Stablecoins bring financial inclusion, but their fate is still undecided

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Stablecoins have become a $160 billion+ market. However, regulatory uncertainty around the world threatens their future. We have seen the digital asset industry invest in effective lobbying campaigns. More is needed.

There are numerous threats to the stablecoin market. For example, regulators could rein in the market by requiring changes to issuer business models. As Tether (USDT) makes clear on its transparency page , stablecoins are not fully backed by dollars. Instead, a pool of assets that yields slightly more than 5% for stablecoin issuers backs the world’s first popular real-world asset. Issuers typically do not pass on any of the returns they earn to their holders.

Tightening regulatory belts

Stablecoin promoters argue that this is because stablecoins are not securities and face a relatively light regulatory regime compared to most tokens with centralized teams. However, stablecoins could cease to exist as a currency and a lightly regulated financial instrument. Donald J. Trump has promised to allow stablecoins to expand in the United States, while the European Union and Switzerland are exploring legislation that could weaken stablecoins.

Unlike many digital assets, question marks remain over the future of stablecoins due to the major stablecoins’ reliance on centralized issuers.

While stablecoins do not generate profits for their owners, they can still be considered a security. In fact, a February 2024 federal court ruling in New York determined that a stablecoin can become a security when combined with a yield.

Stablecoins have an issuer that profits from the stablecoin: companies like Tether, Circle, Coinbase, etc. Circle also uses BlackRock as the “primary asset manager of USDC cash reserves.” Moreover, securitized bonds with negative nominal coupons are available today, even though investors have no reasonable expectation of profit.

In a September 2023 amicus curiae brief in a legal battle between Binance and the SEC, Circle argued that stablecoins are not securities because users do not expect to make a profit. However, the SEC argued in its lawsuit against Binance that Binance’s stablecoin, BUSD, has been a security “since its inception” and has relied heavily on the fact that it has provided returns.

Indeed, Binance’s stablecoin invests money in “profitable” opportunities. Binance also promised “interest-like” payments to people in the US for “simply buying BUSD and placing BUSD in yield programs.”

SEC approach

The SEC does not rely solely on the Howey analysis. For example, it could be argued that stablecoins represent an equity stake in an open-ended company under the Investment Company Act of 1940, particularly if the stablecoin resembles a money market fund with the Net Asset Value of the shares pegged 1:1 to the U.S. dollar.

So it’s not unreasonable to think that the SEC would consider a stablecoin backed by a bundle of assets to be an asset-backed security.

In the Binance case, the New York Department of Financial Services ordered Paxos to stop managing BUSD. In 2023, a Paxos spokesperson said the company did not consider its stablecoins to be securities under Howey or Reves. Stablecoin sponsors argue that the stablecoins do not meet the three-part Howey test of an investment contract and that the sponsors keep the profits for themselves. They argue that the stablecoins preserve value and prevent losses, but do not create profits.

In a court of law, an SEC lawyer might argue that just because issuers keep all the profits doesn’t mean stablecoins aren’t securities. All it takes is a judge to agree with that argument and rule. After all, a stablecoin is a receipt for an off-chain asset. There are also secondary markets for stablecoins and an issuer-investor relationship. Financial instruments representing the underlying digital assets (like the Bitcoin (BTC) ETF) are considered securities. So why aren’t stablecoins?

Stablecoin advocates would be wrong. For a stablecoin to constitute a security, a security buyer does not have to expect to make or lose money by buying or selling a security. The crypto market would be disrupted because stablecoins operate under the assumption that they are currencies, not securities.

Centralization once again

Moreover, the dominant stablecoin model is highly centralized, raising concerns that they may be securities and putting the stablecoin and broader cryptocurrency markets at risk of government intervention.

U.S. or any country’s authorities may revoke stablecoin issuers’ access to the banking and financial system. If a USD stablecoin issuer is located overseas, the U.S. government may require foreign governments to exclude such entities from their banking systems. Furthermore, U.S. authorities may require stablecoin issuers to comply with anti-money laundering and know-your-customer procedures, as Swiss authorities recently did in a guidance document.

If the digital asset sector continues to demonstrate the impact it clearly has at the moment, stablecoins could continue to spread and millions of people could reap the benefits of financial inclusion.

Sarah Austin

Sarah Austin is an entertainment and technology executive and co-founder of Tilted.xyz, a game streaming consumer app featuring e-commerce for game assets. Sarah is an American author and technology entrepreneur. She is the former CMO and co-founder of the Metaverse funding platform QGlobe and the former CEO of the artificial emotional intelligence agent Broad Listening.