Full text of the US SEC stablecoin regulation: What kind of stablecoin is not a security?

Author | SEC Division of Corporation Finance

Compilation | Aki Chen Wu said blockchain

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Introduction

To further clarify the applicability of U.S. federal securities laws in the field of crypto assets [1], the Division of Corporation Finance has issued relevant opinions on specific types of crypto assets (commonly referred to as “stablecoins”) [2]. This statement only pertains to stablecoins that meet the following types:

1. Design a mechanism to ensure it is pegged to the US Dollar (USD) at a 1:1 ratio,

2. Supports redeeming US dollars at a 1:1 ratio (i.e., 1 stablecoin can be exchanged for 1 US dollar),

3. Backed by low-risk and highly liquid reserve assets, its dollar valuation always covers the redemption demand of the circulating stablecoins.

As elaborated later, we refer to such stablecoins covered by this statement as “Covered Stablecoins.”

Overview of Stablecoins

A stablecoin is a type of crypto asset designed to keep its value stable relative to a reference asset, such as the U.S. dollar or other fiat currencies, commodities such as gold, or a basket of assets. Typically, stablecoins track the value of a reference asset at a 1:1 ratio. Stablecoins may maintain their value stability in different ways: in some cases, stablecoins are backed by reserve assets, which use the assets held in the reserves to ensure a 1:1 exchange of the stablecoin with the reference asset; In other cases, stablecoins maintain stability through mechanisms other than reserves, such as relying on algorithms to adjust the supply of stablecoins in response to changes in market demand [3].

Due to the different stable mechanisms and reserve assets (if applicable), the risks faced by stablecoins also vary significantly. Stablecoin issuers typically provide and sell stablecoins at a price equivalent to the reference asset (1:1). For example, when the reference asset is the US dollar, the issuer sells 1 stablecoin for 1 dollar; if it supports trading small fractions, it still corresponds to a 1:1 value (for instance, 0.5 stablecoins correspond to 0.50 dollars). When users redeem, the issuer usually utilizes reserve assets to exchange stablecoins back to the reference asset at a 1:1 ratio.

1. The company’s finance department’s stance on compliant stablecoins [4]

According to the operational model and applicable conditions described in this statement, the company’s financial department believes that the issuance and sale of compliant stablecoins do not constitute the issuance and sale of securities as defined in 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 “minting” (i.e., creation) and redemption of compliant stablecoins do not need to fulfill the relevant transaction registration procedures with the U.S. Securities and Exchange Commission (SEC) according to the Securities Act, nor do they need to apply the exemption provisions regarding registration under the Securities Act.

2. The core characteristics of compliant stablecoins

1. Covered Stablecoins are a class of crypto assets designed to be used for payment settlement, fund transfer, or to store value. These stablecoins are designed to maintain a stable 1:1 rigid peg to the U.S. dollar (USD), ensuring that the issuer can meet redemption obligations as needed by holding sufficient U.S. dollars and other reserve assets that are considered low-risk and highly liquid. [6]

These supporting assets are held in reserve accounts denominated in US dollars, with a total value equal to or exceeding the redemption value of compliant stablecoins in circulation. The issuer of compliant stablecoins can mint and redeem them at a 1:1 ratio with US dollars, without any quantity restrictions. In other words, the issuer is always prepared to mint one stablecoin for 1 US dollar (or the corresponding ratio) and redeem one stablecoin for 1 US dollar (or the corresponding ratio), with no upper limit on the amount minted or redeemed.

Through this fixed price, unlimited minting and redemption mechanism, the market price of compliant stablecoins can maintain a stable peg to the US dollar.

2. Covered Stablecoins are minted by the issuer and issued and sold by the issuer or its designated intermediaries. In some cases, any holder can directly mint and redeem stablecoins with the issuer at a 1:1 ratio to the dollar. 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 case, holders who are not designated intermediaries cannot directly mint or redeem stablecoins from the issuer; their only way to acquire or dispose of stablecoins is through secondary market trading, which may involve transactions with designated intermediaries.

3. Covered Stablecoins may trade at prices in the secondary market that deviate from their redemption price. However, their “fixed price, unlimited minting and redemption” mechanism provides arbitrage opportunities for designated intermediaries or other qualified holders who can directly mint and redeem with the issuer, thereby helping to keep the market price close to the redemption price.

For example, when the market price is higher than the redemption price, such entities can mint stablecoins directly from the issuer at a 1:1 ratio and put them into the market. As the supply increases, the market price typically decreases, approaching the redemption price. Conversely, when the market price is lower than the redemption price, these entities will purchase stablecoins on the secondary market and redeem them directly from the issuer. As the circulating quantity in the market decreases, the price usually rises, again approaching the redemption price.

