What is a stablecoin?

The Wall Street Journal reports that Paxos,  a company focused upon stablecoins, has been issued with a notice they are to be sued by the New York Department of Financial Services (NYDFS).

Sources cited by the Wall Street Journal (WSJ) say the U.S. Securities and Exchange Commission (SEC) plans to sue Paxos for violating investor protection laws. People familiar with the matter say Paxos received a Wells Notice, a letter sent by a securities regulator regarding a prospective lawsuit. The notice alleges that the stablecoin Binance USD, which Paxos issues and manages, is an unregistered security.

It’s an interesting development as stablecoins are cryptocurrencies tied to real currencies like the US dollar. In the case of Paxos, they tie their issuance of crypto to Binance US dollar stablecoins. A stablecoin is backed by its equivalent in fiat currencies but, according to some, Binance didn’t have the dollar reserves to back their currency. The result? The regulator has shut it down:

US financial regulators have shut down further issuance of BUSD, the Binance-branded stablecoin, as a clampdown on the crypto sector gathers momentum. Paxos, the stablecoin company behind issuance of the token, said on Monday it would end its relationship with the Binance exchange over BUSD, which is used to help traders move more quickly in and out of the crypto market.

It does seem strange in some ways but, in others, makes perfect sense. After all we had the Terra Luna debacle last year. Terra, a stablecoin, was twinned with Luna, an algorithm (depending on your own definition). You can find out more about that story here, and the gist of it is that Terra and Luna were backed by nothing but code. It wasn’t stable.

Paxos claim that “BUSD [Binance US dollar] is 100% backed by reserves held in either or both (i) fiat cash in dedicated omnibus accounts at insured U.S. banks1 and/or (ii) U.S. Treasury bills (including through repurchase agreements and/or money-market funds invested in U.S. Treasury bills)”.

But the action of the NYDFS implies it is not.

Interesting.

Even more intersering is the move of Binance CEO, Changpeng Zhao (better known as CZ), who has distanced himself from Paxos, claiming the token they issue is not supported by Binance.

Anyways, the main reason I’m blogging about it is that the NYDFS action with Paxos spurred Coinbase into posting a long thread on twitter. You can link to the tweets but, to make it easier, I’m reposting here as I think their perspective around stablecoins is useful and educational:

This week the NYDFS ordered US-based Paxos to stop issuing US dollar-denominated stablecoin BUSD and the SEC issued a Wells notice to Paxos. We don’t know what aspects of BUSD might be of interest to the SEC. What we do know: stablecoins are not securities.

Let’s unpack what US Dollar-backed stablecoins are, their role in creating a more equitable and efficient financial system, and why it’s imperative that the US fosters development of stablecoins at home.

First, what’s a US Dollar-backed stablecoin? US Dollar-backed (or cash equivalent) stablecoins are digital currencies pegged to a reserve asset like the US Dollar and are designed to remain equal to the value of their peg.

One way to peg digital currency to USD: take $1 in cash or cash equivalents for every stablecoin created and hold it in cash, t-bills, or other cash equivalent funds that back up the full value in circulation. Disclosures then drive transparency of the 1:1 backing, like USDC.

Why use a stablecoin like USDC? The value of fiat-pegged stablecoins stays stable over time, and their digital properties make them faster, more efficient, and more accessible ways to conduct commerce. Their stable value over time is also why they’re not used as investments.

For customers, stablecoins like USDC transcend banking hours and global borders. You can send anyone in the world USDC and they’ll receive it instantly. You don’t need a US bank account to hold value pegged to USD, protecting against local currency devaluation.

For businesses, stablecoins like USDC make settling payments instant and cost-effective. They allow you to receive payments in just seconds, without the long processing time and high fees that can be associated with intermediaries like banks and credit card companies.

Stablecoins help bridge the gap from traditional finance to a more efficient and equitable financial system. As more global cash digitizes, the US will benefit enormously if USD continues to be the most trusted and used global reserve currency for fiat-backed stablecoins.

We can only do this if we foster development of stablecoins within our borders. 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.

Remember, stablecoins are already regulated. Paxos is regulated as a NY Trust Company by NYDFS. USDC is regulated as a stored value instrument, just the same as a simple money order is, under US state money transmitter laws.

Getting this right means real dialogue between regulators and the industry followed by clear rules for the industry and lanes for the various regulators themselves.

This is how we ensure the promise of greater financial accessibility, efficiency, and innovation that safe technology like stablecoins can provide in the US. Not through threats of litigation without explanation or a basis in existing law.