Currently, there is no comprehensive national regulatory framework for stablecoins.

Authored by: Athena

1. Definition of Stablecoins

1.1. Theoretical Definition

The Bank for International Settlements (BIS) considers digital stablecoins to be a type of encrypted digital currency designed to maintain a stable value relative to specific assets or a basket of assets. Stablecoins are token-based, and their validity is verified based on the tokens themselves rather than the identity of the transacting parties, i.e., they are account-based payments.

The price stability mechanism of digital stablecoins can be divided into two types: algorithm-based and collateral-based. Algorithm-based stablecoins do not have any assets as backing but instead use algorithms to adjust supply and demand balance based on the current price of the stablecoin, thereby maintaining its exchange rate stability. For example, Basis adjusts supply and demand to peg to 1 USD. Collateral-based stablecoins use assets such as fiat currency, gold, or digital assets as collateral to maintain stability, providing a higher level of certainty compared to the former.

1.2. Definition by U.S. Authorities (H.R.8827-Stablecoin Classification and Regulation Act of 2020)

(1) Definition of "Stablecoin"

The term "stablecoin" refers to any cryptocurrency or other privately issued digital financial instrument that:

(A) is distributed directly or indirectly to investors, financial institutions, or the public;

(B) is

(i) denominated in or pegged to the U.S. dollar; or

(ii) denominated in or pegged to the currency of another country or state; and

(C) at the time of issuance

(i) has a fixed nominal redemption value;

(ii) is intended to establish a reasonable expectation or belief among the public that the instrument will maintain a stable nominal redemption value, effectively fixing the nominal redemption value; or

(iii) regardless of intent, has the effect of reasonably leading the public to expect or believe that the instrument will maintain a stable redemption value, effectively keeping its redemption amount unchanged.

(2) Nominal Redemption Value

(A) For stablecoins in general, "nominal redemption value" refers to the value at which stablecoins can be redeemed at any time upon request for the equivalent value in U.S. dollars or any other currency of another country or state, or in any other form accepted for payment or discharge of debts denominated in or pegged to U.S. dollars or any other currency of another country or state.

(B) Treatment of notes pegged to the U.S. dollar: For the purposes of (A) above, stablecoins pegged to the U.S. dollar or an equivalent form of currency should use the explicit or implicit pegged exchange rate at the time of issuance for the calculation of the redemption.

(C) Treatment of instruments denominated in or pegged to the currency of another country or state: For the purposes of (A) above, stablecoins denominated in or pegged to the currency of another country or state or an equivalent form of currency should use the explicit or implicit exchange rate at the time of issuance for the calculation of the redemption.

(D) Definition of equivalent form of currency.

(i) Deposits as defined in section 3 of the Federal Deposit Insurance Act;

(ii) Electronic currency and remittance balances;

(iii) Other stablecoins;

(iv) Any other financial instrument issued for circulation, payment, or discharge of debts denominated in or pegged to U.S. dollars or any other currency of another country or state.

According to the H.R.8827 legislation, stablecoin refers to any cryptocurrency or privately issued digital financial instrument that is distributed directly or indirectly to the public, denominated in or pegged to the U.S. dollar or the currency of another country/state, and has a fixed nominal redemption value at the time of issuance, or through its design and effect reasonably leads the public to believe its redemption value is stable.

2. Federal Regulatory Framework

Currently, there is no comprehensive national regulatory framework for stablecoins. Historically, the regulatory system surrounding stablecoins has been characterized by uncertainty and confusion.

One of the distinctive features of U.S. regulation of stablecoins is the uncertainty about which federal agencies have the authority to regulate these products. This has been a longstanding issue in the cryptocurrency market in recent years, particularly regarding the question of whether certain technologies should be regulated as securities or commodities, leading to disagreements between the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Gary Gensler, the Chairman of the SEC, stated that crypto products "fall under the securities laws and must operate within our securities regime," while the CFTC declared that "Bitcoin and other virtual currencies" are commodities. This territorial dispute has extended to stablecoins, with Gensler stating that many stablecoins are similar to money market mutual funds and may fall under the jurisdiction of the SEC.

Both the SEC and CFTC believe that stablecoins need regulation to minimize risks to the financial system. The CFTC has taken enforcement actions against stablecoin issuers for violating the Commodity Exchange Act (CEA). For example, the CFTC reached a settlement with the company behind the stablecoin Tether, as these companies were suspected of making false statements regarding the reserves supporting the stablecoin. The order against Tether required them to pay a $41 million fine and cease and desist from further violations of the CEA. Additionally, the CFTC rejected any attempt by the SEC to claim exclusive jurisdiction and asserted that BUSD is a commodity in a separate lawsuit against Binance.

