Stablecoin issuers can be the crypto industry’s Achilles heel
When New York regulators ordered crypto exchange Paxos to stop minting stablecoins this week, it exposed one of the EthereumETH ecosystem’s biggest weaknesses: fiat-backed stablecoin issuers that must follow laws in their respective jurisdictions.
The combined market cap of the three major stablecoins (USDTUSDT, USDCUSDC, BUSDBUSD respectively) is equal to ~46% of Ethereum’s total market cap today of ~$180 billion, according to CoinMarketCap.com. These three stablecoins are fiat-backed, meaning that each stablecoin is supposedly backed 1:1 by cash, short-dated US Treasuries, and, in the case of USDT, non-US Treasuries, precious metals, loans and investments. In contrast, the Ethereum ecosystem’s premier DeFi project, Uniswap, has a market cap of $5 billion.
The rationale of many cryptocurrency firms is to decentralize finance by reducing reliance on institutional powers and increasing opportunities for self-storage and peer-to-peer transaction access. They have therefore often had problems gaining access to the traditional banking system. Stablecoins offered a solution to this challenge, allowing both users and crypto exchanges to reduce their reliance on slow wire transfers by representing dollars on-chain. But the major stablecoins have idiosyncratic risks, due to their dependence on centralized financial institutions, which is becoming increasingly apparent as regulators clamp down on stablecoin issuers themselves.
Such was the case this week with Paxos Trust Co, the issuer of BUSD through a partnership with fellow crypto exchange Binace. Paxos was asked by the New York Department of Financial Services (NYDFS) to stop issuing that stablecoin, effective February 21. The Securities and Exchange Commission (SEC) also issued Paxos a stern warning this week, alleging that BUSD is a security and could attract further enforcement action. Binance’s CEO, Changpeng Zhao, tweeted Monday: “BUSD is a stablecoin wholly owned and managed by Paxos. As a result, the market value of BUSD will only decrease over time. Paxos will continue to service the product and manage redemptions.”
In accordance Nansen data analytics, around 90% of BUSD is still held on Binance, the world’s largest cryptocurrency exchange. The exchange has played a key role in increasing the use of cryptocurrencies in emerging markets by providing convenient interfaces for users to convert local currencies to BUSD and other cryptocurrencies. According to a 2022 MasterCard survey, a third of respondents from Latin America claimed to have used stablecoins for daily purchases. Stablecoins like BUSD opened up new opportunities for people disconnected from the global economy. Will current users of BUSD migrate to other fiat-backed stablecoins, experiment with crypto-backed alternatives, or stop relying on stablecoins altogether?
Regulating fiat-backed stablecoins out of the market will temporarily make it more difficult for individuals and businesses worldwide to access the cryptocurrency ecosystem. But that wouldn’t stop innovation and experimentation with crypto-backed stablecoin alternatives like DAIDAI. Nor would regulation of stablecoins stop the growing use of cryptocurrencies such as bitcoin. The MakerDAO Foundation behind DAI can expect regulators to also scrutinize nonprofits and other types of stablecoin issuers, not just crypto exchanges. The MakerDAO community recently launched a $5 million legal defense fund.
For now, the US dollar and the banking system are still king and queen of the internet economy. But unless regulators provide clarity and work together with the crypto industry, US regulators may soon lose their advantage in the international markets. If so, American banks may find themselves crushed by the wheels of history.
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