Full Text of U.S. SEC Stablecoin Regulation: What Kind of Stablecoin is Not a Security?

Original Title: Statement on Stablecoins

Original Author: U.S. Securities and Exchange Commission Corporate Finance Division

Original Translator: Aki Chen, Blockchains Are Us

To further clarify the applicability of U.S. federal securities laws in the cryptocurrency field [1], the Corporate Finance Division has issued relevant guidance regarding a specific type of cryptocurrency (commonly referred to as "stablecoins") [2]. This statement is only applicable to stablecoins that meet the following criteria:

Designed with a mechanism to ensure a 1:1 peg to the U.S. Dollar (USD), supporting redemption of U.S. Dollars on a 1:1 basis (i.e., 1 stablecoin is redeemable for 1 U.S. Dollar), backed by low-risk and highly liquid reserve assets, with the U.S. Dollar value always covering the redemption demand of circulating stablecoins.

As elaborated later in this document, we refer to such stablecoins covered by this statement as "Compliant Stablecoins."

Stablecoin Overview

A stablecoin is a type of cryptocurrency designed to maintain its value relative to a reference asset (such as the U.S. Dollar or another fiat currency, gold or other commodities, or a basket of assets). Generally, stablecoins are intended to track the value of the reference asset at a 1:1 ratio. Stablecoins may employ different mechanisms to maintain their value stability: in some cases, stablecoins are backed by reserve assets, using assets held in reserves to ensure a 1:1 exchange with the reference asset; in other cases, stablecoins maintain stability through mechanisms outside of reserves, such as relying on algorithms to adjust the stablecoin's supply based on market demand [3].

Given the different stabilizing mechanisms and reserve assets (where applicable), stablecoins face significant differences in risk. Stablecoin issuers typically offer and sell stablecoins at a price equivalent to the reference asset (1:1 ratio). For example, when the reference asset is the U.S. Dollar, the issuer would sell 1 stablecoin at a price of 1 U.S. Dollar; if trading in fractional amounts, the value would still correspond at a 1:1 ratio (e.g., 0.5 stablecoins corresponding to 0.50 U.S. Dollars). Upon redemption by users, issuers usually utilize reserve assets to exchange stablecoins back to the reference asset at a 1:1 ratio.

1) Corporate Finance Division's Position on Compliant Stablecoins [4]

Based on the operational model and applicable conditions outlined in this statement, the Corporate Finance Division believes that the issuance and sale of Compliant Stablecoins do not constitute acts of issuing or selling securities as defined by Section 2(a)(1) of the Securities Act of 1933 or Section 3(a)(10) of the Securities Exchange Act of 1934 [5].

Therefore, relevant parties participating in the issuance (i.e., creation) and redemption of compliant stablecoins do not need to comply with the registration requirements of the Securities Act with the U.S. Securities and Exchange Commission (SEC), nor do they need to rely on any registration exemptions under the Securities Act.

2) Core Features of Compliant Stablecoins

Compliant Stablecoins are a type of cryptocurrency asset designed to serve as a means of payment settlement, fund transfer, or store of value. These stablecoins are designed to maintain a 1:1 fixed anchoring relationship with the U.S. Dollar (USD) by holding sufficient USD reserves and other assets deemed low-risk and highly liquid to ensure the issuer can meet redemption obligations on demand.[6]

These backing assets denominated in USD are held in reserve accounts, with their total value equal to or exceeding the redemption value of circulating compliant stablecoins. The issuer of compliant stablecoins can mint and redeem them at a 1:1 ratio with the USD, without any quantity restrictions. In other words, the issuer is always prepared to mint one stablecoin for $1 (or an equivalent proportion) and redeem one stablecoin for $1 (or an equivalent proportion), with no limits on the minting and redemption amounts.

Through this fixed-price, unlimited minting and redemption mechanism, the market price of compliant stablecoins can maintain a stable anchoring relationship with the USD.

