Understanding Stablecoin Regulation in the US and Beyond

The US Securities and Exchange Commission (SEC) views stablecoins as securities, subject to federal securities laws.

The SEC has been actively regulating stablecoins, particularly those issued by companies like Facebook and its Libra project.

The Commodity Futures Trading Commission (CFTC) has also taken an interest in stablecoins, considering them commodities.

The CFTC has jurisdiction over stablecoins that are considered commodities, but not securities.

The US Treasury Department has been working with the CFTC and the Federal Reserve to develop a regulatory framework for stablecoins.

Stablecoins are not yet widely recognized as a regulated asset class in the US, but regulatory clarity is on the horizon.

The CFTC has issued a no-action letter to allow certain stablecoins to operate without being registered as a security.

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The regulatory framework for stablecoins is rapidly evolving, with various proposals and regulations being put in place to ensure the stability and security of these digital assets. In the US, the International Organization of Securities Commissions (IOSCO) has proposed that stablecoins be regulated as financial market infrastructure alongside payment systems and clearinghouses.

To be considered a legitimate stablecoin issuer, companies must meet strict requirements, including maintaining reserves of not less than 100% of the nominal value of their outstanding issued payment stablecoins as of the end of each business day. This can include US dollars, demand deposits at a depository institution, certain US Treasury Bills, and repurchase agreements backed by US Treasuries.

In Europe, the Markets in Crypto Assets Regulation has taken effect, banning algorithmic stablecoins and requiring all others to have assets held in custody by a third party. Reserves must be liquid and have a 1:1 ratio of assets to coins.

In New York, the Department of Financial Services (DFS) has issued its Guidance on the Issuance of U.S. Dollar-Backed Stablecoins, outlining general requirements for USD-backed stablecoins issued by issuers subject to DFS oversight. These requirements include redeemability, reserves, and attestations.

The DFS Guidance requires stablecoin issuers to adopt clear, conspicuous redemption policies, approved in advance by DFS in writing, that confer to holders the right to timely redemption of the stablecoin at par. Timely redemption is defined as occurring not more than two business days after the redemption order.

To issue a payment stablecoin in the US, a company must be either a non-depository state trust company with an outstanding nominal value of up to $10 billion or a depository institution that has submitted applications to their chartering authority and the Federal Reserve Board for authorization.

Stablecoins can be categorized into three main types: fiat-collateralized, commodity-backed, and collateralized stablecoins.

Fiat-collateralized stablecoins, like Tether (USDT) and TrueUSD (TUSD), maintain a reserve of a fiat currency, such as the U.S. dollar, as collateral, assuring the stablecoin's value.

Tether (USDT) was the third-largest cryptocurrency by market capitalization, worth more than $112 billion, as of late June 2024.

Commodity-backed stablecoins, like Tether Gold (XAUt), are cryptocurrencies that are pegged to the market value of commodities such as gold, silver, or oil.

These stablecoins generally hold the commodity using third-party custodians or by investing in instruments that hold them.

Collateralized stablecoins attempt to achieve stability by backing each issued token with a pool of reserve assets, typically at a 1:1 reserve ratio.

USD Coin (“USDC”) is an example of a collateralized stablecoin, which purports to back each USDC token with one US dollar.

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Fiat-Collateralized Stablecoins are a type of stablecoin that maintains a reserve of a fiat currency as collateral, assuring the stablecoin's value. This reserve is typically held by an independent custodian and is regularly audited.

Tether (USDT) and TrueUSD (TUSD) are popular fiat-collateralized stablecoins backed by U.S. dollar reserves and denominated at parity to the dollar. As of late June 2024, Tether (USDT) was the third-largest cryptocurrency by market capitalization, worth more than $112 billion.

Fiat-collateralized stablecoins like Tether can be invested in on some of the best crypto exchanges and apps like Kraken and Coinbase.

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Algorithmic stablecoins don't rely on reserve assets to keep their value stable, instead using a computer program to control supply.

Their strategy is similar to central banks, which also don't rely on reserve assets to keep their currency stable. However, central banks have the advantage of being the issuer of legal tender, giving their monetary policy credibility.

Algorithmic stablecoin issuers can't fall back on this advantage, as seen with the TerraUSD (UST) algorithmic stablecoin, which plunged more than 60% in May 2022, losing its peg to the US dollar.

These coins attempt to achieve stability by manipulating supply in response to value fluctuations, using autonomous mechanisms like smart contracts to "burn" or "mint" coins when the price deviates from an external peg.

Algorithmic stablecoins have unique vulnerabilities, including the complexity of their algorithms making them vulnerable to confusion and/or attack.

The complexities of their algorithms can lead to major issues, as seen with recent examples of algorithmic stablecoins "de-pegging" and erasing billions of US dollars of value.

The regulatory landscape for stablecoins is a complex and evolving space. Currently, there is no comprehensive, nationwide regulatory framework for stablecoins in the United States.

In Europe, the Markets in Crypto Assets Regulation, which took effect in 2023, has imposed strict requirements on stablecoin issuers, including a 1:1 ratio of assets to coins and a ban on algorithmic stablecoins.

Regulators have been taking steps to provide guidance on the issuance and use of stablecoins. For example, the New York Department of Financial Services (DFS) issued its Guidance on the Issuance of U.S. Dollar-Backed Stablecoins in June 2022, outlining requirements for redeemability, reserves, and attestation.

