Stablecoin Regulation in The United States

Stablecoins are a subset of blockchain-enabled digital assets that seek to maintain price stability, often by pegging their value to another asset with a stable value, such as U.S. dollars. Since inception, the asset class has earned increasing attention, with more than 200 stablecoin projects announced since 2017.[1]  Further, due to the gaining popularity of stablecoins, many coins have recently seen dramatic spikes in market capitalization. For example, since January 2020, Coinbase’s U.S. dollar-pegged USD Coin (USDC) has experienced 250% growth to a market capitalization of $1.86 billion.[2] In that same period, U.S. dollar-pegged Binance USD (BUSD) has seen an 800% rise in market capitalization while the market capitalization of the digital asset-collateralized stablecoin, DAI, is up 970%.[3]

Currently, there are two main varieties of stablecoins: algorithmic coins and collateral-backed coins. Algorithmic stablecoins generally rely on a liquid market of digital bonds to expand and contract the stablecoin supply, thus creating price stability in the stablecoin. This dynamic is similar to that used by securities market makers, with the notable difference that market makers are intermediaries that make a market in an instrument issued by a third party. In contrast, in the case of an algorithmic stablecoin, the stablecoin algorithm itself is responsible for expanding and contracting the supply of the stablecoin. Algorithmic stablecoins rely on monetary supply policy dynamics instead of collateral as the mechanism for maintaining a stable coin value. The potential benefits of the algorithmic approach include a scalability and automation that may not be feasible with the collateral approach. To date, this category of stablecoin has been difficult to implement in practice, but notable attempts have included NuBits and Basis.

The more common variety of stablecoins are the collateral-backed variety.  Collateral-backed coins peg their value to another asset which is then held as collateral backing the value of the coins. Collateral can be fiat currency, such as U.S. dollars, euros, gold, or even other digital assets. The collateral generally is placed in an account, with a bank or other financial institution, and is in some cases subject to audit to ensure that the collateral truly exists and is sufficient to cover the amount of the outstanding stablecoin obligations. Some of the most well-known stablecoins in this category include Tether (USDT), USD Coin (USDC), Binance USD (BUSD), True USD (TUSD), and Paxos Standard (PAX). All of these stablecoins are pegged to the U.S. dollar at a one-to-one ratio. Also falling into this category is Maker/DAI, an example of a stablecoin pegged to the value of another digital asset.

Perhaps one of the most high-profile examples of a collateral-backed stablecoin to date is Libra, a stablecoin payment project currently being developed by a consortium of companies led by Facebook.  Originally proposed in 2018, pursuant to Libra’s updated 2020 white paper, Libra would be comprised of single-currency backed coins, each pegged to a single currency, such as U.S. dollars, and a multi-currency coin, pegged to a basket of single-currency coins.  To maintain a stable value, according to the white paper, each single-currency stablecoin would be backed 1:1 by a reserve consisting of approximately 80% held in short-term government securities and 20% held in fiat and money market funds.[4]

In light of their cross-border nature, stablecoin projects must work with regulators around the world to determine the appropriate regulatory treatment of this relatively new asset class.  With this in mind, this article seeks to provide an overview of how U.S. regulators are approaching the evolving world of stablecoins.

U.S. FEDERAL AND STATE REGULATION (TO DATE)

In the U.S., financial regulation is distributed among numerous federal agencies and state regulators.  As a result, due to the unique characteristics of stablecoins, and virtual currencies generally, stablecoins are potentially exposed to the concurrent, and potentially overlapping, jurisdiction of multiple U.S. regulators.  We address below a non-exclusive sample of the regulators overseeing stablecoins:  the U.S. Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Department of the Treasury; state money transmission and virtual currency regulators; the Office of the Comptroller of the Currency (“OCC”); the Securities and Exchange Commission (“SEC”); and the Commodity Futures Trading Commission (“CFTC”).  It is important to note that, because of concurrent, and potentially overlapping, jurisdiction, regulation and/or licensing by one or more of these regulators does not necessarily obviate the need to comply with the requirements of the other regulators.

