The end of BNB and BUSD? (Patreon)

After rallying 30-40% in January, crypto has taken a breather in the first two weeks of February. What was mainly a macro driven rally has paused in the wake of ambiguous macro signals including the most recent higher than expected nonfarm payroll and CPI print that’s lead to a overall bounce in USD strength and yields. And more importantly, we are starting to witness the first volley of regulatory pressure as the SEC has landed several heavy blows at the crypto industry recently including Kraken and Binance/Paxo. We’ll analyze the two cases below and talk about the implications.

1. SEC vs Kraken

Last week, SEC made a surprise announcement that an settlement was reached between SEC and Kraken regarding Kraken’s staking services. Kraken paid a fine of $30mn dollars for the failure of not registering it’s staking service with the SEC, and have discontinued the staking service permanently.

For those not familiar, “staking” is the act of locking up certain crypto tokens within its own blockchain network as a way to help secure and validate the blockchain. In return, the “staker” receives rewards in the form of additional yield. Now it sounds very similar to Gemini’s earn program where they lost $1bn of customer’s deposits because they lent it to the now bankrupt Genesis. But technically, it is completely different.

Regardless, it is easy to see why “staking” is under SEC’s crosshairs. We don’t have data to show the size of the staking business for Kraken, but it is rather substantial for Coinbase. Last quarter, Coinbase generated $62mn of revenue from staking which accounted for 11% of their total revenue. Margins on such business should be rather lucrative as it’s already expanding on current user base and infrastructure. Hence this is probably why Coinbase’s CEO Brian Armstrong had such a major reaction stating that staking services are not securities, tweeting that “We will happily defend this in court if needed”. As we can see in Coinbase’s revenue split below that the staking business has consistently grown over the years in both bull and bear markets, hence it is a crucial piece of business for Coinbase to defend.

Interestingly after SEC’s announcement, instead of dumping, staking related tokens all started to rally aggressively. LDO, the largest liquid staking protocol, rallied 11% in the 24 hours past SEC’s announcement. The price have cooled since then, but it’s still up around 10% for the past two weeks and have outperformed ETH by 17% over the same period. To interpret this, the market is saying that SEC may have the power to ban staking in regulated CeFi institutions but staking will continue to live on in Defi with the major Defi protocols potentially able to gain market share due to SEC’s actions. While that may be true for now, but let’s check out SEC’s second action next to understand their ambition.

2. SEC vs Binance/Paxo

The second major SEC action came a few days ago when a lawsuit was announced against Paxos, the creator of Binance’s stablecoin, BUSD. The allegation is that BUSD is a security and that Paxos has failed to register BUSD with the SEC. As a result, Paxos’ regulator, the New York Department of Financial Services (NYDFS) ordered Paxos to halt the issuance of BUSD. This means that BUSD can only be redeemed for fiat, and not the other way around which blocks a major onramp point from fiat to crypto for the industry. This is a big deal. BUSD is the 3rd largest stablecoin and accounts for 12% of total stablecoin market share.

The immediate implication is that on-ramp flow would be negatively affected as holders of BUSD are likely to redeem given the uncertainty of the situation. There are also several nuances to consider. On the positive side is that Paxos is a regulated entity with audited reports and monthly attestations so that the BUSD is for certain backed 1:1 with money in a bank account. However, the audited reports ONLY cover Ethereum based BUSD. Binance operates a bridge which converts the ETH-BUSD into Binance Chain-BUSD, which is not under audit. Indeed, there have been discrepancies where it is shown that Binance-BUSD has been undercollateralized by the bridge with on-chain analysis.

These issues were quickly acknowledged and fixed by Binance once it became public. But still, the unaudited Binance-BUSD is still a source of concern regarding the reputation of Paxos.

And the rumor was that Circle, the issuer of USDC, informed NYDFS that BUSD was undercollateralized, leading to NYDFS’s notice where they explicitly stated that Binance-BUSD is not regulated.

Due to this, there may be a medium term impact on Binance’s operations since most Binance trading pairs are against BUSD. In the event that BUSD redemption snowballs to the point that liquidity is reduced meaningfully, then there could be disruptions to Binance’s operations. And if that’s the case, then there would be a cascading effect on BNB token price which would then put even more pressure on BUSD redemptions.

A longer term impact is that if SEC wins in court and classifies BUSD as a security, then any stablecoin could essentially be considered security. No token would be safe, even the darling USDC. It is worth while to watch this space very carefully as it unfolds. Now, no one in their right mind would believe that a stablecoin is a security. In fact, Paxos has issued a strong rebuttal and looks like this issue will be settled in court.