A recent proposed U.S. bill, 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 set for a Senate vote.

The bill provides a clear division of regulatory authority between the SEC and CFTC: if stablecoins are centralized, they fall under the jurisdiction of the SEC; if stablecoins are decentralized, they fall under the jurisdiction of the CFTC.

Centralized cryptocurrencies are considered "securities" because they may involve investors' expectations of management and operation by a centralized organization, aligning with the traditional definition of securities. According to the Howey test, if a transaction involves capital investment, investment in a common enterprise, and profits solely from the efforts of the promoter or a third party, the transaction may be considered a security. Centralized digital assets typically involve a central organization or entity and may have characteristics more similar to traditional securities, such as reliance on the issuer's reputation and expected profits. 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 operation but are based on decentralized technologies such as blockchain, maintained by network participants. Their value primarily depends on market supply and demand, rather than the reputation or efforts of a centralized entity. Decentralized cryptocurrencies typically do not rely on a single central entity but operate through distributed ledger technology (such as blockchain) maintained by network participants. These assets are more akin to commodities because their value primarily depends on market supply and demand, rather than the reputation of an issuing entity. Therefore, the CFTC, as the regulator of the commodities market, is responsible for regulating these decentralized digital assets.

The bill specifically defines decentralization as: among other requirements, if no one has unilateral control over the blockchain or its use, and no issuer or affiliate has control of 20% or more of the digital asset or its voting rights. If the bill is passed, it will provide clearer regulation for stablecoins.

2.1. Possible Regulatory Direction of the U.S. SEC

On April 4, 2022, Gary Gensler, Chairman of the U.S. SEC, addressed three policy issues related to stablecoins at the University of Pennsylvania's Capital Markets Association annual meeting. Firstly, Gensler pointed out that stablecoins raise public policy considerations related to financial stability and monetary policy under the U.S. SEC's regulations on money market funds and other securities. These considerations include the manner of stablecoin backing and the potential impact of losing pegs or issuer insolvency on the broader crypto ecosystem. Secondly, Gensler highlighted concerns about the potential use of stablecoins for illicit activities, expressing worries about their facilitation for individuals attempting to circumvent public policy objectives related to traditional banking and financial systems, such as anti-money laundering, tax compliance, and sanctions. Thirdly, Gensler raised issues related to investor protection, which could benefit from enhanced oversight. He expressed concerns about potential conflicts of interest and market integrity issues arising from stablecoins held by cryptocurrency trading and lending platforms, as there is a counterparty relationship between customers and platforms.

2.2. Possible Regulatory Direction of the CFTC

The Chairman of the U.S. CFTC reiterated in a Senate hearing on March 8, 2023, that stablecoins and ether are commodities and fall under the jurisdiction of the U.S. CFTC.

During a Senate Agriculture hearing, CFTC Chairman Rostin Behnam was questioned by Senator Kirsten Gillibrand about the differing views held by regulatory agencies following the CFTC's settlement with stablecoin issuer Tether in 2021. Behnam stated, "Despite the regulatory framework surrounding stablecoins, in my view, stablecoins will still be commodities." He added, "Our enforcement team and commission are clear that Tether is a commodity." The U.S. CFTC has asserted that certain digital assets such as ether, bitcoin, and Tether are commodities, as seen in the lawsuit against FTX founder Sam Bankman-Fried in mid-December 2022.

2.3. Possible Regulatory Direction of the U.S. Treasury

In a report in September 2022, the U.S. Treasury pointed out that the impact of stablecoins and their payment systems may be "difficult to predict." The liquidation of TerraUSD caught the attention of U.S. Treasury Secretary Janet Yellen, who quickly began discussing the possibility of regulating stablecoins. Yellen believes that a regulatory framework is needed to mitigate stablecoin risks.

Stablecorp CEO Alex McDougall stated, "We have allowed 'experiments' like TerraUSD to dominate, with their growth far exceeding their inherent risk scope." For some reasons, Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) introduced a bipartisan bill in June to the U.S. Senate, called the Responsible Financial Innovation Act (RFIA). Among other matters, the bill aims to regulate "payment stablecoins." Fedenia said, "It includes tax requirements for various digital assets and imposes stricter requirements on stablecoins, which, according to Gillibrand, would not allow the use of TerraUSD." The bill also includes provisions on cybersecurity and the potential establishment of self-regulatory organizations and disclosure requirements.