 Financial Crimes Enforcement Network

To date, FinCEN has interpreted the Bank Secrecy Act (“BSA”) to apply to virtual currencies.[5]  In particular, FinCEN has interpreted its money services business (“MSB”) regulations[6] to apply to persons that are administrators or exchangers of virtual currency as engaged in money transmission services.[7] FinCEN’s position is based on the conclusion that “[a]ccepting and transmitting anything of value that substitutes for currency makes a person a money transmitter under the regulations implementing the BSA.”[8]

Although FinCEN has to date largely avoided addressing stablecoins by name, a speech by FinCEN Director Kenneth Blanco in late 2019 provided clear guidance on the application of the MSB regulations to stablecoin transactions.  In that speech, Director Blanco stated that “it should be understood that transactions in stablecoins, like any other value that substitutes for currency, are covered by our definition of ‘money transmission services.’ This means that accepting and transmitting activity denominated in stablecoins makes you a money transmitter under the BSA. It does not matter if the stablecoin is backed by a currency, a commodity, or even an algorithm — the rules are the same. To that point, administrators of stablecoins have to register as MSBs with FinCEN.”[9]

State Money Transmission and Virtual Currency Regulators

State Money Transmission Licensing

Because a virtual currency is value that can be received, held, and transmitted, U.S. states have generally addressed the regulation of virtual currency activity through their existing money transmission laws, to the extent they have done so at all.  Each U.S. jurisdiction—with one exception—regulates nonbank money transmission under jurisdiction-specific licensing regimes.  State money transmission licensing laws generally define regulated activity broadly to include “receiving money for transmission” or “receiving money or monetary value for transmission.”  States also define regulated money transmission activity to include selling or issuing stored value/prepaid access.

Because a stablecoin may be deemed a virtual currency under applicable state money transmission laws—or be deemed to constitute money or monetary value in the absence of an expressly limiting definition[10]—activities involving stablecoins could potentially be subject to regulation as money transmission in many U.S. states.[11]  In this regard, statutory definitions of “money” and “monetary value” differ among money transmission laws.  Some statutes do not define “money” at all, while others define it to include only government-issued fiat currencies or government-issued fiat currency as well as “monetary value.”  In some states, “monetary value” is defined broadly as a medium of exchange, whether or not redeemable in money.

As explained in greater detail immediately below, a number of states have issued interpretations and guidance indicating they interpret their money transmission laws to apply to virtual currency because it constitutes “money” or “monetary value.”  Other states have amended their money transmission laws to expressly address money transmission activity involving virtual currency.  (In addition, two states—Louisiana and New York—have crafted standalone regulatory regimes for virtual currency activity that are separate from their money transmission licensing regimes.  These regimes are addressed separately below.)

States that expressly regulate virtual currency activity as money transmission.  States including Georgia, North Carolina, and Rhode Island have amended their money transmission laws in recent years to regulate receiving, storing, and transmitting virtual currency under the same money transmission licensing regime as receiving, storing, and transmitting fiat currency.  Other states, such as South Dakota and New Mexico, have issued guidance indicating that they interpret virtual currency to be “monetary value” and therefore receiving, transmitting and storing virtual currency—including stablecoins—would generally be subject to regulation under existing definitions of regulated money transmission activity.

States expressly confirming that virtual currency activity is not money transmission but related movement of fiat currency may be subject to regulation.  A number of states, including Illinois, Kansas, Maryland, Tennessee, Texas and Virginia, have issued guidance indicating that virtual currency does not meet the definition of money or monetary value under their respective money transmission statutes.  Regulators in each of these states have also indicated, however, that, where the virtual currency services also involve transfer of fiat currency (such as receiving fiat currency to convert to virtual currency for transmission, or transmitting fiat currency to a third party seller of virtual currency), such activities could be subject to regulation as money transmission.  It is also possible that regulators in these states could subsequently reach the conclusion that a stablecoin may be subject to regulation as money transmission even if other virtual currencies are not.  One state that has already done so is Texas.  In 2019, the Texas Department of Banking updated a supervisory memorandum it had previously issued to address stablecoins specifically.  The Banking Department reasoned that a stablecoin that is “pegged to sovereign currency may be considered a claim that can be converted into currency” and therefore would be subject to regulation as money transmission “because the issuer has taken on the obligation [express or implied] to provide sovereign currency in exchange for the stablecoin at a later time (upon the holder’s request).”[12]

States with broad exclusions for virtual currency activity from money transmission regulation.  A few states, including Wyoming and New Hampshire, have amended their money transmission laws to exclude certain virtual currency activities from regulation.  In addition, some states, including Pennsylvania and North Dakota, have issued guidance indicating that virtual currency activity, such as operating an exchange, would not be subject to regulation as money transmission even if fiat currency is also handled to facilitate virtual currency exchange.  These exclusions likely apply to stablecoins, with the caveat that every product or service must be evaluated on its own facts on a state-by-state basis to ascertain the potential applicability of such exclusions.

