Thursday, January 28, 2021

Defining the "regulated" in "regulated stablecoin"

1/n This is a thread on what is means to be a "regulated stablecoin." (This was originally meant for Twitter, but I didn't feel like wrestling with the 240-word limit and threading, plus it got a bit long, so now it's a blog post).

2/n People in the cryptocurrency space often use the term of art "regulated stablecoin." No one has a monopoly over what "regulated stablecoin" means. It is a community-defined term. It's not terribly well-defined. But it should be. 

3/n It should be well defined because when newcomers enter the crypto space, and they have to choose what stablecoins to adopt, they may assume that those stablecoins that are tagged as "regulated stablecoins" are products that offer a degree of government-provided consumer financial protection.

4/n But are there government agencies that actually provide consumer financial protection to stablecoin users? If so, which agencies? What is the nature of this protection? And what stablecoin should you buy if you want to benefit from this protection?

5/n Novices can take heart. In the U.S., state financial agencies such as the New York Department of Financial Services (NYDFS), Florida Office of Financial Regulation, and Texas Department of Banking do in fact check the assets, investments, and reserves of financial institutions that issue stablecoins and/or other payments instruments. The also vet executives and directors of these payments companies, conduct examinations, and ask for audited financial statements.

6/n For instance, below is a screenshot of "eligible securities" as set out by California's Department of Financial Protection & Innovation (DFPI). When a customer deposits funds with a payments company operating in California, this list circumscribes how that company can invest those funds. In theory this should stop a payments provider from betting their customers' savings on wild and dangerous speculations, and losing it all.

California Money Transmission Act [source]

7/n So what companies do these regulators supervise? PayPal is licensed by the NYDFS. So are stablecoin issuers Paxos Trust, Circle, Coinbase, and Gemini Trust. 

PayPal, Coinbase and Circle are also regulated by the Florida Office of Financial Regulation, the Texas Department of Banking, California's DFPI, and a number of other regulators.

8/n To repeat, all of these state departments provide users of supervised payments instruments and stablecoins with an extra layer of financial protection. 

9/n Other countries may have agencies that also provide customers of payments platforms with a degree financial protection. For instance, in Singapore the Monetary Authority of Singapore (MAS) provides a financial regulatory framework for payment companies. In the U.K., the Financial Conduct Authority (FCA) does. 

However, many jurisdiction do not have an established regulatory frameworks for protecting customers of payments companies. These are unregulated jurisdictions.

10/n So to qualify as a "regulated stablecoin," a stablecoin issuer should be licensed with a regulatory body like the NYDFS or DFPI in the U.S., MAS in Singapore, the FCA in UK, or any other similar body. 

11/n FinCEN-registration isn't sufficient for qualification as a "regulated stablecoin." The U.S Financial Crimes Enforcement Network (FinCEN) does not get involved in consumer financial protection. FinCEN is an anti-money laundering watchdog.

12/n Which gets us to a recent article I wrote for Coindesk about one particular stablecoin, Tether. A spokesperson for Deltec, Tether's banker, suggests that Tether should be included in the category "regulated stablecoin." He puts forward Tether's FinCEN registration as the basis for inclusion.

13/n Deltec further invokes Tether's FinCEN-registration to say that Tether's regulation is just as iron-clad as its stablecoin competitors. Paolo Ardoino, a Tether executive, approves, saying: "It's deceitful how some competitors claim to be 'more regulated' as part of their pitch. No such thing."


14/n Unlike its competitors, Tether is not regulated by an agency that provides consumer financial protection.

15/n That is, Tether appears to operate from a jurisdiction that does not have a financial regulatory framework for payments companies.

16/n Meanwhile, Tether's stablecoin competitors such as Paxos, Coinbase, and Circle have gone to great lengths to be approved by agencies that do in fact offer these assurances to consumers (i.e the NYDFS). These stablecoins are, in short, better regulated than Tether, which lacks a license from a regulator that provide consumer financial protection.

17/n  Tether's counsel disagrees with my article.

