The term “Bitcoin” comes with both negative and positive connotations. For many, the word evokes a reaction somewhere between confusion and skepticism. This is perhaps because cryptocurrencies are associated with being unstable, vulnerable, and not easily regulated. While this may be true of some, a class of digital currencies—known as “stablecoins”—have been addressing these problems. So, what exactly are stablecoins? And more importantly, how will they transform regulatory framework moving forward?
The lowdown on stablecoins
First and foremost, stablecoins are digital currencies or assets that utilize one or more stabilization methods to maintain a value of around $1 USD. In one category, there are "fully-reserved" or “fiat-collateralized” stablecoins that are backed, one-for-one, by the U.S. dollar. These can be classified as digital dollars.
In the other category, there are "protocol-based" stablecoins that steady value through other means. These stabilizers can include commodity collateralization, crypto collateralization, or non-collateralization. As their names suggest, both commodity and crypto collateralization require backing by a commodity or other cryptocurrency, respectively. Non-collateralization, on the other hand, means that the stablecoin is not backed by any asset. Instead, using an algorithm to control supply, new coins are created to meet market demand.
Putting aside their differences, stablecoins overall will likely become the first fully regulated cryptocurrencies. The million-dollar question is: how should they be regulated and by whom? Unfortunately, the answer to that is equal parts simple and aggravating: it depends. That is to say, the category of token—or rather, its collateralization and the way it is used—will likely determine which regulators claim jurisdiction.
A look at current regulation
If there were one word to sum up the current regulatory framework for stablecoins in the U.S., it might be “messy.” In other words, there is no uniform way that all stablecoins are regulated by government agencies. This is where the intended use of the coin comes in. Rather than view all stablecoins the same, regulators consider the parties, purpose, and potential issues of a given transaction. This means that they will look at whether stablecoins have been used for investment and trading (as securities or commodities), banking (as deposits), or money transfer (as exchange). Of course, with each of these categories comes problems and the need for regulators to address them.
There are three federal agencies in the U.S. that could play a role here. These are: (1) The Securities and Exchange Commission (SEC), (2) the Commodity Futures Trading Commission (CFTC), and (3) Financial Crimes Enforcement Network (FinCEN). For the SEC, determining whether a given stablecoin qualifies as a security has traditionally required application of SEC v. W.J. Howey Co. With the Howey test, a major question concerns the profits that would be expected from managing a given asset. Stablecoins, however, are inherently stable in value. This has led the SEC to predominantly determine that stablecoins are exempt from securities laws assuming they are unlikely to appreciate. In that sense, the purchase of stablecoins has not been an “investment contract” for purposes of regulation by the SEC.[1]
Much unlike the SEC, CFTC views many stablecoins as subject to the Commodity Exchange Act. This is because those collateralized by fiats or commodities would likely constitute spot commodities vulnerable to fraud and manipulation. What’s more, in some states, a fiat-collateralized stablecoin could be characterized as a deposit; thus, it would require the deposit-receiving institution to be licensed as a bank entity. This has also been the approach taken by many foreign banks, including the European Central Bank (ECB). There, if the token issuer “does not grant credit and guarantees redeemability at par, and end users have a claim on the issuer,” the stablecoin is considered digital “money.” The result is that stablecoin issuers may be classified as banks under the laws of the EU.
Finally, FinCEN’s take on stablecoins has largely hinged on its determination that those involved in digital currency transactions are Money Services Businesses (MSB). According to FinCEN Director Kenneth Blanco, this is true regardless of the form of collateralization. The result of that determination, moreover, is that stablecoins are subject to the anti-money laundering and financial crimes oversight of the agency.
What the future may hold
Amidst Covid-19, the stablecoin market has soared in popularity. Given their low transaction costs and price stability, it is quite likely that the U.S. government will make use of stablecoins for the purposes of delivering aid. To explore this, the U.S. Senate Banking Committee recently held a hearing on the U.S. Digital Dollar and its place in the American banking system. This is likely only one of many legislative moves in the push for stablecoins to revamp the U.S. economy.
[1] Note that this is not true of cryptocurrency in general. As the recent case SEC v. Telegram has shown, the Howey test may be construed to classify certain cryptocurrencies as securities. This requires that the tokens be part of a “scheme”—including purchase agreements and undertakings—that renders them “securities” for the purposes of SEC regulation.
By Jessica Hart
Associate Intern
