On May 10, during a “The World Class” podcast, Brad Garlinghouse, Ripple’s CEO, said, “The U.S. government is going after Tether, that is clear to me,”
Later, he explained on his X account that he was not trying to attack Tether. He added that since the U.S. government has made it clear it wants to tighten control over issuing companies, Tether, as a key player in the ecosystem, is automatically on regulators’ radar.
In this article, we look at what is happening within the context of interactions between governments and stablecoins and whether there are potential threats.
Reasons for regulation of stablecoins
Governments, by definition, have to fight potential investor fraud, tax evasion, money laundering, etc.. We see that the process is underway: from the SEC’s investigation into the dollar unpegging of UST, and Facebook’s legal problems with Libra (now known as Diem), to the regulation of stablecoins, which we will discuss in more detail below.
What are stablecoins? In case you are not aware, there are three types of stablecoins:
Fiat-backed stablecoins are backed by fiat currency, usually the dollar or the euro (with the dollar being more common). They are Centralized.
Crypto-backed stablecoins are backed by other cryptocurrencies. Examples include DAI and EOSDT.
Algorithmic or non-backed maintain stablecoin price stability through algorithms that manage the number of stablecoins in circulation. They are Decentralized.
Bridging the gap between traditional finance and cryptocurrencies, stablecoins also provide liquidity for buying other tokens. We have discussed the classifications of stablecoins and how they work in our previous material.
Stablecoins are gaining more and more weight due to capitalization growth. For example, USDT, the largest issuer of Tether, boasts a market cap of $111.47 billion as of May 2024, ranking third after Bitcoin and Ethereum. Other prominent players such as USDC ($33.47 billion) and DAI ($5.52 billion) also confirm their crucial role.
This type of interest from investors, and institutions is also raising concerns from governments around the world, prompting them to look for ways to regulate this category of digital currency.
But besides the widespread popularity of stable-value coins, they are still at the center of regulators’ attention for other reasons as well:
- Challenging the sovereignty of central banks
For users, central bank digital currencies (CBDCs) may seem very similar to stablecoins.
Both can be a convenient digital payment option. However, some nuances are driving governments around the world to regulate stablecoins.
One is the potential threat to a country’s financial stability. If stablecoins are pegged not to the national currency but, for example, to the U.S. dollar, this can contribute to “dollarisation”. Widespread use of stablecoins pegged to currencies other than their own weakens their country’s monetary policy and potentially leads to profit leakage from the local economy.
To address these problems, countries are looking at CBDCs as a potential solution. CBDCs are digital currencies issued directly by central banks, offering a government-backed alternative to private stablecoins. By creating a regulatory framework for stablecoins, governments aim to mitigate the risks they pose and ensure the health of the financial system.
This risk is also underlined by the IMF, stating that foreign currency stablecoins could also lead to currency substitution if they are used as a store of value and means of payment in countries with weak currencies.
- Taxation issues
The tax treatment of transactions involving stablecoins remains unclear, potentially creating opportunities for tax evasion due to the anonymity some stablecoins offer. Tracking transactions and identifying owners becomes more difficult, hindering tax collection efforts.
- Illicit activities
Regulators are also concerned about the potential misuse of stablecoins for money laundering and terrorist financing. For instance, a UN Office on Drugs and Crime report highlights Tether’s USDT as a popular payment method for criminals in Southeast Asia. Additionally, consumer protection in this evolving space remains a question mark.
- Risks of financial sustainability
Beyond illicit activities, the operational stability of stablecoins raises concerns. Structure flaws could lead to failures that exacerbate financial turmoil. A sudden loss of peg to the dollar or liquidity problems could trigger market panic and disrupt financial stability.
- Lack of transparency of reserves
Compounding these risks is the lack of transparency surrounding some stablecoin reserves. Issuers like Tether have been criticized for not providing sufficient information about how they back their coins. This raises doubts about their ability to maintain the peg, as SEC head Gary Gensler once pointed out by comparing them to casino poker chips.
In addition to the reasons described above, the International Monetary Fund (IMF) identifies the following risks, which entail the proliferation of stablecoins.
How stablecoins are regulated in different countries
The world has yet to develop a clear, unified policy to regulate stablecoins. New rules and restrictions emerge regularly, but some countries are leading the way in establishing frameworks.
