Written by: Athena
1. Definition of Stablecoin
1.1. Theoretical Definition
The Bank for International Settlements believes that digital stablecoins can be defined as encrypted digital currencies whose purpose is to maintain a stable value relative to a specific asset or a basket of assets. Stablecoins are token-based; their validity is verified based on the token itself, rather than on the identity of the counterparty, that is, account-based payments.
There are two types of price stabilization mechanisms for digital stablecoins: one is based on algorithms; the other is based on collateral. Algorithm-based digital stablecoins do not have any assets as endorsements, but only use algorithms to adjust the supply and demand balance according to the current price of stablecoins, thereby maintaining the exchange rate of stablecoins. For example, Basis is benchmarked against 1 US dollar to adjust supply and demand. The second is a digital stablecoin based on collateral, which uses assets such as legal currency, gold, and digital assets as collateral for the stabilization mechanism. Its stabilization mechanism has higher certainty than the former.
1.2. Definition by the US authorities (HR8827-Stablecoin Classification and Regulation Act of 2020)
(1) The term “stablecoin” means any cryptocurrency or other privately issued digital financial instrument, and
(A) distributed directly or indirectly to investors, financial institutions, or the general public;
(B) Yes
(i) denominated in or pegged to the United States dollar; or
(ii) denominated in or pegged to another country or state currency; and
(C) When issuing
(i) have a fixed notional redemption value;
(ii) is intended to create a reasonable expectation or belief among the public that the instrument will retain a stable nominal redemption value such that the nominal redemption value is effectively fixed; or
(iii) the effect of the instrument, regardless of its intention, is to create a reasonable expectation or belief in the public that the instrument will maintain a stable redemption value so that its redemption amount is effectively fixed.
(2) Nominal redemption value
(A) With respect to Stablecoins generally, “nominal redemption value” means the value of a Stablecoin that, at the time of issuance, is readily redeemable on demand for U.S. dollars or any other national or state currency or functional currency equivalent, or is otherwise acceptable in payment or satisfaction of obligations denominated in U.S. dollars or any other national or state currency.
(B) Treatment of U.S. dollar-pegged notes. For purposes of subparagraph (A), the value of a stablecoin pegged to the U.S. dollar or a functional currency equivalent that is readily convertible into U.S. dollars on demand at the time of issuance shall be calculated using the express or implied pegged rate for such conversion at the time of issuance.
(C) Treatment of instruments denominated in or pegged to the currency of another country or state.—For purposes of subparagraph (A), the value of a stablecoin denominated in or pegged to the currency of another country or state or to a functional currency equivalent thereto that is readily convertible into U.S. dollars at the time of issuance shall be calculated using the explicit or implicit exchange rate for such conversion at the time of issuance.
(D) Definition of functional monetary equivalent.
(i) deposits as defined in section 3 of the Federal Deposit Insurance Act;
(ii) electronic money and remitter balances;
(iii) other stablecoins;
(iv) any other financial instrument issued for the purpose of circulating as currency, paying or satisfying obligations denominated in United States dollars or any other national or state currency.
According to the definition of HR8827, stablecoin means any cryptocurrency or privately issued digital financial instrument that is distributed directly or indirectly to the public and is pegged or denominated in the U.S. dollar or other national/state currency and has a fixed nominal redemption value at the time of issuance, or through its design and effects, the public reasonably believes that its redemption value is stable.
2. Regulatory framework at the federal level
Currently, there is no comprehensive national regulatory framework for stablecoins. Historically, the regulatory regime surrounding stablecoins has been characterized by uncertainty and confusion.
One of the hallmarks of U.S. regulation of stablecoins is uncertainty about which federal agencies have the authority to regulate these products. This has been an issue for the cryptocurrency market over the past few years, particularly with disagreements between the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) over whether certain technologies should be regulated as securities or commodities, or both. SEC Chairman Gary Gensler has said crypto products are “subject to securities laws and must operate within our securities regime,” while the CFTC has declared that “Bitcoin and other virtual currencies” are commodities. This turf war has extended to stablecoins, with Gensler saying many stablecoins resemble money market mutual funds and therefore may fall under the SEC’s jurisdiction.
Both the SEC and CFTC believe that stablecoins need to be regulated to minimize risks to the financial system. The CFTC has gone a step further and taken enforcement actions against stablecoin issuers for violations of the Commodity Exchange Act (CEA). For example, the CFTC settled with the companies that created the stablecoin Tether for allegedly making false statements about the reserves backing the stablecoin. The order against Tether required them to pay a $41 million fine and cease and desist from further violations of the CEA. In addition, the CFTC rejected any attempt by the SEC to assert exclusive jurisdiction and claimed in a separate lawsuit against Binance that BUSD is a commodity.
