security.

To be clear, there are dozens of distinct types of investment contracts.

‘Guaranteed’ $1 with the opportunity to earn more

Furthermore, the SEC could regard Binance’s promise that BUSD would not lose value as a bedrock on which it constructed its various claims about BUSD’s profit opportunities. By promising to always redeem BUSD for at least $1 — and possibly allow BUSD holders to earn more than $1 through its various schemes — Binance could have easily passed the Howey Test by providing a common enterprise in which buyers invest money expecting to profit from the efforts of others.

In its lawsuit, the SEC explained how both BNB (which fluctuates in price) and BUSD (which does not fluctuate in price) can be offered as securities.

According to commissioners, “While investors’ profits with respect to Binance’s crypto asset security BNB came in the form of price appreciation, BUSD investors’ expectation of profits came from the potential for direct, interest-like payments made by Binance, in part from the proceeds of deploying BUSD investors’ capital.”

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Rumors are circulating that the Securities and Exchange Commission (SEC) will soon issue an enforcement notice to Circle over its stablecoin USDC.

The move comes as part of the SEC’s current crackdown on stablecoins and follows its enforcement letter to Paxos, demanding the exchange stop minting Binance stablecoin BUSD because it may be a security.

In a statement issued last year, SEC chair Gary Gensler argued that stablecoins could be defined as securities due to the “wide brush” by which Congressional law defined securities. Gensler argued that:

“Stablecoins have features similar to, and potentially competing with, money market funds, other securities, and bank deposits, and raise important policy issues.

“As discussed in the President’s Working Group Report on Stablecoins, it is important to ensure that we have appropriate safety and soundness protections, investor protections, and safeguards against illicit activity.”

According to the SEC’s own definition, money market funds are funds that give an interest rate payment slightly higher than bank accounts.

“Money market funds, sometimes called money funds, are a type of mutual fund developed in the 1970s as an option for investors to purchase a pool of securities that generally provided higher returns than interest-bearing bank accounts,” says the SEC.

“Money market funds invest in high-quality, short-term debt securities and pay dividends that generally reflect short-term interest rates. Many investors use money market funds to manage their cash and other short-term funding needs. They have since grown significantly and currently hold about $3 trillion in assets.”

According to Gensler, Circle can expect an enforcement notice over USDC because the reserves backing USDC are managed in a money market fund called Circle Reserve Fund. This fund is managed by BlackRock and specializes in money, cash, and treasuries that mostly mature in no longer than 397 days.

Read more: Waves DEX users panic as USDT and USDC disappear

Indeed, Circle has admitted that its “operations are directly impacted by changes in interest rates, among other macroeconomic conditions.” Currently, Circle is making most of its profits from treasury yields, yet, inversely, it has also suffered a lot of USDC selling as holders sold their stablecoins to put their cash into treasuries.

The SEC’s potential enforcement notice to Circle will be ironic given that it’s been reported that it was Circle itself that tipped off the authorities on BUSD and kickstarted the SEC’s investigation.

Meanwhile, large movements of USDC have been reported on the chain. This is allegedly due to USDC holders trying to sell their coins on Binance. USDC is currently the second biggest stablecoin with a $40.9 billion market cap.

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Paxos has announced that from February 21, it will no longer issue new Binance USD (BUSD) tokens.

Binance USD is a dollar-pegged stablecoin issued by Paxos that carried the Binance brand name. Protos previously reported on the work of Jonathan Reiter which showed that Binance Peg BUSD, a token pegged to BUSD issued by Binance, hadn’t always been appropriately backed.

The order to stop minting new tokens comes from the New York Department of Financial Services (NYDFS), according to a statement posted by the regulator. The statement also explicitly draws attention to the fact that it had authorized Paxos to issue BUSD on Ethereum, but hadn’t authorized Binance Peg BUSD.

This comes several days after CoinDesk reported that Paxos was under investigation by NYDFS.

Paxos in its press release notes that it doesn’t expect that this will affect its Paxos Dollar (USDP), Pax Gold (PAXG), or other lines of business.

On Sunday the Wall Street Journal (WSJ) reported that Paxos has also received a Wells Notice from the Securities and Exchange Commission (SEC), detailing the SEC’s intention to sue the company alleging that BUSD is an unregistered security.

SEC chair Gary Gensler has previously communicated his belief that stablecoins may be securities, specifically pointing out that even if it doesn’t fail the Howey Test, it can still be a security under legislation passed by Congress.

Read more: Binance’s stablecoin BUSD hasn’t always been 1:1 backed, report

Changpeng Zhao, CEO of Binance, noted that “funds are SAFU” and that they’ll need to move away from BUSD as the primary pair for trading.

Several months ago, Binance announced that it automatically converted user deposits of other stablecoins into BUSD.

It’s not yet clear if these regulatory interventions will extend to other stablecoins. The largest stablecoin, Tether (USDT), is banned from operating in New York following its previous settlement with the New York Attorney General.

The largest stablecoin, Tether, is already banned from operating in New York following its previous settlement with the New York Attorney General. A previous Protos FOIA request to the SEC requesting documents on Tether was returned with an exemption citing documents compiled for law enforcement efforts.

Recent regulatory statements from banking regulators have suggested that banks need to be very cautious when engaging with cryptocurrency.

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