Compliant Stablecoins are minted by the issuer and issued and sold by the issuer or designated intermediaries. In some cases, any holder can directly mint and redeem stablecoins with the issuer at a 1:1 ratio to the USD. In other cases, only designated intermediaries are eligible to directly mint and redeem stablecoins with the issuer at the same 1:1 ratio.

In the latter scenario, non-designated intermediary holders cannot directly mint or redeem stablecoins with the issuer; their sole means of acquiring or disposing of stablecoins is through secondary market transactions, which may include transactions with designated intermediaries.

The trading price of compliant stablecoins on the secondary market may deviate from their redemption price. However, the "fixed-price, unlimited minting and redemption" mechanism provides arbitrage opportunities for designated intermediaries or other eligible holders who can directly mint and redeem with the issuer, helping to keep the market price close to the redemption price.

For example, when the market price is higher than the redemption price, these parties can mint stablecoins directly from the issuer at a 1:1 ratio and sell them on the market. With an increase in supply, the market price usually decreases, approaching the redemption price. Conversely, when the market price is lower than the redemption price, these parties buy stablecoins on the secondary market and redeem them directly with the issuer. As the circulating supply decreases, the price typically rises, once again approaching the redemption price.

This Statement Covers Compliance Stablecoin Market Activities [7]

Compliance Stablecoins are positioned in the market solely for commercial purposes, specifically as a means of payment, a tool for fund transfers, or a store of value, and not as an investment product. Market participants typically emphasize that Compliance Stablecoins are designed to provide stable, fast, reliable, and easy-to-use payment, currency transfer, and value storage mechanisms. In addition, such stablecoins are often likened to a "digital dollar."

Market participants may also explain that Compliance Stablecoins have the following characteristics:

Designed to be pegged to or equal in value to the US dollar (USD) (e.g., one Compliance Stablecoin corresponds to one US dollar).

Do not entitle holders to any interest, profit, or other income rights.

Do not represent an investment in or any ownership interest in the issuer or any third party.

Do not grant holders any governance rights over the issuer or the stablecoin itself.

Holders' economic interests or losses are not affected by the financial performance of the issuer or any third party.

As described below, we believe that stablecoins introduced in the following manner demonstrate that Compliance Stablecoins are not issued or sold as securities.

1) Reserve Account

The issuer of Compliance Stablecoins will use the proceeds from their sale to purchase specific assets, which are held in a centralized asset pool called a "Reserve." The assets held in the reserve include US dollars (USD) or other assets considered low risk and highly liquid to ensure the issuer can meet all redemption requests on demand. [8]

The reserve assets at all times support the circulating amount of Compliance Stablecoins at a ratio of not less than 1:1. Reserve assets are only used to fulfill redemption requests, and while the issuer may earn income from them (e.g., interest), the following applies:

Reserve assets can be sold during the redemption process but are always managed separately from the issuer's or any third party's other assets and may not be commingled.

Reserve assets may not be used for the issuer's operations or general business purposes.

Reserve assets may not be lent, pledged, or rehypothecated.

The custody of reserve assets should ensure they do not become subject to third-party claims.

Under the aforementioned arrangement, the issuer may not use reserve assets for trading, speculation, or discretion-driven investment operations. While the issuer can decide how to use the income generated from the reserve assets (e.g., interest), such income is not distributed to Compliance Stablecoin holders.

In some cases, an issuer may publish a "Proof of Reserves" as an auditing or verification mechanism to demonstrate that its issued stablecoin is backed by sufficient reserve assets.