This statement covers the compliance activities in the stablecoin market [7].

The market positioning of Covered Stablecoins is solely for commercial purposes, that is, as a means of payment, a tool for fund transfer, or a store of value, rather than as an investment product. Market participants often emphasize that compliant stablecoins provide a stable, fast, reliable, and easy-to-use means of payment, currency transfer, and value storage. Additionally, such stablecoins are often likened to the “digital dollar.”

Market participants may also explain that compliant stablecoins have the following characteristics:

1. Designed to be pegged to the value of the US dollar (USD) or to maintain stability (for example: a compliant stablecoin corresponds to one dollar).

2. Does not grant the holder any rights to interest, profits, or other benefits.

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

4. No governance rights are granted to holders over the issuer or the stablecoin itself.

5. The economic benefits or losses of the holders are not affected by the financial performance of the issuer or any third parties.

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

1. Reserve Account

The issuers of Covered Stablecoins will use the proceeds from their sales to purchase specific assets, which are held in a pool of assets known as the “Reserve”. The assets held in the reserve include US dollars (USD) or other assets considered to be low risk and highly liquid, to ensure that the issuer can meet all redemption requests as needed. [8]

Reserve assets are supported at a ratio of no less than 1:1 for the amount of compliant stablecoins in circulation at any time. Reserve assets are used solely for paying redemption requests, although the issuer may earn income from them (such as interest), but:

1. Reserve assets may be sold during the redemption process, but must always be managed separately from the assets of the issuer or any third party and must not be commingled.

2. Reserve assets must not be used for the issuer’s operations or general business purposes.

3. Reserve assets shall not be lent, pledged, or re-pledged.

4. The holding method of reserve assets should ensure that they do not become the subject of third-party claims.

Based on the above arrangement, the issuer shall not use reserve assets for trading, speculation, or investment operations driven by subjective judgment. Although the issuer can decide how to use the income generated from reserve assets (such as interest), such income will not be distributed to holders of compliant stablecoins.

In some cases, the issuer will release a “Proof of Reserves” as an auditing or verification tool to demonstrate that its issued stablecoins are 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 the meaning of “security” by enumerating a variety of financial instruments, including “stock”, “note” and “evidence of indebtedness”. Because Covered Stablecoins have the characteristics of notes or other debt instruments in some respects, we rely on the standard established by the U.S. Supreme Court in Reves v. Ernst & Young. [9] As discussed below, we will also refer to the “Howey Test” established in the U.S. Securities and Exchange Commission v. W.J. Howey & Co. for supplementary analysis. [10]

Reves Case Analysis

In the Reves case, the U.S. Supreme Court held that since “notes” are one of the instruments enumerated in the definition of “securities” in the Securities Act and Exchange Act, all notes should be presumed in principle to constitute securities. [11] However, the presumption can be rebutted by showing that the note bears a high degree of similarity to several notes issued in a typical business transaction, and thus appropriately excludes it from the definition of “security”. [12] This so-called “family similarity test” consists of the following four factors:

1. Analysis of the True Intentions of Trading Related Parties: Examining the motivations that drive rational sellers and buyers to engage in transactions.

2. Circulation of securities: Examine whether the financial instrument belongs to tools used for “general trading for speculation or investment.”

3. Reasonable expectations of the investing public: Examine whether ordinary investors would reasonably expect that the note is a security regulated by federal securities laws.

4. Risk Mitigation Characteristics: Examine whether the securities possess certain characteristics (for example, being subject to other regulatory mechanisms) that significantly reduce the risk of the securities, thereby diminishing the necessity of compliance with the Securities Act and the Exchange Act. [13]

The federal court adopts a comprehensive balancing test when applying the Reves test, where no single factor should be considered in isolation to determine whether a note constitutes a security or non-security. [14]

1. The true intentions of related parties in transactions

If the seller’s purpose is to raise funds for the overall operation of its business or for significant investments, while the buyer is primarily concerned with the expected profits generated by the note, then the note is likely to be considered a security. [15] Conversely, if the purpose of the note exchange is to serve actual business scenarios or consumer use, then the note is less likely to be recognized as a security.