States taking a wait-and-see approach. One state that has taken a unique approach is California, which has—through its (recently renamed) Department of Financial Protection and Innovation (“DFPI”)—publicly confirmed in a number of recent opinion letters that it is not currently regulating companies engaged in virtual currency activity because “the Department has not concluded whether cryptocurrencies constitute a form of money or determined whether a business that purchases and sells cryptocurrencies triggers the application of California’s money transmission law.” California has cautioned that it could change its approach in the future; the DFPI has been careful to not state that activity involving virtual currency is exempted from regulation.

State Virtual Currency Licensing

Only two states, New York and Louisiana, have adopted stand-alone virtual currency regimes.

The New York virtual currency licensing regime applies to “virtual currency business activity” involving New York or a New York resident.   This includes “storing, holding, or maintaining custody or control of virtual currency on behalf of others,” “receiving virtual currency for transmission or transmitting virtual currency,” or “controlling, administering, or issuing a virtual currency.”  Virtual currency is defined to include “any type of digital unit that is used as a medium of exchange or a form of digitally stored value . . . includ[ing] digital units of exchange that (i) have a centralized repository or administrator; (ii) are decentralized and have no centralized repository or administrator; or (iii) may be created or obtained by computing or manufacturing effort.”  A stablecoin would likely therefore constitute a virtual currency and a person seeking to engage in issuing receiving, transmitting or holding such a stablecoin involving New York or New York residents would need to consider this regime.

The new Louisiana regime which  took effect August 1, 2020 is similar to New York’s.  However, while virtual currency business activity includes “engaging in virtual currency administration,” what this entails is narrower than New York’s definition because it applies to “issuing virtual currency with the authority to redeem the currency for legal tender, bank credit, or other virtual currency.”  Even this narrower definition would likely apply to a stablecoin, given that such a coin can be redeemed for—and is valued based on—a fiat currency.

OFFICE OF THE COMPTROLLER OF THE CURRENCY

On September 21, 2020, the OCC issued an interpretative letter clarifying that national banks and federal savings associations (“FSAs”) under the agency’s purview are authorized to receive deposits from stablecoin issuers, including deposits that are considered stablecoin reserves, and may engage in activities that are incidental to accepting deposits from stablecoin issuers.[13]

In the interpretive letter, the OCC staff clarified that as long as banks and FSAs are vigilant in the required anti-money laundering and know your customer procedures (“AML/KYC”) proscribed under the BSA and other federal banking and securities laws, they may hold stablecoin reserves as a service to their customers.

The OCC limited its interpretation to holding reserves of a stablecoin associated with hosted wallets[14] that are backed by a single fiat currency and redeemable by the holder of the stablecoin on a 1:1 basis for the underlying fiat currency upon submission of a redemption request to the issuer.[15]

SECURITIES AND EXCHANGE COMMISSION

On September 21, 2020, the staff of the SEC Strategic Hub for Innovation and Financial Technology (“FinHub”) issued a statement in apparent coordination with the OCC’s release of its stablecoin interpretative letter.  While restating the SEC staff position that “[w]hether a particular digital asset, including one labeled a stablecoin, is a security under the federal securities laws is inherently a facts and circumstances determination,” the SEC staff also stated that “[w]e believe that market participants may structure and sell a digital asset in such a way that it does not constitute a security.”