2) Legal Qualitative Analysis

Both Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act define "security" by listing various financial instruments, including "stock," "note," and "evidence of indebtedness." As compliant stablecoins exhibit characteristics of notes or other debt instruments in certain aspects, we analyze them based on the standard established by the U.S. Supreme Court in Reves v. Ernst & Young. [9] As described below, we will also refer to the "Howey Test" established in the U.S. Securities and Exchange Commission v. W.J. Howey Co. case for supplementary analysis. [10]

Reves Case Analysis

In the Reves case, the U.S. Supreme Court found that since "notes" are one of the instruments listed in the definitions of "security" in the Securities Act and the Exchange Act, all notes should generally be presumed to constitute securities. [11] However, this presumption can be rebutted by demonstrating a high degree of similarity between the note in question and several types of notes issued in typical commercial transactions, thus appropriately excluding it from the definition of "security." [12] This so-called "family resemblance test" includes the following four factors:

Analysis of the true intent of the transaction parties: Examining the motives that prompt a rational seller and buyer to engage in the transaction.

Circulation of the security: Examining whether the financial instrument is used in transactions "involving common trading for speculation or investment."

Reasonable expectations of the investing public: Examining whether ordinary investors would reasonably expect the note to be a security regulated by federal securities laws.

Risk reduction features: Examining whether the note has certain characteristics (e.g., subject to other regulatory mechanisms) that significantly reduce its risk, thereby decreasing the necessity of applying the Securities Act and the Exchange Act. [13]

Federal courts take a balanced, comprehensive approach when applying the Reves test, and no single factor should be considered in isolation to determine whether a note constitutes a security. [14]

1) Analysis of the True Intent of the Transaction Parties

If the seller's purpose is to raise funds for its overall operations or significant investments, while the buyer is primarily focused on the expected profits from the note, the note is likely to be considered a security. [15] Conversely, if the purpose of exchanging the note is to serve an actual business scenario or consumer use, the note is unlikely to be classified as a security.

As mentioned earlier, the buyer of a compliant stablecoin purchases it due to its stability and the need for it as a means of payment or store of value in commercial transactions. Since a compliant stablecoin neither pays nor promises interest, nor grants the holder any payment or asset rights other than the 1:1 USD redemption, the buyer does not purchase and hold the stablecoin for profit expectations. The issuer of a compliant stablecoin uses the sale proceeds to replenish the reserve account. Although the issuer may utilize the income generated from the reserve to support its business operations, the issuance and purchase are primarily for commercial purposes rather than investment purposes.

2) Circulation of Securities

In the Reves case, the U.S. Supreme Court pointed out that this factor examines whether there are "widespread sales to the general public for investment or speculative purposes." When a financial instrument is "sold and distributed to the general public," this factor is satisfied, which compliant stablecoins adhere to.

However, the price stability design of a compliant stablecoin helps ensure that its secondary market trading is not for speculative or investment purposes. Although arbitrage opportunities may arise in the secondary market when there is a deviation between the market price and the redemption price, such arbitrage opportunities are effectively limited as the issuer can redeem on demand and mint and redeem on a 1:1 basis with the U.S. dollar at any time.

3) Reasonable Expectations of the Investing Public

This factor aims to examine the marketing and sales approach of the relevant financial instrument. In the Reves case, the court explicitly stated: "The advertising characterized the note as an 'investment'...and there were no countervailing factors sufficient to create a genuine issue of fact as to that characterization."

As mentioned earlier, compliant stablecoins are not promoted as investment instruments. Instead, they are marketed as a stable, fast, reliable, and easily accessible means of transferring value or storing value, without emphasizing potential profits or investment returns. Therefore, from the perspective of the investing public, it would not be reasonable to expect such stablecoins to be regulated as investment instruments under securities laws.

4) Risk-Reducing Features

In the Reves precedent, this factor focuses on risk-mitigating features such as whether the note has collateral backing, insurance coverage, or is subject to other regulatory mechanisms, thereby "significantly diminish[ing] the risk of the financial instrument to the point where the application of securities laws is no longer necessary." The issuer of an asset-backed stablecoin maintains a reserve mechanism designed to fully fulfill redemption obligations. This reserve consists of USD and/or other assets considered low risk and highly liquid to ensure the issuer can meet all redemption requests at any time.