United States (US)
US authorities have long been actively working on a legal framework for the cryptocurrency market. In October 2021, they proposed transferring most regulatory power to the Securities and Exchange Commission (SEC). On May 22, 2024, the US House passed the crypto FIT21 bill. The Senate now needs to vote. FIT21 is a bill that aims to clarify the treatment of digital assets under US law.
On May 23rd, 2024, the House of Representatives passed a bill restricting the Federal Reserve from issuing a central bank digital currency (CBDC), also known as the “digital dollar.” However, this is just the first step in a long legislative process. The bill now faces a vote in the Senate, and could potentially be vetoed by the President even if it passes.
Regarding the regulation of stablecoins, work has also been underway since 2022. So in April 2024, Senators Gillibrand and Lummis introduced an updated version of the “Lummis-Gillibrand Payment Stablecoin Act” to “provide for effective regulation of payment stablecoins, and for other purposes.”
The bill, if passed, would require stablecoin issuers to back their tokens with fully reserved assets in cash or cash equivalents. It would also ban algorithmic stablecoins and prohibit issuers and users from using stablecoins for illegal or unauthorized purposes, like money laundering. Issuers must be either non-depository trust companies registered with the Board of Governors of the Federal Reserve System or depository institutions “authorized as an issuer of national payment stablecoins.” These entities would be supervised by both state and federal regulators.
To date, the bill on stablecoins is expected, with negotiations ongoing between key figures. The Senate might include it in a broader package.
European Union (EU)
The EU has been working for several years to tighten oversight of the stablecoin market. They are developing a regulatory framework called MiCA (Markets in Crypto-Assets) with investor protection as a priority.
In 2024, the Council of Europe adopted rules to regulate digital assets, receiving unanimous support from all 27 member countries. The regulation classifies crypto assets into payment tokens, stablecoins pegged to various assets, and others. Each crypto project requires a white paper detailing the terms and conditions, primarily to protect ordinary investors.
The regulation excludes airdrops, utilitarian tokens, NFTs, and loyalty programs (as long as users can’t exchange points).
United Kingdom (UK)
In 2022, the UK government announced its ambition to become a global hub for cryptocurrency technology and investment. This ambition took a step forward in 2023 with the passing of a bill that established cryptocurrencies, including stablecoins, as regulated financial activities. Under this framework, the Bank of England would oversee large, systemically important stablecoin issuers, while the FCA would regulate the broader cryptocurrency market.
Further solidifying its commitment, the UK announced in April 2024 that it would introduce new legislation by June or July 2024 to regulate specific crypto activities, including stablecoin issuance, staking, exchange operations, and custody services.
Switzerland
The Swiss Financial Market Supervisory Authority (FINMA) oversees stablecoin licensing in Switzerland. To qualify for a license, stablecoin projects must meet stringent stability and anti-money laundering (AML) requirements. For instance, all stablecoin holders need to be thoroughly identified by the issuing institution or authorized distributors.
In September 2019, FINMA issued initial guidelines outlining how they would assess stablecoins under Swiss regulations.
The regulatory framework adapts to the type of stablecoin. Depending on the backing assets, the specific requirements may differ. Fiat-backed stablecoins with a fixed redemption value (e.g., 1 token = 1 CHF) are classified as bank deposits. Tokens linked to a basket of assets might be considered collective investment schemes, while those backed by commodities could be classified as securities or derivatives.
Generally, only a prudentially supervised institution, such as a bank or asset manager of collective investment schemes, can issue stablecoins in Switzerland. Notably, algorithmic stablecoins are exempt from licensing due to their inherent risk and the difficulty of applying existing regulations to their mechanisms. However, AML requirements still apply.
Singapore
In August 2023, Singapore’s financial regulator, the Monetary Authority of Singapore (MAS), took a step towards regulating stablecoins. The new framework focuses on single-currency stablecoins (SCS) issued within Singapore, ensuring they’re backed by real assets. These are cryptocurrencies pegged to a stable asset, like the Singapore Dollar or any other G10 currency.
MAS aims to create a bridge between traditional finance and the digital asset world. However, to ensure stability, issuers must hold a minimum capital of $740,000 (SGD 1 million) and guarantee redemption within 5 business days of a request.