Notwithstanding the above general statements made in the stablecoin context, the SEC and its staff have yet to apply any specific securities analysis in the context of a stablecoin. However, when analyzing digital assets, including cryptocurrencies and so-called “utility tokens,” the SEC and its staff has applied the investment contract test set forth in SEC v. W. J. Howey Co., 328 U.S. 293 (1946) (“Howey”).[16] The factors of the Howey case are: (1) whether purchasers of a financial instrument contributed money (or valuable goods or services); (2) whether purchasers invested in a common enterprise; (3) whether purchasers reasonably expected to earn profits through that enterprise; and (4) whether the expected profits were to be derived from the efforts of others.[17] A finding that all four factors exist supports a conclusion that a financial instrument is an investment contract and therefore a security.

It is possible that, under a Howey analysis, stablecoins – particularly collateral-backed stablecoins – are not securities. Specifically, some stablecoins may “fail” one of the principal Howey factors: that a purchaser must have an expectation of profit.  As the Supreme Court stated in United Housing Foundation v. Forman, “profit” for purposes of the Howey test means “capital appreciation resulting from the development of the initial investment … or a participation in earnings resulting from the use of investors’ funds.” [18]  An expectation of profit results when “the investor is ‘attracted solely by the prospects of a return’ on his investment.  By contrast, when a purchaser is motivated by a desire to use or consume the item purchased – ‘to occupy the land or to develop it themselves,’ as the Howey Court put it – the securities laws do not apply.”[19] Howey is a fact-specific analysis and therefore it is not clear how it may apply to any particular stablecoin project.  However, at a minimum, it would appear that the guidance on the profit element is relevant to many stablecoins.

Importantly, even if stablecoins (particularly certain collateral-backed stablecoins) are not determined to be investment contracts under the analysis in Howey, it is possible that stablecoins could be deemed to be securities under other rationales.[20]  Market participants should note that the SEC staff offered to engage with them “regarding whether activities with respect to a specific digital asset may invoke the application of the federal securities laws.”[21]

COMMODITY FUTURES TRADING COMMISSION

The CFTC takes the position that all varieties of cryptocurrencies – presumably including stablecoins – are commodities for purposes of the Commodity Exchange Act.[22]  The term “commodity,” defined in Section 1a(9) of the Commodity Exchange Act, is extremely broad, covering everything from physical commodities to “services, rights, and interests,” which the CFTC has indicated includes cryptocurrencies.[23]

To the extent that stablecoins are deemed to be commodities, the CFTC would have jurisdiction over margined,  leveraged, or financed transactions in stablecoins that involve investors that do not qualify as “eligible contract participants,” as defined in Section 1a(18) of the CEA (so-called “retail” investors).  In addition, by virtue of being deemed commodity transactions, stablecoin transactions would imbue the CFTC with anti-fraud and anti-manipulation authority.[24]

CONCLUSION

The above review demonstrates that the evolution of stablecoins is being closely watched by numerous regulators in the U.S.  Although regulatory reactions generally lag market developments, we expect to see further stablecoin statements and guidance – and likely enforcement – by U.S. federal and state regulators as stablecoin projects continue to develop and as user adoption increases.

References

[1] See Blog: Stablecoins: The Complete Guide, Part I- Past & Present (2014-2019), CoolBitX Ltd., available at: https://www.coolwallet.io/the-complete-guide-to-stablecoins-part-i-2014-2019/#:~:text=The%20world’s%20first%20stablecoin%20BitUSD,and%20Charles%20Hoskinson%20(Cardano) (last accessed October 1, 2020).

[2] See Samuel Haig, Stablecoins Post Triple-Digit Growth in 2020, but Institutional Rivals Loom, Cointelegraph (Sept. 11, 2020), available at: https://cointelegraph.com/news/stablecoins-post-triple-digit-growth-in-2020-but-institutional-rivals-loom.

[3] See id.

[4] See Libra White Paper v.2.0 (Apr. 2020), available at: https://libra.org/en-US/white-paper/.

[5] 31 U.S.C. §§ 5311 et seq. FinCEN has defined “virtual” currency as a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency.”  In turn, “convertible virtual currency” that may be subject to regulation “has an equivalent value in real currency, or acts as a substitute for real currency.”

[6] Under the BSA, an MSB is required to comply with certain registration requirements, as well as requirements related to customer identification procedures, transaction monitoring, recordkeeping, and reporting.

