As you can see i’ve changed a few settings but it still looks weird, and if I import a psd it works just fine with the same settings changed (filter: nearest, compress without alpha and compression setting: TC vector displacementmap)
Thank you raycar5. I have tried to reproduce this with a similar PNG but I think I am missing a step you are taking. How are you saving the PNG from Photoshop?
If you go under view in the Texture Editor of the imported PNG, turn on Alpha and it will render black over the stretched pixels. I believe that this is artifact of the compression process for the asset and should not effect any use of the texture. The engine rounds 4 pixels to the nearest color in the compression process, so you white is rounded to match your yellow.