Therefore, considering all relevant factors, this department believes that based on the Reves Test, Asset-Backed Stablecoins do not constitute securities, for the following reasons:

· The issuer uses the proceeds from the sale to establish a reserve account, and the buyer's motivation is not primarily based on the expectation of profit;

· The distribution of Asset-Backed Stablecoins does not encourage speculation or investment trading behavior;

· A reasonable buyer would not expect this type of stablecoin to be an investment vehicle;

· The ongoing provision of a sufficient reserve that can be readily used to fulfill redemption obligations constitutes a substantive risk mitigation mechanism.

In summary, the issuance and sale of Asset-Backed Stablecoins are intended for commercial or consumer use rather than for investment purposes.

Howey Test Analysis

If Asset-Backed Stablecoins are not considered notes or other debt instruments and are not explicitly listed as other financial instruments under Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act, then a further analysis of the issuance and sale activities must be conducted under the "investment contract" standard, known as the Howey Test. This test, centered on the "economic realities," is used to assess whether arrangements or instruments not within the scope of the above statutes constitute securities.^[22]

When analyzing the economic substance of a transaction, the Howey Test focuses on whether there is an investment of money in a common enterprise and whether the investor expects profits predominantly from the efforts of others (usually the project's efforts).^[23] Since the Howey case, the Supreme Court has distinguished between an investor's motive (attracted by the "profit-making prospect" [24]) and a consumer's motive (for the "use or consumption of the purchased item").^[25] Federal securities laws apply only to transactions involving investment activities and do not apply to consumer transactions.^[26]

As mentioned earlier, buyers of Asset-Backed Stablecoins do not purchase such stablecoins based on the profit expectation from the entrepreneurial or managerial efforts of others. This instrument is not marketed in the market as an investment product nor emphasizes any profit potential.^[27] Conversely, the buyers acquire Asset-Backed Stablecoins with the motivation to use them as a "digital dollar" for payments or store of value, similar to scenarios involving the use of dollars.

Therefore, this department believes that the issuance and sale of Asset-Backed Stablecoins do not constitute an investment contract and are not securities under the securities laws.

For further information, please submit an online request form through the following website to contact the Chief Legal Advisor's Office of this department: https://www.sec.gov/forms/corp_fin_interpretive

[1] In this statement, "crypto asset" refers to an asset generated, issued, and/or transferred through a blockchain or similar distributed ledger technology network, including but not limited to assets referred to as "tokens," "digital assets," "virtual currencies," and "coins," relying on cryptographic protocols to achieve its functionality. Additionally, the "issuer" referred to in this statement includes both the issuer itself and its affiliates.

[2] This statement represents the views of the staff of the Division of Corporation Finance of the U.S. Securities and Exchange Commission (the "Division"). This statement is not a rule, regulation, guidance, or official statement of the U.S. Securities and Exchange Commission, and the Commission has neither approved nor disapproved its content. Like all staff statements, this statement has no legal force: it does not change or amend existing law, nor does it impose new legal obligations on any entity.

[3] Unlike reserve asset-backed stablecoins, algorithmic stablecoins typically rely on specific algorithmic mechanisms to maintain price stability rather than being backed by real-world assets.

[4] The Division only expresses views on Compliance Stablecoins as described in this statement. For other types of stablecoins, this statement does not provide an assessment, including but not limited to the following categories:

Stablecoins designed to peg the value to a non-U.S. dollar reference asset (such as non-U.S. fiat currency, commodities, other crypto assets, etc.). Stablecoins using alternative stability mechanisms (such as algorithmic mechanisms) to achieve value pegging. Stablecoins pegged to the U.S. dollar value but not redeemable for U.S. dollars. And income-generating stablecoins (referred to as "yield-bearing stablecoins"), including stablecoins that provide holders with income, interest, or other passive revenue, whether in the form of regular payments, reward mechanisms, or through a "re-basing" mechanism that automatically adjusts the stablecoin's total supply.