A recent proposed bill in the United States, the Financial Innovation and Technology for the 21st Century Act (FIT 21), provides guidance for future stablecoin regulation. The bill has been passed by the House of Representatives and is about to be voted on in the Senate.
The bill clearly divides the supervision of the SEC and CFTC: if the stablecoin is centralized, it will be under the jurisdiction of the SEC; if the stablecoin is decentralized, it will be under the jurisdiction of the CFTC.
Centralized cryptocurrencies are considered "securities" because they may involve investors' expectations of the management and operations of centralized organizations, which is consistent with the definition of traditional securities. According to the Howey test, if a transaction meets the following characteristics: capital investment, investment in a common enterprise, and profit solely due to the efforts of the promoter or a third party, then such a transaction may be considered a security. Centralized digital assets often involve a central organization or entity, and they may have characteristics more similar to traditional securities, such as relying on the reputation and expected profits of the issuer. Therefore, the SEC, as the regulator of the securities market, is responsible for regulating these centralized digital assets.
Decentralized cryptocurrencies are considered "commodities" because they do not rely on centralized management and operations, but are based on decentralized technologies such as blockchain and are maintained by network participants. Their value depends primarily on market supply and demand, rather than on the reputation or efforts of a centralized entity. Decentralized cryptocurrencies, which are generally not dependent on a single central entity, operate through distributed ledger technologies (such as blockchain) and are maintained by network participants. These assets are more similar to commodities because their value depends primarily on market supply and demand, rather than on the reputation of a single issuing entity. Therefore, the CFTC, as the regulator of the commodity market, is responsible for regulating these decentralized digital assets.
The bill specifically defines decentralization as: among other requirements, if no one person has unilateral power to control the blockchain or its use, and no issuer or associated person has 20% or more control over the digital asset or voting power in the digital asset. If the bill is passed, it will bring more clarity to stablecoin regulation.
2.1. Possible regulatory direction of the US SEC
On April 4, 2022, Gary Gensler, Chairman of the U.S. SEC, spoke at the annual meeting of the Capital Markets Association of the University of Pennsylvania, raising three policy issues related to stablecoins. First, Gensler pointed out that stablecoins raise public policy considerations in financial stability and monetary policy that are involved in the U.S. SEC's regulations on money market funds and other securities. These considerations include how stablecoins are supported and the impact that the loss of pegs or the collapse of issuers may have on the broader crypto ecosystem. Second, Gensler pointed out that stablecoins raise questions related to their potential use for illegal activities. Specifically, Gensler expressed concerns about whether stablecoins could facilitate those who seek to circumvent public policy goals associated with traditional banking and financial systems, such as anti-money laundering, tax compliance, and sanctions. Third, Gensler pointed out issues related to investor protection that could benefit from increased supervision. Gensler expressed concerns about potential conflicts of interest and market integrity issues raised by stablecoins owned by cryptocurrency trading and lending platforms because of the counterparty relationship between customers and platforms.
2.2. Possible regulatory direction of CFTC
The Chairman of the U.S. CFTC once again claimed at a Senate hearing on March 8, 2023 that stablecoins and Ethereum are commodities and should fall under the jurisdiction of the U.S. CFTC.
During the Senate Agriculture hearing, CFTC Chairman Rostin Behnam was asked by Senator Kirsten Gillibrand about the different views held by the regulator and the SEC following the CFTC's settlement with stablecoin issuer Tether in 2021. Behnam responded that "despite the regulatory framework around stablecoins, in my opinion, stablecoins will continue to be commodities." He added: "It is clear to our enforcement team and the Commission that the stablecoin Tether is a commodity." The U.S. CFTC has asserted that certain digital assets such as Ethereum, Bitcoin, and Tether are commodities, such as in its lawsuit against FTX founder Sam Bankman-Fried in mid-December 2022.
2.3. Possible regulatory direction of the U.S. Treasury Department
The U.S. Treasury Department noted in a September 2022 report that the impact of stablecoins and their payment systems could be "difficult to predict." TerraUSD's liquidation caught the attention of U.S. Treasury Secretary Janet Yellen, who soon began talking about the possibility of stablecoin regulation. Yellen believes that a regulatory framework is needed to guard against stablecoin risks.
"We have allowed 'experiments' like TerraUSD to take over, and to grow at a pace that far outstrips the inherent risks," said Alex McDougall, CEO of Stablecorp. For some reason, Senator Kirsten Gillibrand (D-NY) and Senator Cynthia Lummis (R-WY) introduced a bipartisan bill to the U.S. Senate in June called the Responsible Financial Innovation Act (RFIA). Among other things, the bill hopes to regulate "payment stablecoins." "It includes tax requirements for various digital assets, as well as stricter requirements for stablecoins, which, according to Gillibrand, would not allow the use of TerraUSD coins," Fedenia said. The bill also includes provisions on cybersecurity, as well as the possible establishment of a self-regulatory organization and some disclosure requirements.