In July 2023, an updated version of the bill was reintroduced in the Senate. The updated bill explicitly states that stablecoins will be managed by state and federal banking regulatory agencies, primarily issued by depository institutions, and are neither commodities nor securities. However, the bill does provide a pathway for institutions seeking to issue stablecoins, namely obtaining a limited charter from the Office of the Comptroller of the Currency (OCC). It is noteworthy that the new bill stipulates that algorithmic stablecoins will be considered hybrid instruments and fall under the regulation of the U.S. CFTC. Additionally, according to the updated bill, issuers of algorithmic stablecoins will be prohibited from referring to these products as "stablecoins."

Stablecoin legislation is also underway in the House of Representatives. The Clarity for Payment Stablecoins Act, led by Republican Congressman Patrick McHenry, recently passed the House Financial Services Committee primarily along party lines. Non-bank issuers will face requirements similar to banks, such as capital, liquidity, and risk management requirements. The bill excludes digital assets representing deposits created by banks and imposes a two-year moratorium on the creation of new algorithmic stablecoins (referred to as "endogenous collateral stablecoins"), while directing the Treasury to conduct further research on them.

3. State-Level Regulatory Policies and Legislative Developments

Amid the federal uncertainty of the U.S. SEC and CFTC, various regulatory frameworks for stablecoin issuers have emerged at the state level. Currently, many states regulate virtual currency activities under their money transmission laws, but few provide specific guidance on stablecoins.

3.1. Regulatory Treatment in Texas (Regulatory Treatment of Virtual Currencies Under the Texas Money Services Act)

The Texas statute considers stablecoins backed by sovereign currency to be regulated under its money transmission law. According to Texas law, stablecoins "may be considered a claim for money or monetary value that is convertible into money."

Money Transmission

Stablecoins pegged to sovereign currency may be considered a claim for money or monetary value that is convertible into money, falling within the definition of money or monetary value under Section 151.301(b)(3) of the Texas Finance Code. If a stablecoin is backed by sovereign currency and the holder of the stablecoin has a redemption right, the holder has a claim against the sovereign currency backing the stablecoin, as the issuer is obligated to provide the sovereign currency in exchange for the stablecoin at a later date upon the holder's request.

Policy Statement

Under the Money Services Act, stablecoins backed by sovereign currency may be considered money or monetary value, and receiving stablecoins in exchange for a commitment to provide stablecoins at a later time or place may fall under money transmission. The licensing analysis will depend on whether the stablecoin provides the holder with a redemption right to sovereign currency, creating a claim that is convertible into money or monetary value. This is the case regardless of whether the redemption right is explicitly or implicitly granted by the issuer.

3.2. Regulatory Policy in Nebraska (Nebraska Revised Statute 8-3024)

The statute outlines that digital asset custodians are authorized to engage in 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 asset or cryptocurrency is

(a) publicly traded for at least six months before the provision of custody services; 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) Issuing stablecoins and holding deposits at a financial institution insured by the Federal Deposit Insurance Corporation, which has its principal charter office in this state, has any branch office in this state, or has any branch office of a financial institution that had its principal charter office in this state before becoming a branch office of that financial institution; and

(3) Conducting payment activities using an independent node verification network and stablecoins.

3.3. Wyoming Stable Token Act

Summary of the Act:

• A single stable token represents a virtual currency token with a value of 1 US dollar.
• A stable token can be redeemed for 1 US dollar upon request (unless the short-term US Treasury bill rate falls below zero, or the value of assets held in the trust account falls below 1 US dollar per stable token).
• The nominal value of all circulating tokens will be 100% deposited into the newly established Wyoming Stable Token Trust Account (although the trust will not create any trust obligation between the state government and token holders).
• The trust funds will be invested solely in low-risk short-term US Treasury bonds.
• Any investment income exceeding 102% of the value of circulating tokens will be deposited into the Wyoming Stable Token Management Account to cover operational costs and support other state government work.
• The bill establishes the Wyoming Stable Token Committee, responsible for issuing and overseeing the program.
• The bill stipulates that the committee "shall endeavor to issue at least one Wyoming stable token by December 31, 2023." The Wyoming Treasury will provide $500,000 in seed funding for the issuance and management of the tokens, but it is expected that these funds will be repaid from anticipated interest income.

3.4. New York Stablecoin Regulation (DFS Guidance)

On June 8, 2022, the New York Department of Financial Services (DFS) issued the "USD-Backed Stablecoin Issuance Guidance" ("DFS Guidance"), outlining the general requirements for issuers regulated by the DFS to issue USD-backed stablecoins.

