Reasons why SEC accuses Binance's BUSD of being a security? How do Paxos and Binance profit from BUSD?

The SEC has filed a lawsuit against the world's largest cryptocurrency exchange, Binance, with 13 significant charges, including the classification of the stablecoin BUSD as an unregistered security. The reasons behind this decision are detailed in the lawsuit.

In addition to BUSD being deemed a security, BNB, SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, and COTI are also considered securities, with many of the reasons linked to investment promotion.

Explore the full list of allegations against Binance by the SEC.

Binance's BUSD Interest Rate Products Stir Up Trouble

The SEC alleges that from September 2019 to February 2023, Binance, as part of its ecosystem, offered and sold BUSD to U.S. investors through interest rate products, claiming that investors could earn returns simply by purchasing BUSD or using it in Binance's Earn program.

The SEC states that investors who purchased BUSD participated in a common enterprise - the BUSD ecosystem - along with Binance and other BUSD holders. Through this ecosystem, BUSD holders and Binance could earn returns through various forms of capital allocation.

For example, Binance promoted the profit potential of BUSD, mentioning that investors could earn various Annual Percentage Yields (APY) based on their holdings of BUSD. The profit opportunities for BUSD that Binance promoted included Binance Earn, margin, and futures products.

For instance, Binance had a "BUSD Reward Program" that promised interest payments to BUSD investors for simply holding BUSD on the Ethereum blockchain.

Binance explained to investors that they would rank all crypto addresses holding BUSD based on the average daily BUSD balance within a 30-day period. Then, a certain amount of BUSD would be distributed based on the percentage of BUSD held by the crypto address relative to the total market value of BUSD.

The SEC believes that the profit expectations of BUSD investors directly stem from something akin to interest earned by Binance, a portion of which comes from the returns generated by using BUSD investors' funds.

Binance's BUSD is an Investment Contract

The SEC claims that since its inception, BUSD has been offered and sold as an investment contract and is considered a security.

Paxos and Binance Collaborate for BUSD Profitability

The SEC explains that BUSD is an ERC-20 token issued on the Ethereum blockchain.

According to the "Stablecoin Services Agreement" between Binance's subsidiary, Binance Switzerland AG, and trust company A on September 5, 2019, the BUSD protocol note: Trust company A should be Paxos. The two parties agreed to "establish and manage the issuance and redemption platform for BUSD," exchanging at a value of one U.S. dollar and maintaining reserve funds to support redemptions.

Binance's subsidiary agreed to "list, market, and promote BUSD" to investors. Subsequently, Binance marketed BUSD as a so-called "stablecoin," claiming it was backed by cash and cash equivalents and could be redeemed for U.S. dollars at a 1:1 ratio, enabling investors to participate in various interest schemes within Binance's ecosystem.

Trust company A agreed to invest the funds from the purchase of BUSD by investors, which are essentially the BUSD reserve funds, in profit opportunities that could benefit both Trust company A and Binance. Trust company A and Binance agreed to equally share the net interest income generated from the BUSD underlying reserve funds.

The funds from investors purchasing BUSD were purportedly pooled in reserve funds, from which Binance received a 50% share of the returns. As more investors bought BUSD, the returns increased. Binance then used a portion of these returns to promote and expand the BUSD ecosystem, thereby giving BUSD profit potential.

As of February 10, 2023, over $16 billion worth of BUSD had been issued. At that time, around 90% of the BUSD was controlled by Binance, with most being deposited by investors and held in Binance wallets.

Paxos Ordered to Halt BUSD Issuance

On February 21, 2023, the New York State Department of Financial Services (NYDFS) supervising Paxos requested it to cease minting BUSD, citing "many issues in the supervision of Paxos related to its relationship with Binance."

BUSD Incident Recap | Is the Stablecoin a Security? Regulatory Request to Halt Issuance? Response from Binance's Zhao Changpeng? Any Connection with USDC?