Here are some key requirements outlined in the DFS Guidance:

Legislators have also introduced bills to create a comprehensive framework for the regulation of stablecoins. For example, Senators Kirsten Gillibrand and Cynthia Lummis introduced the Responsible Financial Innovation Act in June 2022, which defines and creates requirements for payment stablecoins aimed at promoting these new technologies while protecting consumers and markets.

The bill would require issuers to maintain high-quality liquid assets equal to not less than 100 percent of the face amount of the issued stablecoins' value. The bill also sets forth optional frameworks for banks and credit unions to issue payment stablecoins and creates an authorization for special depository institution charters under both state law and the National Bank Act to issue payment stablecoins.

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The US regulatory landscape for stablecoins is still evolving, but there are some key developments to note. A bipartisan bill, the Lummis-Gillibrand Payment Stablecoin Act, was introduced in April 2024, aiming to create a comprehensive regulatory framework for stablecoins. This bill seeks to promote responsible innovation, preserve US dollar dominance, and protect consumers and digital asset market participants.

The bill defines a payment stablecoin as any crypto asset designed to be used as a means of payment or settlement, with the issuer obligated to redeem it for a fixed amount of US dollars. The bill would require payment stablecoin issuers to maintain reserves of not less than 100% of the nominal value of their outstanding issued payment stablecoins.

The bill would also establish comprehensive supervision and enforcement powers for state bank supervisors, the OCC, and the FRB, including broad cease-and-desist authority, removal authority, and the ability to impose civil monetary penalties. Additionally, the bill would create a tailored holding company supervision framework for depository institution issuers that are not within a bank holding company.

US Senators Cynthia Lummis and Kirsten Gillibrand introduced a bipartisan bill to create a US regulatory framework for stablecoins. The Lummis-Gillibrand Payment Stablecoin Act seeks to foster innovation and promote US dollar dominance while protecting consumers and mitigating illicit finance risks.

The bill supersedes the pair's 2022 proposed Responsible Financial Innovation Act, focusing specifically on the comprehensive regulation of payment stablecoins. As defined by the bill, a "payment stablecoin" would be any crypto asset used as a means of payment or settlement, with the issuer obligated to redeem the asset for a fixed amount of US dollars.

Key provisions of the bill include reserve requirements, custody of reserve assets, prohibition on rehypothecation, redemption, mandatory disclosures, Bank Secrecy Act obligations, and unauthorized participants.

Here are the key requirements for payment stablecoin issuers:

The bill would classify payment stablecoin issuers as financial institutions, subjecting them to various regulations and requirements. It would also prohibit individuals with certain criminal convictions from serving as executive officers or controlling more than 5% of the shares of a payment stablecoin issuer.

Related reading: Clarity for Payment Stablecoins Act

A bank holding company or insured depository institution that has chartered a payment stablecoin issuer would be considered a "bank" for purposes of the Bank Holding Company Act.

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Under the new framework, a tailored holding company supervision framework would be created for depository institution issuers that are not within a bank holding company.

All subsidiaries and affiliates of a payment stablecoin issuer would be limited to activities that are "financial in nature" as defined in the Bank Holding Company Act.

To obtain a controlling interest in a payment stablecoin issuer, a legal or natural person would need to be engaged in activities that are predominantly "financial in nature".

Payment stablecoin issuers would be subject to the same restrictions on transactions with affiliates as are applicable to a Federal Reserve member bank under Sections 23A and 23B of the Federal Reserve Act.

Here's a quick rundown of the restrictions on M&A:

Stablecoins offer a safe haven for users who want to avoid the risk of volatility in the cryptocurrency market, with their relative stability making them particularly attractive candidates to integrate the traditional financial system with blockchain-based cryptocurrencies.

Their digital nature makes them well suited to future digital innovations, such as Web3 – a movement to reorganize the internet around decentralized technologies.

Stablecoins can be sent to “smart contracts,” software contracts that can autonomously perform functions that were traditionally relegated to banks, such as escrow reserves, collateralized lending, derivatives, and asset management.

However, the current iteration of stablecoins has proven itself to be a significant source of risk to financial stability, with a pattern of being hacked, losing investor confidence, and tumbling in value.

These failures have prompted regulators to seriously consider the systemic risks posed by stablecoins and their rapid growth adjacent to the traditional financial ecosystem.

Here are some reasons why stablecoins are important:

Some types of stablecoins have been created, based on the assets used to stabilize their value, such as fiat currency or commodities held in reserve.

We're consulting to help develop a regime for fiat-backed stablecoins, specifically those used as a means of payment. The Treasury's recent Policy Statement sets out their intention to define fiat-backed stablecoins in legislation.

Intriguing read: Fiat-backed Stablecoins Are

The Treasury is considering making changes to the payments legislation to enable retail payments for goods and services to be made using fiat-backed stablecoins. This includes an option to allow certain stablecoins issued outside of the UK to be used for payments.

We're working on a joint publication package with the Bank of England and the Prudential Regulation Authority, which will include a Discussion Paper on systemic payment systems using stablecoins. Our goal is to explain how our proposed regimes interact and our approach for dual regulation.

We're also publishing a joint 'Roadmap paper' with the Bank and Prudential Regulation Authority to accompany these publications. This paper aims to provide a clear understanding of how our proposed regimes will work together.