Regarding redeemability, the DFS Guidance requires stablecoin issuers to adopt a "clear, prominent redemption policy and obtain prior written approval from the DFS," granting holders the right to timely redeem stablecoins at face value. The DFS defines "timely" redemption as within two business days of the redemption order being issued, but this requirement may be subject to exceptions if the DFS "believes that timely redemption may jeopardize the asset support requirements of the reserve or the orderly liquidation of reserve assets."

As for reserves, the DFS Guidance mandates that stablecoins must be fully backed by reserve assets, which can only include: (1) short-term US Treasury securities; (2) repurchase agreements with approved counterparties; (3) government money market funds, subject to DFS-approved limits; and (4) deposit accounts at chartered depository institutions in the United States, subject to DFS-approved allowable amounts held at any specific institution. The DFS also requires issuers to manage liquidity risk, ensuring 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.

Regarding attestation, the DFS Guidance requires issuers to publish monthly reports to the DFS and the public prepared by an independent US-licensed registered public accountant (CPA), detailing: (1) the value and composition of reserves; (2) outstanding stablecoin units; (3) whether reserves are sufficient to fully support outstanding stablecoin units; and (4) compliance with all reserve conditions set by the DFS. The DFS Guidance also requires issuers to obtain an annual report, demonstrating management's assertion of the effectiveness of internal controls, structure, and procedures to comply with the monthly reporting requirements, and submit it to the DFS within 120 days of the coverage period, although issuers are not required to publicly release the report.

4. Major Legal Disputes: Terraform Case - Cryptocurrency Securities Fraud

LUNA is the governance token of the Terra blockchain network, which is a delegated proof-of-stake blockchain network designed to issue and maintain a stablecoin, UST, a token designed to trade precisely at 1 US dollar. To incentivize long-term holding and usage of UST, Terraform Labs (the creator of the Terra blockchain network) introduced Anchor, a purportedly low-risk, high-yield savings protocol, guaranteeing an annual yield of 20% on UST deposits.

To maintain the peg of UST, the protocol utilized a mechanism called "seigniorage," which theoretically incentivized arbitrage trading, creating upward or downward price pressure. Arbitrage traders were incentivized to buy UST whenever it fell below 1 US dollar and sell UST whenever it rose above 1 US dollar, as UST could always be precisely exchanged for 1 US dollar's worth of LUNA at the protocol level, regardless of the market price of UST. This process continued until it failed. Once UST became unpegged in May 2022, it triggered a bank run to exchange UST for LUNA, further decoupling from the peg, ultimately leading to a death spiral, causing the price of LUNA to plummet to zero.

On February 16, 2023, the U.S. SEC sued Terraform Labs and its founder Do Kwon, alleging the issuance and sale of UST and LUNA as unregistered securities. (Note: At this time, there was no clear regulatory policy, and the SEC regulated both UST and LUNA as securities. If this case occurred after the passage of FIT 21, LUNA, as an algorithmic stablecoin, should fall under the jurisdiction of the CFTC.) On July 31, 2023, the trial court denied Terraform Labs and Kwon's motion to dismiss, ruling that their marketing of the Anchor protocol as a revenue-generating mechanism was sufficient to constitute an investment contract, thus falling under securities. While the court ruled that BUSD and other stablecoins were not isolated securities because fixed-price assets themselves do not have a "reasonable expectation of profits," Terra's marketing and sale of equity derivatives (through the Mirror protocol) and interest-bearing products (through the Anchor protocol) to encourage UST "deposits" constituted the unregistered issuance and sale of securities.

5. Conclusion

This article extensively discusses the regulatory framework and definition of stablecoins in the United States. With the passage of the Responsible Financial Innovation Act (RFIA) and the Clarity for Payment Stablecoins Act, stablecoins have a clearer definition: any digital financial instrument privately issued and pegged to the US dollar or other legal tender with a fixed nominal redemption value. These acts require stablecoin issuers to meet specific capital, liquidity, and risk management requirements and obtain a charter from the Office of the Comptroller of the Currency (OCC). Federal agencies such as the SEC and CFTC are also actively vying for regulatory authority over stablecoins and have proposed their respective regulatory directions, while the emergence and advancement of FIT 21 have made the future regulation of stablecoins more clear. Additionally, this article discusses the different policies and legislative dynamics at the state level, including the specific implementation policies of Wyoming and New York.

The continued attention of FIT 21 and federal agencies to stablecoins is accelerating the advancement of the United States' regulatory framework for stablecoins. In the future, it is expected that the United States will further strengthen regulatory measures for stablecoins to ensure their stability and safety in the financial system. Regulatory agencies may continue to refine the legal framework to address evolving market demands and technological innovations.

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