Stablecoins are supposed to be boring: safe-as-houses
payment tokens (well, safe as U.S. dollars, anyway) that trade one-to-one for
an underlying fiat currency. But this week the industry is churning with drama.

On Monday, September 5, Binance – the
world’s largest crypto exchange by volumes – shocked the stablecoin world by announcing
it would deplatform three of the biggest payment tokens.

As of September 29, it will convert customers’ holdings of three stablecoins into its own, called BUSD. The exchange will no longer support trading in their spot or futures pairs, or in their use as collateral to post margin – thus removing them from the staking and lending in DeFi protocols.

Safe havens?

Stablecoin instruments are akin to money
market funds in traditional finance, intended to never “break the buck” and
skew away from the value of their underlying fiat.

As safe havens in the volatile world of
digital assets, they have the potential to evolve into deposits, which means
the exchanges or DeFi lenders that are best connected to those deposits have an
edge on sourcing them.

BUSD, although issued by Binance, is operated
by Paxos, a New York-regulated financial institution, which operates New York bank
accounts and manages the BUSD supply and its reserves.

Binance’s BUSD is already the third-largest stablecoin by volume, with a market cap of $19.43 billion. Daily volumes in BUSD jumped on Monday to $6.5 billion, according to CoinMarketCap.

US regulated

The three stablecoins that Binance is
effectively throwing off its exchange include two smaller tokens, Pax Dollar
(USDP) and True USD (TUSD), as well as USD Coin (USDC) – the second-largest
stablecoin, with a market cap of over $50 billion.

Giving USDC the push is what surprised many in the crypto markets. USDC is backed by Circle, a $9 billion crypto firm with investors including Accel, BlackRock, Fidelity and FTX, a crypto exchange focused on leveraged products.

Pax is also, like BUSD, regulated by the
New York State Department of Financial Services, which means it can access the
New York-regulated banking system. (As is another stablecoin managed by Gemini,
a rival exchange.)

USDC is not formally regulated in that way, but it is informally regulated as it operates under 46 US state money-transmitter licenses. Together, all of these stablecoins operate under US regulations, one way or another.

BUSD blitz

What prompted Binance to throw USDC and two
other stablecoins under the bus?

One explanation is straightforward: kill
the competition. BUSD is a distant number-three to Circle’s USDC in the world of
stablecoins. But Binance’s exchange is the dominant industry player, with $268 million
in daily volumes. Binance is throwing its weight around, denying those flows to
USDC.

It’s a bold move to take away one of the
most popular tokens for Binance’s users. Binance says it is doing this to enhance liquidity and capital efficiency for
its users, but it risks alienating them.

There’s no question that many stablecoin pairs are redundant, which fragments liquidity. If market makers need to play with just one pair versus USD, another versus euro (etc), then it consolidates liquidity and will lead to better pricing – in BUSD.

Tether and the art of war

But why not kick USDT, aka Tether, off
Binance’s exchange too? Tether is the biggest stablecoin by far, with a market
cap of $67 billion.

Maybe its size means attacking Tether
head-on would be a bridge too far.

One market maker
thinks Binance is attacking Tether in a subtler fashion.

Evgeny Gaevoy, the
founder of Wintermute, a digital-asset market maker, tweeted his view that ending
various stablecoin pairs will make it easier in some ways to use USDC: traders won’t
need to convert it into BUSD or Tether on the exchange to trade perpetual swaps
or other instruments, but they can still deposit USDC on the exchange. This
means they can use USDC more seamlessly to access products, even if they’re
denominated now in BUSD.

Such a conversion will
remain necessary for Tether. And this is why Binance’s move may be actually an
attack on Tether, not USDC. Eventually, the ease of applying USDC to
BUSD-denominated margin will prevail over the extra step of converting USDT
into BUSD.

But Binance isn’t
defenetrating Tether, either. It’s too big. On the other hand, Tether is also plagued
with reputational problems and market concerns about its reserve assets – which
Tether’s operators consistently refuse to be credibly audited. Tether is run by
shadowy people behind Bitfinex, an offshore crypto exchange, without
regulation.

Tether is also a less
efficient stablecoin, requiring a T+1 process to mint and burn tokens – a legacy
of its opacity, and the refusal of the few banks that accept crypto-denominated
deposits, such as Silvergate and Signature Bank, to serve Tether. Those banks
are at the heart of stablecoin reserves management. They enable market makers
to mint and redeem USDC and BUSD almost instantly, but won’t allow Tether
deposits. And now that ease of conversion will extend to all of Binance
exchange’s retail investors.

Gaevoy concludes: “It’s not USDC ‘delisiting’, it’s another big step towards Tether losing ground to US-native stablecoins.”

Risks to Binance

The move creates three
risks for Binance. First is that users leave because they want USDC, Pax or Trust
as their stablecoins. But, as explained above, they can still use those
stablecoins to make deposits or withdrawals seamlessly into BUSD, which sooths
the sting.

The second risk is
that Binance now has to manage that BUSD conversion. Although this should be
straightforward, it could assume market risks if one of those stablecoins
undergoes a huge price action – as happened earlier this year with Terra.
(Terra’s collateralization was based on algorithms, whereas USDC is meant to be
collateralized by US dollars.)

The third risk is
political: as mentioned, these stablecoins are essentially products of the
United States. But US regulators don’t trust Binance, which has tried to wriggle
out of any global regulation, and since 2020 has been forced to block US citizens
as customers. US regulators will scrutinize a deal that consolidates a
Binance-issued stablecoin into the market leader.

Binance will hope that
its collaboration with Paxos will blunt such concerns: BUSB, if not its issuer,
must comply with US laws.

According to data provider
Messari, BUSD launched in 2019 as ERC-20 tokens on Ethereum – and therefore can
be used to access Ethereum-based projects, using ERC-20 smart contracts. They are
collateralized one-for-one by US dollars held in Paxos-owned US bank accounts
(eg Silvergate and Signature).

Although reliance on
the Ethereum network provides security, removing the need for third parties to
manage BUSD token creation and burning, Paxos retains the power to alter those
smart contracts to pause BUSD token transactions and wipe balances of frozen accounts
– a compliance requirement of its New York DFS license. Paxos also publishes
monthly reports detailing the US dollar reserves backing BUSD tokens.