In July 2023, the Senate reintroduced an updated version of the bill. The updated bill makes it clear that stablecoins will be governed by state and federal banking regulators, issued primarily by depository institutions, and are neither commodities nor securities. However, the bill does provide a way for institutions that only seek to issue stablecoins to obtain a limited charter to issue stablecoins from the Office of the Comptroller of the Currency (OCC). It is worth noting that the new bill provides that algorithmic stablecoins will be treated as hybrid instruments and regulated by the U.S. CFTC. In addition, under the updated bill, issuers of algorithmic stablecoins will be prohibited from calling these products "stablecoins."
Stablecoin legislation is also making its way through the House of Representatives. House Republicans, led by Rep. Patrick McHenry, introduced the Clarity for Payment Stablecoins Act, which recently passed the House Financial Services Committee on a mostly party-line basis. Non-bank issuers would face bank-like requirements, such as capital, liquidity, and risk management requirements. The bill would exclude digital assets created by banks that represent deposits, and would also enact a two-year moratorium on the creation of new algorithmic stablecoins (known as “endogenously collateralized stablecoins”) while directing the Treasury Department to study them further.
3. State-level regulatory policies and legislative developments
Amid this federal uncertainty with the SEC and CFTC, various regulatory frameworks for stablecoin issuers have emerged at the state level. Currently, many states regulate virtual currency activities through their money transmission laws, but few states provide specific guidance on stablecoins.
3.1. Regulatory Treatment of Virtual Currencies Under the Texas Money Services Act
The Texas bill deems stablecoins backed by sovereign currencies to be regulated by its money transmission laws. Under Texas law, stablecoins "may be considered a claim convertible into money and therefore fall within the definition of money or monetary value."
Currency Spread
Stablecoins pegged to sovereign currencies can be considered a claim that is redeemable for money and therefore fall within the definition of money or monetary value under Texas Finance Code § 151.301(b)(3). If a stablecoin is backed by sovereign currency reserves and the holder of the stablecoin has a redemption right, then the holder has a claim on the sovereign currency that backs the stablecoin because the issuer is obligated to provide the sovereign currency at a later date (upon the holder's request) in exchange for the stablecoin.
Policy Statement
Sovereign-backed stablecoins may be considered money or monetary value under the Money Services Act, so receiving a stablecoin in exchange for a promise to provide the stablecoin at a later time or in a different location may constitute money transmission. The permissibility analysis will depend on whether the stablecoin provides the holder with a redemption right in sovereign currency, thereby creating a claim convertible into money or monetary value. This is the case regardless of whether the redemption right is expressly granted by the issuer or implied.
3.2. Nebraska Regulatory Policy (Nebraska Revised Statute 8-3024)
The bill states that digital asset custodians are entitled to conduct one or more of the following digital asset business activities:
(1) Providing digital asset and cryptocurrency custody services. Such custody services may not be provided for digital assets or cryptocurrencies unless the digital assets or cryptocurrencies are
(a) was first publicly traded more than six months before the date on which the custody services were provided; or
(b) created or issued by any bank, savings bank, savings and loan association, or building and loan association organized under the laws of this state or organized under the laws of the United States and doing business in this state;
(2) Issues stablecoins and holds deposits as reserves for stablecoins with a Federal Deposit Insurance Corporation-insured financial institution that has its principal charter office in this state, any branch in this state, or any branch of a financial institution that had its principal charter office in this state immediately prior to becoming a branch of such financial institution; and
(3) Use independent node verification networks and stablecoins for payment activities.
3.3. Wyoming Stable Token Act
Summary of the bill:
A single stablecoin is a virtual currency representation of $1.
One stable token is redeemable on demand for $1 (unless U.S. Treasury bill rates fall below zero, or the value of assets held in the trust account falls below $1 per stable token).
100% of the notional value of all tokens in circulation will be deposited into a newly established Wyoming Stable Token Trust (although the trust will not create any fiduciary obligations between the state and token holders).
Trust funds will be invested only in low-risk, short-term U.S. Treasury securities.
Investment proceeds that exceed 102% of the value of the circulating tokens will be deposited into the Wyoming Stable Token Management Account to pay operating costs and fund other state government work.
The bill establishes the Wyoming Stable Coin Commission, which will be responsible for issuing and overseeing the program.
The bill states that the commission “shall endeavor to issue at least one Wyoming stablecoin by December 31, 2023.” The Wyoming State Treasury will provide $500,000 in initial funding for the issuance and administration of the token, but it is expected that the funds will be repaid from expected interest income.
3.4. New York Stablecoin Regulation (DFS Guidance)
On June 8, 2022, the New York Department of the Treasury (Dep't Fin. Serv., DFS) issued the "Guidelines for the Issuance of U.S. Dollar-Backed Stablecoins" ("DFS Guidance"), which outlines the general requirements for DFS-regulated issuers to issue U.S. dollar-backed stablecoins.