This move comes alongside the licensing of the Singapore affiliate of Circle, a major stablecoin issuer. While algorithmic stablecoins, not backed by traditional assets, currently fall outside the licensing requirements, they remain unregulated for now.
Hong Kong
Hong Kong plans to introduce special rules for stablecoins. The Hong Kong Monetary Authority (HKMA) published a draft for public discussion in December 2023.
The rule applies to stablecoins used in Hong Kong or pegged to the Hong Kong dollar. Stablecoins must be fully collateralized and licensed by the HKMA and FSTB (Financial Services and Treasury Board) to operate in Hong Kong. Unlicensed stablecoins can be used, but only by qualified investors. Initially, regulators considered applying electronic money (SVF) regulations to stablecoins but later decided on separate rules.
How stablecoins are currently cooperating with governments in 2024
One of the largest stablecoin issuers, Tether, is seeking to become a trusted partner of US authorities. ProPublica, a public interest outlet, reports Tether has spent around $600,000 lobbying the U.S. Senate and House of Representatives since the beginning of 2022, with a quarterly spend of $120,000. Since December 1, 2023, Tether has taken a proactive stance by implementing a policy of freezing suspicious wallets and cooperating with the US Department of Justice and the Office of Foreign Assets Control (OFAC). Further demonstrating this commitment, the issuer announced in the spring of 2024 that it would block all transactions made in USDT stablecoins by sanctioned individuals and organizations.
In response to a May 13th tweet by Ripple CEO, Tether confirmed its prioritization of OFAC/SDN compliance. He mentioned that the company onboarded the FBI and USSS, participated in 198 law enforcement requests to block wallets (90 with US law enforcement), 339 in the last 3 years (158 with US law enforcement), and more.
Circle CEO Jeremy Allaire, the creator of the USDC stablecoin, a token with a market capitalization of over $32 billion, believes clear enforcement of regulations will benefit cryptocurrency. The company actively engages with major regulatory and legislative entities. Circle has pushed for stablecoin legislation over the past few years. The company spent $400,000 on lobbying efforts to support legislation related to stablecoins, according to the Open Secret data.
Annual lobbying amounts for Circle. Source: Open Secrets
What to expect from regulators in 2024
We have already witnessed significant developments in the regulatory landscape across major fintech hubs. As the regulatory environment solidifies, it will pave the way for two key trends: institutional adoption and end-user-focused applications.
Several major financial centers are implementing new requirements for stablecoin issuers. The European Union’s Markets in Crypto Assets (MiCA) regulation takes effect in July 2024. This comprehensive framework addresses key concerns by mandating adequate reserves, redemption rights for token holders, and secure asset segregation from issuers.
Following suit, Hong Kong is conducting consultations to establish its regulatory framework and is expected to publish guidelines with final rules by mid-year. This will allow stablecoin issuers to operate within a defined regulatory environment.
The UK government is rushing to implement limited stablecoin and staking regulations in late May before a potential election later this year. This limited window highlights the urgency of establishing a clear regulatory framework for crypto assets.
The United States currently faces a wait-and-see approach. While various draft proposals for a national regulatory framework are under consideration, their passage seems unlikely due to the upcoming elections.
Conclusion
Countries around the world are struggling to find a balance between innovation and investor protection. While there is no one-size-fits-all approach globally, several jurisdictions are taking the lead, creating mechanisms focused on transparency, reserve requirements, and licensing. This global push for regulation, coupled with industry collaboration among stablecoin issuers, paves the way for a future where both innovation and investor protection can thrive, ultimately shaping how institutions and consumers interact with crypto assets.
FAQ
What is a stablecoin?
A stablecoin is a type of cryptocurrency designed to maintain a stable value. There are three main types: fiat-backed stablecoins, which are backed by fiat currency like the dollar or euro and are centralized; crypto-backed stablecoins, which are backed by other cryptocurrencies; and algorithmic or non-backed stablecoins, which use algorithms to manage supply and maintain price stability, and are decentralized.
Are stablecoins regulated?
While there isn’t one uniform set of regulations around the world, many jurisdictions are working on creating frameworks that focus on transparency, requiring reserves to be held by stablecoin issuers, and licensing.