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

Author: SEC Corporate Finance Division

Compiled by: Aki Chen Wu said blockchain

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 provided relevant opinions on certain types of crypto assets (commonly referred to as "stablecoins") [2]. This statement only applies to stablecoins that meet the following types:

The design mechanism ensures a 1:1 peg with the US dollar (USD),

Support redemption of US dollars at a 1:1 ratio (i.e., 1 stablecoin can be exchanged for 1 US dollar),

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

As elaborated in the following text, we refer to such stablecoins covered by this statement as "Covered Stablecoins."

Overview of Stablecoins

Stablecoins are a type of cryptocurrency designed to maintain their value relative to a reference asset (such as the US dollar or other fiat currencies, gold, or a basket of assets). Generally speaking, stablecoins track the value of the reference asset on a 1:1 basis. Stablecoins may use different methods to maintain their value stability: in some cases, stablecoins are backed by reserve assets, using the assets held in reserve to ensure a 1:1 exchange 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 based on changes in market demand [3].

Due to the differences in stabilization 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 supporting the trading of small fractions, it still corresponds to a 1:1 value (for example, 0.5 stablecoins correspond to 0.50 dollars). When users redeem, the issuer typically utilizes reserve assets to exchange stablecoins back to the reference asset at a 1:1 ratio.

1. The position of the company's finance department on compliant stablecoins [4]

According to the operational model and applicable conditions described in this statement, the company's finance 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 Exchange Act [5].

Therefore, relevant parties participating in the "minting" (i.e., creation) of compliant stablecoins and the redemption of compliant stablecoins do not need to fulfill the relevant transaction registration procedures with the U.S. Securities and Exchange Commission (SEC) in accordance with the Securities Act, nor do they need to apply the exemption clauses regarding registration under the Securities Act.

2. The core features of compliant stablecoins

Covered Stablecoins are a type of crypto asset designed to serve as a payment settlement, fund transfer tool, or to meet storage needs. These stablecoins are designed to maintain a stable 1:1 rigid peg with the US Dollar (USD) by holding sufficient US Dollars and other assets considered low risk and highly liquid, ensuring that the issuer can meet redemption obligations on demand. [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 the circulating compliant stablecoins. The issuers of compliant stablecoins can mint and redeem them at a 1:1 ratio with US dollars, with no limits on the quantity. In other words, the issuer is always prepared to mint one stablecoin for 1 US dollar (or the equivalent proportion) and to redeem one stablecoin for 1 US dollar (or the equivalent proportion), with no upper limit on the quantities 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.

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 equivalent to the US 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 transactions, which may include transactions with designated intermediaries.

Covered Stablecoins may experience a divergence in trading prices from their redemption prices in the secondary market. However, their mechanism of "fixed price, unlimited minting and redemption" provides arbitrage opportunities for designated intermediary institutions or other qualified holders who can directly mint and redeem with the issuer, thereby helping to keep market prices 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 typically rises, again approaching the redemption price.

The compliance stablecoin market activities covered by this statement [7]

Covered Stablecoins are positioned in the market solely for commercial purposes, namely as a means of payment, a tool for fund transfer, or a store of value, and not as investment products. Market participants typically emphasize that Covered Stablecoins provide a stable, fast, reliable, and easy-to-use means of payment, currency transfer, and value storage. Furthermore, such stablecoins are often compared to a "digital dollar."

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

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).

No rights to any interest, profits, or other benefits are granted to the holder.

does not represent any investment or other ownership interests in the issuer or any third party.

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

The economic benefits or losses of the holder are not affected by the financial performance of the issuer or any third party.

As described below, we believe that the stablecoins launched 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 called a Reserve. The assets held in the reserve include US dollars (USD) or other assets deemed low-risk and highly liquid, to ensure that the issuer can meet all redemption requests as needed. [8]

Reserve assets are at all times backed by a ratio of no less than 1:1 for the quantity of compliant stablecoins in circulation. Reserve assets are only used to pay redemption requests, although the issuer may derive profits from them (such as interest), but:

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

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

Reserve assets must not be lent, pledged, or re-pledged.

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

Based on the above arrangements, the issuer shall not use reserve assets for trading, speculation, or investment operations driven by subjective judgment. Although the issuer may 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 a means of auditing or verification to prove that the stablecoins issued are backed by sufficient reserve assets.