As mentioned earlier, buyers purchase compliant stablecoins due to their stability and their demand as a means of payment or a store of value in commercial transactions. Since compliant stablecoins neither pay nor promise to pay interest, nor do they grant holders any payment or asset rights beyond a 1:1 redemption for US dollars, buyers are not purchasing and holding the stablecoin with profit expectations. [16] The issuer of the compliant stablecoin will use the proceeds from sales to enrich the reserve account, and although they may utilize the income generated from reserves to support their business operations, both their issuance and purchase are primarily for commercial purposes, rather than for investment purposes. [17]

2. Circulation methods of securities

In the Reves case, the U.S. Supreme Court pointed out that this factor lies in examining whether there are “general transactions conducted for speculative or investment purposes.” This factor is met when financial instruments are “offered and sold to the general public,” which is precisely the case for compliant stablecoins. [18]

However, the price stability design of compliant stablecoins helps ensure that their trading in the secondary market 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 will be effectively limited as issuers can redeem on demand and mint or redeem at a 1:1 ratio with the US dollar at any time.

3. Reasonable expectations of the investing public

This factor aims to examine the marketing and selling methods of relevant financial instruments. In the Reves case, the court clearly stated: “The advertisement for the notes in this case describes them as ‘investments’, … and there are no countervailing factors sufficient to cause a reasonable public to question that description.”[19]

As mentioned earlier, Covered Stablecoins are not promoted as investment instruments. Instead, they are marketed as a stable, fast, reliable, and easily accessible means of value transfer or storage, rather than emphasizing potential profits or investment returns. Therefore, from the perspective of the investing public, it would not be reasonable to expect that such stablecoins fall under the category of investment instruments regulated by securities laws.

4. Risk Mitigation Features

In the Reves precedent, this factor focuses on risk mitigation features such as whether the note is collateralized, insured, or subject to other regulatory mechanisms that “significantly reduce the risk of the financial instrument so that the application of securities law is no longer necessary.” [20] The issuer of an asset-backed stablecoin maintains a reserve mechanism designed to fully meet redemption obligations, [21] The reserve is made up of U.S. dollars and/or other assets deemed low-risk, highly liquid to ensure that the issuer can fulfill all redemption requests at any time.

Therefore, based on a comprehensive assessment of various factors, this department believes that asset-backed stablecoins do not constitute securities under the Reves case standard for the following reasons:

1. The issuer will use the proceeds from the sale to establish a reserve account, and the buyer’s motivation for purchase does not stem from expectations of financial returns;

2. The distribution method of asset-backed stablecoins does not encourage speculative or investment trading activities;

3. Rational buyers should not reasonably expect that such stablecoins are investment instruments;

4. Continuously providing sufficient reserves that can be used at any time to fulfill redemption obligations constitutes a substantial risk mitigation mechanism.

In short, the issuance and sale of asset-backed stablecoins is intended for commercial or consumer purposes, rather than for raising investments.

Howey Analysis

If asset-backed stablecoins are not considered notes or other debt instruments, and do not fall under the other financial instruments explicitly listed in Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act, their issuance and sale must be further analyzed according to the “investment contract” standard, namely the Howey Test. This test centers on “economic reality” and is used to assess whether arrangements or instruments not included in the aforementioned provisions constitute securities. [22]

When analyzing the economic substance of a transaction, the Howey test focuses on the following elements: whether there is an investment of money in a common enterprise and whether the investor has a reasonable expectation of profits to be derived from the efforts of others (usually the project party). Since the Howey case, the Supreme Court has distinguished between the investor’s motivation (i.e., being attracted by the “prospect of return on investment” [23]) and the consumer’s motivation (i.e., for the purpose of “using or consuming the purchased subject”). Federal securities laws only apply to transactions involving investment activities, not to consumer transactions. [24]

As mentioned earlier, buyers of asset-backed stablecoins do not purchase such stablecoins based on the profit expectations that may arise from the entrepreneurial or management activities of others. This tool has not been marketed in the market as an investment product, nor has it emphasized any profit potential. [25] On the contrary, the motivation for buyers to purchase asset-backed stablecoins is to use them as “digital dollars” for payment or storage, with their behavior resembling 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 classified as securities under the securities law.

For further information, please submit an online request form through the following website to contact the office of the Chief Legal Counsel of this department:

[26] For the purposes of this Notice, “crypto asset” means assets generated, issued, and/or transferred through blockchain or similar distributed ledger technology networks, including, but not limited to, assets known as “tokens”, “digital assets”, “virtual currencies” and “coins”. and relies on cryptography protocols to achieve its functionality. In addition, the term “issuer” in this statement includes the issuer itself and its affiliates.

[27] This statement represents the views of the staff of the Division of Corporation Finance of the SEC. The statement does not constitute rules, regulations, guidance, or formal statements of the U.S. Securities and Exchange Commission (referred to as the “Commission”), and the Commission has not approved or disapproved its contents. As with all staff statements, this statement is not legally binding **: it does not alter or amend existing law, nor does it create new legal obligations for any party.

