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The first shot in a regulatory crackdown on stablecoins may have been fired this week, after a New York regulator ordered Paxos to cease issuing BUSD and a federal regulator threatened that stablecoins could be securities.

On Monday (February 13), the New York Department of Financial Services (DFS) that it has ordered Paxos to stop issuing new BUSD and redeem all existing tokens for US dollars as soon as possible.

The DFS said it moved to shut down BUSD due to “several unresolved issues” related to Paxos's “oversight” of its relationship with Binance.

One of those issues, which was mentioned explicitly, is that Binance has issued its own BUSD tokens outside of its relationship with Paxos and outside of the permissions provided by the DFS.

The DFS said it had authorised Paxos to issue BUSD on the ethereum blockchain only, but had not authorised any other entity to issue BUSD on any other blockchain.

However, the DFS pointed out that Binance has issued its own BUSD on the BNB Smart Chain, which the DFS refers to as “Binance-peg BUSD”.

In response to the DFS announcement, Paxos published a confirming that it will end its relationship with Binance and BUSD, but will continue to process Paxos-issued BUSD to US dollar redemptions until February 2024.

Using blockchain explorer tools, one can see that there is currently $14bn BUSD on the (issued by Paxos), and $4.8bn BUSD on the (issued by Binance).

Could stablecoins be securities?

Later the same day, Paxos published a separate informing users that it has also received a Wells Notice from the Securities and Exchange Commission (SEC) related to BUSD.

According to Paxos co-founder and CEO Charles Cascarilla, the SEC is considering suing Paxos on the grounds that BUSD is a security whose offer and sale should have been registered under federal securities laws.

Paxos said it “categorically disagrees” with the SEC’s characterisation of a BUSD as a security, and is prepared to “vigorously litigate” against the SEC if necessary.

Commenting on the Wells Notice, Binance CEO Changpeng Zhao also said the SEC would be wrong to characterise BUSD as a security.

Noting that he himself is “not an expert on US laws”, Zhao linked to a tweet from Australian crypto investor and analyst Miles Deutscher, who argued that stablecoins do not meet the definition of a security under the Howey Test.

“How on earth is a stablecoin considered a security, when it clearly doesn’t meet the Howey Test criteria,” he . “No one has ever had ‘the expectation of profit’ when buying BUSD.”

However, legal experts such as Adam Cochran, partner at venture capital firm Cinneamhain Ventures, said the Howey Test cannot be dismissed so easily in relation to BUSD specifically and stablecoins generally.

“The Howey test is a precedent for investment contracts, and ‘securities’ is a much broader category defined by the 1933 Securities Act,” he .

Cochran pointed out that the Act’s definition of a security includes items such as “debentures”, “evidence of indebtedness” and “certificates of deposit”.

He went on to say that, since almost all stablecoins are backed by securities such as US Treasury bills, this makes stablecoins similar to money market funds, since holders are exposed to those underlying securities even if they don’t profit from them.

“It’s worth fighting tooth and nail, but everyone who is shrugging this off needs to re-evaluate,” said Cochran. “It doesn't have to be a good or lucrative security to be a security.

“If someone is holding or otherwise securing value for you, and you are trusting them to do it, and not otherwise exempted, it’s a security.”

As by Zhao, “If BUSD is ruled a security by the courts, it will have profound impacts on how the crypto industry will develop (or not develop) in the jurisdictions where it is ruled as such.”

The loss of BUSD will mean more trouble for Binance, which as VIXIO PaymentsCompliance reported last week, has already lost its banking partner for international transfers of US dollars.

Up until this week, BUSD had provided easy access to US dollar liquidity for Binance and its users, but that is set to dry up quickly as BUSD holders return their tokens to Paxos over the next 12 months.

Already, since the DFS announcement on Monday, data from shows that over $2bn BUSD has been removed from circulation — the vast majority of which came from Binance.

Nonetheless, at the time of writing, Binance in its total verifiable crypto-asset reserves of $61.5bn. In percentage terms this is about 18 percent of Binance's reserves, at the beginning of the week.

John Reed Stark, an independent consultant and former head of internet enforcement at the SEC, has advised users of Binance and other crypto platforms to withdraw their money immediately.

“The US crypto-regulatory carpet bombing is relentless, resolute and multi-faceted,” he . “The writing’s on the wall. A crypto-bank run akin to 1929 has only just begun. Get. Out. Now.”

Will stablecoins survive?

Further enforcement action related to Paxos, Binance and BUSD will likely mean that stablecoin projects are put on hold until there is regulatory clarity for this type of crypto-asset.

PayPal, for example, has informed that it has put its own stablecoin project on hold until further notice.

The debate about how stablecoins should be regulated is also likely to pick up in the near future.

This week, in an expert to the US Senate Banking Committee, Duke University professor Lee Reiners suggested there are only two viable options for regulated stablecoins that do not put users, or financial stability, at risk.

The first is to require that all stablecoin issuers are depository institutions covered by the Federal Deposit Insurance Corporation (FDIC).

As Reiner points out, this would force existing stablecoin issuers to become banks — an unlikely feat — or existing banks could choose to incorporate stablecoin issuance into their current offerings.

The other option, preferred by Reiner, is for stablecoins to be regulated in the same way as mutual funds.

“Rather than force stablecoins into the banking system, Congress can grant the SEC the authority to regulate them like money market mutual funds, with strict requirements that stablecoin reserves be held in cash and Treasury securities,” said Reiner.

“The composition of reserves should be subject to periodic audits and disclosure, which would impose much-needed market discipline.”