Stablecoin projects are paying rebates to traders, and it caused a big headache for Paxos

When crypto exchange Gemini launched its much lauded stablecoin in 2018, it hoped the market would view its dollar-pegged coin as a regulated and more trustworthy alternative to Tether.

Still, things got off to a slow start, with GUSD lagging behind its competitors. Gemini dollar currently has $90.3M in circulation while Paxos has $132.2M and USDC has $287.2M. To spur adoption, Gemini offered their Gemini dollar to some over-the-counter trading desks at a discount - meaning each $1 token could be bought for less than a dollar. However, traders spotted an arbitrage opportunity in the deal where they could buy the discounted GUSD and then exchange it for Paxos Standard, Paxos' stable coin, at the full dollar price - pocketing the difference, several trading firm employees confirmed to The Block. Traders were unable to redeem their GUSD directly from Gemini, according to a source. 

That caused headaches for Paxos. According to CEO Chad Cascarilla, traders exchanged vast sums of GUSD to PAX and then opened up dozens of accounts under relatives' names to bypass Huobi, a fellow exchange's, $10k transaction limit.  Traders can exchange stable coins - including Pax - on Huobi, but in order to redeem those coins for USD they have to go through the original issuer — in this case, Paxos. The result? A wave of users wanting to cash out their newly acquired PAX.

"Some customers began structuring withdrawals to get around them; they were creating accounts under other people’s names who were not the owners of the funds to try to withdraw more PAX than the $10k limit — as many as 30 accounts in the same day," Cascarilla said in a blog post after Paxos picked up on the conversion trick.

The firm, which claims to scrupulously adhere to Wall Street's KYC norms, responded by investigating those accounts and delaying redemptions. 

Some users felt that Paxos had hassled those redeeming their PAX for dollars about the source of their funds and their trading strategy. Unsurprisingly, given the conspiratorial nature of the crypto world, accusers lambasted the New York-based firm, accusing Paxos delaying redemptions to preserve their market cap. 

That wasn't the motivation, according to Chad Cascarilla, Paxos CEO, who told The Block that the firm was following procedure. "Every time a redemption comes in, and we've now processed $200 million, it goes through a compliance check." And whenever the firm's systems pick up on something suspicious, Paxos digs deeper. And sometimes the firm has to close accounts.

"Obviously, no business wants to deny or stop customers from using their products. But to operate legally, there are certain customers we cannot take — in this case specifically, customers who are trying to circumvent AML/KYC rules," Cascarilla said in a Medium post addressing the controversy. 

"Every account we've closed has been connected to the Huobi incident," Cascarilla said, noting how some users had opened accounts in their brother's, roommate's, and grandmother's names.

Some market observers criticized Gemini's discount. "Sounds like Gemini was basically paying to get volume going in their stable coin," said Joe Saluzzi, a market structure wonk who runs broker Themis Trading. "Reminds me of when BATS first started their exchange. They offered a pricing incentive to drive volume to their exchange and were willing to lose money to gain share."

To be sure, Paxos also offers rebates, according to a spokeswoman. "In certain cases we have [paid rebates] for a small handful of market makers who act as a distribution channel for us (wholesale/retail model)." 

Dave Weisberger, CEO of crypto data technology provider CoinRoutes, said rebates make a lot of sense at first glance."There's not a lot of liquidity in Gemini dollar pairs so if you're Gemini you are going to want to come up with solutions to increase liquidity," he said, referring specifically to Gemini.

Still, he said the approach they took failed to take into account the self-interest of market makers.

"The idea of priming the pump is rational but only as part of a full ecosystem development plan," he said.

"If you fail to understand that market makers are not your friend, and you give them free arbitrage, then they are going to take it. These sort of situations happen," the former market maker and electronic trading veteran added. Gemini declined to comment. 

The post has been updated to note that Paxos also pays rebates. A previous version of this post reported that Gemini gave a 2% discount. That has been removed for clarity.