Unlike reserve-backed stablecoins, algorithmic stablecoins typically rely on specific algorithmic mechanisms to maintain price stability rather than being supported by real assets as reserves.

[1] This department only expresses views on the compliant stablecoins mentioned in this statement. No comments are made on other types of stablecoins, including but not limited to the following categories:

1. Stablecoins aimed at pegging the value of non-US dollar reference assets (such as non-US dollar fiat currencies, commodities, other crypto assets, etc.).

2. Use other stabilization mechanisms (such as algorithmic mechanisms) to achieve value-pegged stablecoins.

3. Although it is pegged to the value of the US dollar, it is not a stablecoin that redeems for US dollars.

4. Stablecoins that have a yield nature (commonly referred to as “yield-bearing stablecoins”), including stablecoins that provide holders with returns, interest, or other passive income, regardless of whether such returns are in the form of periodic payments, reward mechanisms, or achieved through a “re-basing” mechanism, which is a mechanism that automatically adjusts the total supply of the stablecoin.

[2] The views of this department do not have decisive effect and cannot ultimately determine whether a certain stablecoin (including asset-backed stablecoins) constitutes a security. The determination of whether a stablecoin is a security needs to be based 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 certain stablecoin differs from what is described in this statement, then the department’s determination of whether it constitutes a security may also differ.

[3] Examples of such low-risk and highly liquid assets include: US dollar cash equivalents, demand deposits at banks or other financial institutions, US Treasury securities, and money market funds registered under Section 8(a) of the Investment Company Act of 1940. Precious metals or other crypto assets are not included.

[4] As described in the “Legal Analysis” section below, when determining whether the issuer or promoter has engaged in the issuance or sale of securities, federal courts will review the marketing methods used.

[5] Certain asset-backed stablecoin issuers may be subject to state law regulations, and relevant state regulations may specify the types of assets permitted to be held in reserves.

[6] Reves v. Ernst & Young, 494 U.S. 56 (1990). The federal courts apply the standard established in the Reves case, analyzing not only “notes” but also other financial instruments with debt characteristics. See, for example, In re Tucker Freight Lines, Inc., 789 F. Supp. 884, 885 (W.D. Mich. 1991) (the court found that “the approach in Reves applies to all debt instruments, including debt certificates”). Since the issuer of asset-backed stablecoins bears the obligation to fulfill redemption, stablecoins can be regarded as a debt of the issuer. Although asset-backed stablecoins do not possess all the characteristics of typical notes (e.g., no fixed term, no agreed interest payments, etc.), this department still wishes to clarify that even if asset-backed stablecoins are identified as notes or debt certificates, their issuance and sale do not constitute the issuance and sale of securities, according to the department’s view.

[7] SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In cases where facts require, federal courts typically apply both the Reves and Howey tests simultaneously. For example, in the case of Banco Espanol de Credito v. Security Pacific Nat’l Bank, 763 F. Supp. 36 (2nd Cir. 1991), the court assessed the loan participations involved by applying both the Reves and Howey tests.

[8] Reves, 494 U.S. Pages 64–66.

[9] Same as above, page 65. The notes excluded from the definition of “securities” include:

(1) Notes related to consumer financing;

(2) Notes secured by mortgage on housing;

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

(4) Notes for “credit loans” (character loan) for bank customers;

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

(6) Notes used to standardize the recording of book debts arising from commercial transactions.

(7) The loan notes provided by commercial banks for the daily operations of enterprises. [10] Same as above, pages 66-67.

[11] See, for example: SEC v. J.T. Wallenbrock & Associates, 313 F.3d 532, 537 (9th Cir. 2002): “Failure to satisfy one of the factors is not dispositive; all four factors should be considered as a whole.”

[12] Reves Page 60; Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 812 (Second Circuit Court of Appeals, 1994).

[13] In relevant circumstances, we believe that greater weight should be given to the buyer’s motivation. See, for example, the Pollack case, page 813 (the court held that, in circumstances including the buyer “seeking to put funds into safe, conservative investments,” the notes should still be classified as securities, even if the seller’s motivation differs).

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

[15] Reves, 494 U.S. Page 68.

[16] Same as above, pages 68-69.

[17] Id. at Pg. 61. In the Reves case, the court held that there was no risk mitigation factor because the notes were “unsecured and uninsured” and noted that “if the Securities Act and Exchange Act do not apply, the notes would be completely free from the federal regulatory system” (p. 69). See also Pollack, 27 F.3d, p. 814 (noting in the analysis of Reves Factor 4 that “the amended complaint explicitly alleges that the share of the mortgage interest in question is ‘unsecured’ and ‘unsecured.’”).