By the way, I think it's laudable that Tether is registered with FinCEN and has a solid anti-money laundering (AML) program. As best as I can tell, Tether is based in the British Virgin Islands, which would mean that it is legally obligated to follow AML standards set by the British Virgin Island's anti-money laundering authority. Presumably it has doubled-up by also registering with FinCEN.

18/n However, to earn the moniker "regulated stablecoin", an issuer shouldat a minimumcombine registration with an anti-money laundering agency like FinCEN AND supervision by an agency that provides a degree of consumer financial protection. That way a crypto novice's expectations of "regulated", i.e. offering a degree of government-controlled consumer protection, do in fact correspond with reality. I'm afraid Tether doesn't make the cut. But USD Coin, Gemini Dollar, and Paxos Standard do.

19/n That isn't to say that Tether isn't safe for consumers to use. Over the course of history there have been many well-run financial institutions that have not operated under a specific financial regulatory framework.

20/n In fact, to this very day Canada still does not have a financial regulatory framework for payments companies. So whereas PayPal USA operates under a financial regulatory framework that provides consumers a degree of financial protection, PayPal Canada operates as an unregulated payments company, just like Tether. But even though PayPal Canada is unregulated, I still use it.

21/n In last week's blog post, I brought up the Banque d'Hochelega, a successful private Canadian note-issuer in the 1800s, an era with minimal financial regulation. I gave some examples about how the Banque d'Hochelaga managed to communicate to the public how safe their payments media were.

22/n To demonstrate how well Tether consumers are protected, Tether could borrow from the Banque d'Hochelega's bag of tricks. Why not start providing the public with more verified financial information?

23/23 Alternatively, it could seek to become a "regulated stablecoin." That is, it could try to get licensed in a jurisdiction that has a financial regulatory framework that protects customers.


1 comment:

  1. What if we dropped the stablecoin designation. If we drop this term, then we have a cryptocurrency that is like every other cryptocurrency where there is 'money' or virtual currency equivalent exchanged for the crypto. The stablecoin part just implies that the price will be about one dollar. But I don't think this actually matters, and here is why, to everyone who is not a customer of tether you exit tether on the secondary market. Tether is special in that they allow customers to exchange or redeem it with them for the set price of one dollar, but no one else can. I think that some regulators (those that look into counterfeits perhaps or control the dollars in circulation) see tether as a crypto just like bitcoin, with just a set price- not as a dollar. It technically isn't a dollar, it is not legal tender, it is just some crypto with a set price. This is how I have come to think of it as well.

    So it makes sense that it would be regulated like every other cryptocurrency, but not have special regulations on top of it- just because it is priced at a dollar. Priced I think it better than saying asset backed (especially since we know it isn’t backed by 1:1 with dollars but they have deployed or invested the dollars in loans, cash equivalents, etc). Any time there is a claim to the underlying, it implies it is a security. With dollars, backing it just means setting a price, which makes more sense to me. True asset backed, a crypto backed by gold(the asset itself), will fluctuate or get it's value from the underlying commodity held- this is a true asset backed crypto and should definitely be a security where the crypto represents a real asset. I think the difference is that a dollar will always be a dollar and since a dollar isn't a commodity I don't think it is backed by dollars, rather the crypto itself- a stablecoin like tether is being sold for dollars without any real contract in place saying that you will be able to receive future dollars at all (making it just escape being labeled a security or have being a claim backed crypto).

    If we think about it this way though- as priced at a dollar vs backed, if tether is the only issuer, and it is centralized, and the funds are being invested and the profits retained by the entity itself it looks a lot like an ongoing ICO or fundraising event for the company itself- it would not pass the Howey test imo except possibly because the 'investor' doesn't expect to profit from it- if they can hold the peg or price at 1 dollar. It really is quite beautiful what they have achieved. The SEC would have labeled this type of activity a security if not for the 'stablecoin' propaganda which lacks a clear definition - which I think the concept itself shouldn't exist.

    I find tether truly fascinating and enjoy your articles and thoughts. The above is my opinion from merely an outsider.