[5] The Division's views are not conclusive and cannot definitively determine whether a stablecoin (including an asset-backed stablecoin) constitutes a security. The determination of whether a stablecoin is a security depends on a factual analysis of the specific characteristics of the stablecoin and the specific circumstances of its issuance and sale. If the actual situation of a stablecoin differs from that described in this statement, the Division's determination of whether it constitutes a security may also be different.

[6] Examples of such low-risk and highly liquid assets include: U.S. dollar cash equivalents, demand deposits in banks or other financial institutions, U.S. Treasury securities, and money market funds registered under the Investment Company Act of 1940. Excludes precious metals or other crypto assets.

[7] As explained in the "Legal Analysis" section below, in evaluating whether an issuer or promoter is engaged in an offering or sale of securities, federal courts will examine the marketing practices employed.

[8] Some asset-backed stablecoin issuers may be subject to state-law regulation, with state regulations potentially specifying the types of assets permissible in reserves.

[9] Reves v. Ernst & Young, 494 U.S. 56 (1990). Federal courts apply the standard established in the Reves case, not only analyzing a "note" but also applying it to other financial instruments with debt features. See, for example, In re Tucker Freight Lines, Inc., 789 F. Supp. 884, 885 (W.D. Mich. 1991) (court finds the "Reves method applicable to all debt instruments, including debt certificates"). Because asset-backed stablecoin issuers undertake the obligation to fulfill redemptions, stablecoins can be viewed as a debt of the issuer. While asset-backed stablecoins do not exhibit all typical note characteristics (such as no explicit maturity, no agreed interest payments, etc.), the Division wishes to expressly state that even if asset-backed stablecoins were considered notes or debt certificates, their issuance and sale would not constitute an offering and sale of securities, as per the Division's view.

[10] SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In situations where necessary, federal courts typically apply both the Reves and Howey tests. For example, in Banco Espanol de Credito v. Security Pacific Nat'l Bank, 763 F. Supp. 36 (2nd Cir. 1991), the court applied both the Reves and Howey tests concurrently to evaluate loan participations involved in the case.

[11] Reves, 494 U.S. pp. 64–66.

[12] Ibid, p. 65. Notes excluded from the "securities" definition include:

(1) Notes related to consumer financing;

(2) Notes secured by residential mortgages;

(3) Short-term notes secured by small business or their assets;

(4) Notes for bank customers' character loans;

(5) Short-term notes secured by accounts receivable;

(6) Notes used for the orderly recording of commercial transactions' book-debts;

(7) Loan notes provided by commercial banks for enterprise day-to-day operations.

[13] Ibid, pp. 66–67.

[14] See, for example: SEC v. J.T. Wallenbrock & Associates, 313 F.3d 532, 537 (9th Cir. 2002): "Failure to satisfy any one factor is not determinative; the four factors should be considered collectively."

[15] Reves p. 60; Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 812 (2nd Cir. 1994).

[16] In relevant circumstances, we believe greater weight should be given to the buyer's motivation. See, for example, Pollack, p. 813 (court finds that in situations where buyers seek to invest funds in a safe, conservative investment, even if the seller's motivation differs, the note should still be considered a security).

[17] For example, asset-backed stablecoin issuers commonly offer their products in the form of stored-value or pre-paid products and comply with relevant state-level money transmission laws.

[18] Reves p. 68.

[19] Ibid, pp. 68–69.

[20] Ibid, p. 61. In the Reves case, the court found no risk-mitigating factors due to the notes' "unsecured, uninsured" nature, and stated that "if the securities laws and the UCC do not apply, these notes may exist entirely outside the federal regulatory scheme" (p. 69). Also see Pollack, 27 F.3d p. 814 (highlighting that in analyzing the fourth factor of Reves, "the amended complaint expressly states the involved mortgage loan participation interests as 'unsecured' and 'not collateralized'").

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