Here's a recent headline from Coindesk
If true, what does it mean for USDC? Let's take a look.
Conflicting Statements from SEC and CFTC
In October 2021, the Commodity Futures Trading Commission (CFTC) chairman “nearly 60% of cryptocurrencies are commodities” and that his team is positioned to lead regulations over the market. Meanwhile, SEC chairman Gary Gensler has continually commented that nearly all cryptocurrencies, including stablecoins, are no different than securities and, as such, should fall under his sphere of influence in the name of “consumer protection.”
The Howey test, the primary case law on the features of an investment contract, remains the best measuring stick despite its many shortcomings when applied to crypto assets. For this analysis, understand that the degree of decentralization of a protocol is a significant factor in determining which, if any, United States securities regulations apply.
“When a promoter, sponsor, or another third party (or affiliated group of third parties) (each, an “Active Participant” or “A.P.”) provides essential managerial efforts that affect the success of the enterprise, and investors reasonably expect to derive profit from those efforts, then this prong of the [Howey] test is met.
There are essential tasks or responsibilities performed and expected to be performed by an A.P., rather than an unaffiliated, dispersed community of network users(commonly known as a “decentralized” network).”
-SEC guidance “Framework for ‘Investment Contract’ Analysis of Digital Assets
Increased speculation of crypto assets is leading to an attempt by agencies like the SEC to separate what’s considered a currency and what’s considered a security. Cryptocurrencies can be deemed a security if it satisfies specific properties based on the standard definition and interpretation of the Howey Test, the standard legal test applied to assets to determine if they're securities. The four-component questions of the test are:
1. Is there an investment of money?
2. Is there an expectation of future profits?
3. Is the investment of money in a common enterprise?
4. Do any profits come from the efforts of a promoter or third party?
Other tokens created by large centralized companies have recently run into opposition from the US regulators, such as Telegram abandoning its project entirely after a multi-year battle with the SEC. Several landmark cases by the SEC set a precedent for them to evaluate ICOs as securities retroactively, while a recent in November 2022 against LBRY tokens further strengthened the SEC’s case against many altcoins.
Crypto Banking Crackdown
The path to becoming a stablecoin issuer in the United States is increasingly fraught with obstacles. Due to actions taken by US federal regulators in 2022-23, establishing vital banking relationships has become progressively difficult. The recent disruption in the crypto banking sector underscores a paradox faced by centralized stablecoins like USDC. To develop a robust stablecoin, one requires a comprehensive checklist of elements: banking relationships, trading, securities, custodial relationships, a regulatory framework, and wide distribution across the blockchain and crypto space. These incidents highlight that to engage in cryptocurrency transactions, users inevitably intersect with the traditional banking infrastructure.
With these fiat-to-crypto gateways becoming harder to come by, stablecoins could potentially step in to address the vanishing liquidity. They could allow users to deposit with a stablecoin issuer, receive stablecoins, and subsequently transfer them to an exchange. However, a potential challenge arises as stablecoin issuers, such as Circle, continue to rely on banking access, which could be imperiled if their banking choices diminish.
Although a minority of crypto firms have managed to maintain their banking access, newcomers to the space are encountering significant barriers in setting up operational accounts, let alone performing complex transactions like trading treasuries or engaging in overnight reverse repos.
New York's established regulatory framework for stablecoins is widely regarded as one of the most comprehensive in the nation, and it may well serve as an inspiration for federal oversight. Its approach is founded on three fundamental principles:
- Prompt Redemption: Holders should have the right to redeem their stablecoins within two business days of their request.
- Asset-Backed Reserves: Stablecoins must be fully backed by reserve assets. These assets can only include short-term bills, reverse repurchase agreements with approved counterparties, government money market funds, and deposits in US state or Federal depository institutions.
- Transparent Reporting: An independent licensed certified public accountant must conduct monthly reports. These reports should detail the reserve's value and composition, the number of outstanding stablecoin units, and the adequacy of the reserve to fully back these units.
The federal landscape is currently characterized by regulatory ambiguity. Federal institutions like the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) have vacillated on whether banks can partake in crypto-related banking activities. Notwithstanding this uncertainty, private institutions continue to adopt and integrate stablecoins. Signature Bank's adoption of stablecoins for payments in June 2021 and the establishment of the USDF Consortium in January 2022 represent key milestones in this private sector-driven adoption.
Stablecoins Specifically
After stablecoins’ tremendous growth from 2020-2022, the sector has finally become, for better or worse, big enough to catch the attention of regulators. There is no shortage of sound bites, opinions, , and even being proposed from Washington D.C. However, there is still nothing codified into law specific stablecoins, despite the President creating a special working group to address them.
The very idea of stablecoins or “crypto dollars” came under attack from US regulators as the STABLE Act was proposed in December 2020. The STABLE Act was written with “the intent to prevent abuse, opacity, and the potential rise of a stablecoin-based shadow-banking system.” However, the obligations that stablecoin issuers would have to abide by in order to avoid breaking the law are incredibly cumbersome and/or restrictive.
Firstly, any stablecoin issuer would be required to obtain a federal banking charter. In addition, any stablecoin issuers would be required to obtain the approval of both the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) six months before issuance. Finally, the stablecoin issuers would either need to obtain FDIC insurance or deposit dollar reserves directly at the Federal Reserve.
In Q1 2023,the SEC issued Paxos a Wells Notice, indicating their plans to sue Paxos over the issuance of another fiat-backed stablecoin, BUSD. The SEC alleges that BUSD is an unregistered security, although the commission has declined to comment on the potential investigation. This news comes in the wake of a recent report by CoinDesk that Paxos is also under investigation by the New York Department of Financial Services, although the scope of this investigation remains unclear.
The regulatory landscape and stablecoin economy continues to evolve, with Paxos announcing their decision to no longer issue BUSD following the Wells Notice. The impact of this decision on the stablecoin market is expected to be significant, as BUSD is widely used on Binance's exchange and in its DeFi ecosystem. Paxos has pledged to honor all BUSD redemptions through at least February 2024.
Congress is responding to these developments with comprehensive legislative frameworks. Senator Pat Toomey's draft proposal from April 2022 delineates the concept of "payment stablecoins" and offers a potential regulatory approach for their issuance. This proposal also seeks to disengage the Securities and Exchange Commission (SEC) from regulating payment stablecoins, aiming to resolve the longstanding regulatory conflict with the Commodity Futures Trading Commission (CFTC).
Senators Kristen Gillibrand and Cynthia Lummis introduced the Responsible Financial Innovation Act in June 2022. This bill mandates issuers to maintain high-quality liquid assets equal to at least 100% of the face value of the issued stablecoin. It also provides a framework for banks and credit unions to issue payment stablecoins. A third legislative initiative, spearheaded by Representatives Maxine Waters and Patrick McHenry, is currently under development.
In 2023, the Republicans have taken control of the House of Representatives after winning the midterm elections. As a party generally perceived as being more pro-business, they are likely to push back against calls for more stringent regulation. Therefore, it is unlikely that comprehensive regulation of stablecoins will be implemented during this congressional term. The Republicans now oversee committees with subpoena power, which will likely affect the regulatory landscape.
