Stablecoin regulation in the United States

Several regulatory or enforcement measures linked to organizations engaged in stablecoin activities such as issuance, custodial services have been pursued by the US banking agencies, the Securities and Exchange Commission (SEC), US Treasury, and the Commodity Futures Trading Commission (CFTC) in recent months. This article chronologically covers some of the federal authorities' most important initiatives in terms of stablecoins regulation in the United States.

October 15, 2021: CFTC's Tether Order

Tether Holdings Limited and several of its affiliates (Tether), issuers of a US dollar-backed Tether token (USDT), were served with an enforcement order by the CFTC on October 15, 2021. Tether was ordered to pay a $41 million civil monetary penalty by the CFTC for violating Section 6(c)(1) of the Commodity Exchange Act (CEA) and Regulation 180.1(a)(2). The CFTC claimed that Tether had made false or misleading statements and omissions of material facts, including omissions regarding the actual backing of USDT. This includes non-fiat assets such as commercial paper, representations that Tether would fully back USDT with fiat currency in accounts held in Tether's own name, and that Tether would undergo regular professional audits.

The CFTC clarified that USDT is a commodity and, thus, subject to applicable provisions of the (CEA) and Regulations. However, SEC chair Gary Gensler mentioned that stablecoins “may well be securities” and subject to US securities law on September 14, 2021. The CFTC and the SEC both asserting authority over various stablecoin activities serves as a reminder that the activities in which a stablecoin issuer, wallet provider, or intermediary engages may trigger compliance obligations under federal securities laws and the CEA – as well as US banking laws, the consumer protection laws and Bank Secrecy Act/AML/CFT rules.

November 1, 2021: The President’s Working Group (PWG) on Financial Markets report on stablecoins

The Report examines different types of prudential risk posed by "payment stablecoins". Payment stablecoins are those that are meant to maintain a stable value in relation to a fiat currency and, as a result, have the potential to be used as a widely accepted form of payment. The three types of detected risk include:

• the risk of stablecoins losing value due to run risk and potential contagion effects. The term "run risk" refers to the possibility of a depositor withdrawing funds from their accounts at any time. Contagions are usually related to credit booms and financial crises, but they can also lead to a crisis in one market, causing a crash in another;
• payment system risks such as potential disruptions in users' ability to make payments with stablecoins. For instance, risks stemming from incorrect or inadequate system governance, credit risk, and settlement risk can make payment systems less available and reliable for customers if they are not managed comprehensively. They can also cause financial shocks or serve as a conduit for the spread of financial shocks.
• scale risks such as systemic risk, the risk of excessive concentration of economic power, and the risk of anti-competitive effects. For instance, concerns about anti-competitive effects arise when stablecoin customers incur undue frictions or expenses while switching to other payment products or services. Without interoperability standards for stablecoins and stablecoin arrangements, concerns about anti-competitive implications are expected to grow.

According to the report, the agencies advised Congress to quickly pass new legislation to govern stablecoin arrangements, emphasizing stablecoin issuers and custodial wallet providers. Market integrity and investor protection changes, as well as anti-money laundering (AML) and counter-terrorist financing (CFT) measures, are not recommended to be put into place in the report. In addition, the Agencies advised that Congress should consider placing restrictions on custodial wallet providers' involvement with commercial enterprises or their use of users' transaction data.

Recommendations applicable to stablecoin issuers

A stablecoin issuer should be an insured depository institution (IDI) that will be examined, regulated, and supervised by any US federal banking agency – either the OCC, the FRB, or the FDIC. At the holding company level, stablecoin issuers would be subject to the FRB's close monitoring and examination to limit activities that limit association with commercial enterprises. 

The suggestion to limit stablecoin issuers to IDIs may reflect that the financial stability risks of a stablecoin run ranked high among the dangers of stablecoins to be widely used as a payment method. The failure of an IDI to issue the stablecoins as required could result in a "run" on that stablecoin. 