[7] The regulations implementing the BSA define “money transmission services” as the acceptance of funds from one person and the transmission of those funds to another location or person by any means.  31 C.F.R. § 1010.100(ff)(5)(i).  An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency. An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.   An administrator or exchanger that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations, unless a limitation to or exemption from the definition applies to the person.

[8]  FIN-2013-G001, Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (March 18, 2013).

[9]  Prepared Remarks of FinCEN Director Kenneth A. Blanco at Chainalysis Blockchain Symposium (Nov. 15, 2019), available at: https://www.fincen.gov/news/speeches/prepared-remarks-fincen-director-kenneth-blanco-chainalysis-blockchain-symposium.

[10] For example, in a recent federal district court ruling in a criminal anti-money laundering case, the court rule that bitcoin is “money” under the District of Columbia’s money transmission law even though that law does not define “money.” The defendant had tried to argue that the definition of money should be limited to “a medium of exchange currently authorized or adopted by a domestic or foreign government.” The court instead used what it believed to be an “ordinary meaning” of the term: “a medium of exchange — that is, a token that can be traded for goods or services.” The court reasoned that bitcoin “is these things.”  See U.S. v. Harmon, Case 1:19-cr-00395-BAH (D.D.C. Jul. 24, 2020).

[11] It is also possible that a stablecoin could be deemed by a state banking department to constitute “stored value” subject to money transmission licensing, in the sense that it represents monetary value (i.e., the equivalent in fiat currency) evidenced by an electronic record.

[12] See Texas Banking Department, Revised Supervisory Memorandum 107 (Apr. 2019), available athttps://www.dob.texas.gov/public/uploads/files/consumer-information/sm1037.pdf.

[13] OCC Interpretive Letter #1172: OCC Chief Counsel’s Interpretation on National Bank and Federal Savings Association Authority to Hold Stablecoin Reserves (Sept. 21, 2020), available at: https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1172.pdf.

[14] As defined by the OCC, a hosted wallet means “an account-based software program for storing cryptographic keys controlled by an identifiable third party” that receives, stores, and transmits cryptocurrency transactions on behalf of accountholders, which generally do not have access to such keys themselves.

[15] This letter comes on the heels of another OCC digital asset-related letter from July 2020 affirming that banks are allowed to provide both fiduciary and non-fiduciary cryptocurrency custodial and cryptographic-key hosting and other services to their customers, assuming the AML/KYC risks are managed effectively.  OCC Interpretive Letter #1170: Authority of a National Bank to Provide Cryptocurrency Custody Services for Customers (July 22, 2020), available at: https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2020/int1170.pdf.

[16] See, e.g., SEC Staff Framework for “Investment Contract” Analysis of Digital Assets (Apr. 3, 2019).

[17] See also Gary Plastics Packaging v. Merrill Lynch, Pierce, Fenner, & Smith Inc., 756 F.2d 230 (2d Cir. 1985)  (applying the Howey test and finding the existence of an investment contract in a case involving sales of bank certificates of deposit).

[18] 421 U.S. 837 (1975).

[19] United Housing, 421 U.S. at 852-53 (1975) (quoting Howey, 328 U.S. at 300).

[20] For example, the definition of “security” also includes “notes” and “evidences of indebtedness.”

[21] SEC FinHub Staff Statement on OCC Interpretation (Sept. 21, 2020).

[22] See CFTC v. Patrick K. McDonnell, et al., 287 F.Supp.3d 213 (E.D.N.Y. Mar. 6, 2018) (“CFTC has standing to exercise its enforcement power over fraud related to virtual currencies sold in interstate commerce.”); see also CFTC Customer Advisory: Understand the Risks of Virtual Currency Trading, available at: https://www.cftc.gov/sites/default/files/idc/groups/public/@customerprotection/documents/file/customeradvisory_urvct121517.pdf (“the CFTC maintains general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity in interstate commerce”).

[23] See CFTC v. My Big Coin Pay, Inc., No. CV 18-10077-RWZ, 2018 WL 4621727 (D. Mass. Sept. 26, 2018).

[24] Matthew Leising, U.S. Regulators Subpoena Crypto Exchange Bitfinex, Tether, Bloomberg (Jan 30, 2018), available at: https://www.bloomberg.com/news/articles/2018-01-30/crypto-exchange-bitfinex-tether-said-to-get-subpoenaed-by-cftc.