Regarding redeemability, DFS Guidance requires, among other things, that stablecoin issuers adopt a “clear, prominent redemption policy, approved in advance in writing by DFS,” giving holders the right to redeem stablecoins promptly at par. DFS Guidance defines “prompt” redemption as no more than two business days after a redemption order is issued, but exceptions to this requirement may apply if DFS “determines that a timely redemption could jeopardize the asset backing requirements of the reserve or the orderly liquidation of reserve assets.”
As for reserves, DFS Guidance requires that stablecoins must be fully backed by reserve assets, which can only include: (1) short-term Treasury bills; (2) reverse repurchase agreements with approved counterparties; (3) government money market funds, subject to the DFS-approved cap; and (4) deposit accounts at U.S. state or federally chartered depository institutions, subject to the DFS-approved limit on the amount allowed to be held in any particular institution. DFS also expects issuers to manage liquidity risk so that the market value of reserve assets is at least equal to the value of outstanding stablecoin units at the end of each business day.
As for verification, DFS Guidance requires issuers to publish monthly reports to DFS and the public, conducted by an independent U.S.-licensed certified public accountant (“CPA”), detailing: (1) the value and composition of the reserve; (2) the unissued stablecoin units; (3) whether the reserve is sufficient to fully back the unissued stablecoin units; and (4) whether all DFS conditions on the reserve are met. DFS Guidance also requires issuers to obtain a report annually attesting to management’s assertion of the effectiveness of internal controls, structure, and procedures in order to comply with the monthly reporting requirements and to submit it to DFS within 120 days of the covered period, although issuers are not required to publicly release the report.
4. Major legal disputes: Terraform case - crypto asset securities fraud
LUNA is the governance token of the Terra blockchain network, a delegated proof-of-stake blockchain that operates to issue and maintain a stablecoin, UST, a token designed to trade for exactly $1. To incentivize people to hold and use UST for the long term, Terraform Labs (creator of the Terra blockchain network) launched Anchor, a purportedly low-risk, high-yield savings protocol that guarantees a 20% annual yield on UST deposits.
To maintain UST's peg, the protocol uses a mechanism called "seigniorage" that, at least in theory, incentivizes arbitrage trading, creating upward or downward price pressure. Since UST can always be swapped for exactly $1 worth of LUNA at the protocol level (regardless of UST's market price), arbitrage traders are incentivized to buy UST whenever it is below $1 and sell UST whenever it is above $1. This process works until it fails. Once UST is unpegged in May 2022, it will trigger a bank run to exchange UST for LUNA, further decoupling from the peg and ultimately causing a death spiral that will drive the price of LUNA to zero.
On February 16, 2023, the U.S. SEC sued Terraform Labs and its founder Do Kwon, accusing them of offering and selling UST and LUNA as unregistered securities. (Additional note: There is no clear regulatory policy at this time. The SEC regards both UST and LUNA as securities for regulation. If the case occurs later than the time when FIT 21 is passed, LUNA, as an algorithmic stablecoin, should be under the jurisdiction of the CFTC.) On July 31, 2023, the trial court rejected Terraform Labs and Quan Dou’s motion to dismiss, ruling that their marketing of the anchor protocol as a means of generating income was sufficient to constitute an investment contract and therefore a security. Although the court ruled that BUSD and other stablecoins are not isolated securities because there is no "reasonable expectation of profit" for fixed-price assets themselves, Terra’s marketing and sale of equity derivatives (through mirror protocols) and interest-bearing products (through anchor protocols) to encourage UST "deposits" constituted unregistered securities offerings and sales.
5. Conclusion
This article discusses in detail the regulatory framework and definition of stablecoins in the United States. According to the Responsible Financial Innovation Act (RFIA) and the Clarity for Payment Stablecoins Act, stablecoins have a relatively clear definition: any cryptocurrency and privately issued digital financial instrument that is pegged to the US dollar or other legal currency and has a fixed nominal redemption value. These acts require stablecoin issuers to meet specific capital, liquidity and risk management requirements and must obtain a charter from the Office of the Comptroller of the Currency (OCC). Federal agencies such as the SEC and CFTC are also actively competing for regulatory power over stablecoins and have proposed their own regulatory orientations. The emergence and advancement of FIT 21 has made the future regulation of stablecoins clearer. In addition, this article also discusses different policies and legislative dynamics of state-level regulation, including specific implementation policies in Wyoming and New York.
The continued attention of FIT 21 and various federal agencies to stablecoins is accelerating the improvement of the US stablecoin regulatory authorities. In the future, the United States is expected to further strengthen the regulatory measures for stablecoins to ensure their stability and security in the financial system. Regulators may continue to improve the legal framework to respond to evolving market demands and technological innovations.