Recommendations application to stablecoin custodial wallet providers

Stablecoin custodial wallet providers would be subject to federal control, including the ability to prohibit wallet providers from lending customer stablecoins and impose risk-management, liquidity, and capital requirements. To address concerns about economic power concentration, the agencies also advised that Congress examine other rules for custodial wallet providers that are similar to the ones for stablecoin issuers (i.e., prohibitions on association with commercial enterprises or users' transactions data).

November 9, 2021: The Securities and Exchange Commission developments

Many DeFi products and solutions are similar to traditional financial market items and functions. For example, blockchain-based decentralized applications (dApps) allow anyone to get an asset or a loan by posting collateral, similar to traditional collateralized loans. Other products include apps that let users earn passive income by supplying liquidity. 

To the degree that they constitute securities under US federal securities laws, digital asset trading platforms and DeFi arrangements pose investor risks that the SEC is particularly concerned about. According to SEC Commissioner Caroline Crenshaw's statement on November 9, 2021, various DeFi participants, activities, and assets fall under the SEC's jurisdiction because they involve securities and securities-related conduct. Still, no DeFi participants within the SEC's jurisdiction have yet registered. For example, the SEC alleged Coinbase that it deceived investors by failing to register its crypto lending service, Lend which raised $30 million.

February 15, 2022: Draft of Federal stablecoin regulation bill

On February 15, 2022, Rep. Josh Gottheimer (D-NJ), a Democrat from New Jersey, released a "discussion draft" of “The Stablecoin Innovation and Protection Act” of 2022. The proposal intends to distinguish stablecoins from other forms of more volatile cryptocurrencies by putting "necessary consumer and investor protections in place."

Rather than creating a new regulatory framework, the proposed bill is a 9-page document that lays out fundamental concepts and finds a place for stablecoins inside the existing federal regulatory structure. Qualified stablecoins are defined as a cryptocurrency that is redeemable for US dollars on-demand and issued by one of two qualified issuers: an insured depository institution such as a bank or a non-bank qualified stablecoin issuer. It means the volatility of a stablecoin will be lowered, allowing it to be utilized as a payment method. Additionally, a stablecoin would not be considered a security or a derivative, and it would not be subject to the same registration and disclosure obligations as other cryptocurrencies under securities laws.

To avoid regulatory confusion, the bill laid out that the SEC and the CFTC will regulate other digital assets that are not qualified stablecoins. The Office of the Comptroller of the Currency (OCC) would be in charge of supervising stablecoin issuers. This is most likely the first attempt to delegate digital asset oversight to a single entity. Furthermore, non-bank issuers must keep cash or government-issued securities in an amount equivalent to 100% of the value of outstanding eligible stablecoins issued by the non-bank issuer — or even more if the OCC deems it necessary. Non-bank stablecoin issuers should also join an insurance program, which may be subject to additional requirements imposed by the OCC through regulation, such as auditing, AML regulations, leverage ratios, and redemptions requirements — and, perhaps most importantly, interoperability requirements to ensure transferability of all stablecoins in the market easily. 

Overall, the draft bill's goal is not to control every facet of stablecoins, but rather to lay the groundwork for a legal framework that would allow stablecoins to operate in a regulated environment.

The regulatory road ahead

According to both regulators and legal experts, if Congress does not act on recommended legislation to limit the activity to banks, federal regulators will examine additional regulation of stablecoin issuers. The Securities and Exchange Commission and the Commodity Futures Trading Commission do not appear to be preparing any related rulemaking in the foreseeable future, instead focused on laying the groundwork for a legal framework for stablecoins. 

Existing ambiguity about how virtual currency flows through the securities regulations framework, notably in terms of custody and registered digital asset securities offerings, may stifle innovation in this field. However, some of these issues may be addressed by the SEC through the issuance of guidance and the use of other regulatory tools. Going forward, the CFTC may have authority over stablecoin issuers, and they may be subject to rules to ensure that the stablecoins are adequately backed up with currency and that redemption requirements are met.

This article was prepared by the author. The views expressed in this article are the author’s own and do not necessarily reflect the views of the Digital Euro Association.