2. Legal Qualitative Analysis

Sections 2(a)(1) of the Securities Act and 3(a)(10) of the Exchange Act define the meaning of "security" by enumerating various financial instruments, including "stock," "note," and "evidence of indebtedness." Since Covered Stablecoins exhibit characteristics of notes or other debt instruments in certain aspects, we analyze them based on the criteria 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 SEC v. W.J. Howey Co. for supplementary analysis. [10]

Reves Case Analysis

In the case of Reves, the United States Supreme Court held that since "notes" are one of the instruments listed in the definition of "securities" under the Securities Act and the Exchange Act, all notes should be presumed to constitute securities in principle. [11] However, this presumption can be rebutted by proving that the note has a high degree of similarity to several notes issued in typical commercial transactions, thereby appropriately excluding it from the definition of "securities." [12] The so-called "family resemblance test" includes the following four factors:

Analysis of the True Intentions of Related Parties in Transactions: Examining the Motivations that Drive Rational Sellers and Buyers to Engage in Transactions.

The circulation method of securities: examining whether the financial instrument belongs to tools used for "general trading for speculation or investment."

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

Risk mitigation characteristics: Examining whether the notes possess certain features (for example, being subject to other regulatory mechanisms), thereby significantly reducing the risk of the notes and decreasing the necessity to comply with the Securities Act and the Exchange Act. [13]

The federal court adopts a balanced test with a comprehensive consideration when applying the Reves test, and each factor should not be considered in isolation to determine whether a note constitutes a security or non-security. [14]

1. The true intentions of related parties in the transaction

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, 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 uses, then the note is less likely to be recognized as a security.

As mentioned earlier, buyers of compliant stablecoins are motivated by their stability and the demand for them 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 USD, buyers do not purchase and hold these stablecoins with profit expectations. [16] The issuers of compliant stablecoins will use the proceeds from sales to bolster their reserve accounts, and while they may utilize the earnings generated from reserves to support their business operations, both their issuance and purchase are primarily for commercial purposes, rather than investment purposes. [17]

2. The circulation method of securities

In the Reves case, the U.S. Supreme Court pointed out that this factor lies in examining whether there is "a general trading for speculative or investment purposes." When financial instruments are "offered and sold to a broad public," this factor is met, and compliant stablecoins meet this condition. [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 because the issuer 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 sales methods of relevant financial instruments. In the Reves case, the court clearly stated: "The advertisements for the notes in this case describe them as 'investments', ... and there are no countervailing factors sufficient to make a reasonable public question that statement." [19]

As mentioned earlier, Covered Stablecoins are not marketed as investment instruments. Instead, they are promoted 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 are investment instruments regulated by securities laws.

4. Risk Mitigation Features

In the Reves case, the risk mitigation characteristics considered by this factor include: whether the notes have collateral support, whether they are insured, or whether they are subject to other regulatory mechanisms, thereby "significantly reducing the risk of the financial instrument, making the application of securities law unnecessary." [20] The issuer of asset-backed stablecoins maintains a reserve mechanism designed to fully meet redemption obligations, [21] with the reserves consisting of US dollars and/or other assets considered low-risk and highly liquid, to ensure that the issuer can fulfill all redemption requests at any time.

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

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;

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

Rational buyers will not reasonably expect that such stablecoins are investment tools;

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 are intended for commercial or consumer purposes, rather than for raising investment.

Howey Analysis

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

In analysing the economic substance of a transaction, the Howey test focuses on the following factors: whether there is a capital investment in a common enterprise, and whether the investor is based on a reasonable expectation of profits, which will come from the entrepreneurial or managerial efforts of others, usually the project party. Since [23], the Supreme Court has distinguished between the motive of an investor (i.e. being attracted by the prospect of a return on investment [24]) and the motive of a consumer (i.e. for the purpose of "using or consuming the object purchased"). [25] The federal securities laws apply only to transactions in the conduct of investments and not to consumer transactions. [26]

As mentioned earlier, the 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 promoted in the market as an investment product, nor has it emphasized any potential for profit. [27] On the contrary, the motivation for buyers to purchase asset-backed stablecoins is to use them as a "digital dollar" for payment or storage purposes, and their behavior is similar to 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 Act.

For further information, please submit an online request form through the following website to contact the Chief Legal Counsel's Office.

[1] In this statement, "crypto asset" refers to 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 rely on cryptographic protocols to achieve their functions. In addition, the term "issuer" in this statement includes the issuer itself and its affiliates.

[2] This statement represents the views of the staff of the Division of Corporation Finance of the SEC. This statement does not constitute rules, regulations, guidance, or formal statements of the U.S. Securities and Exchange Commission (referred to as the "Commission"), nor has the Commission approved or disapproved its content. Like all staff statements, this statement is not legally binding **: it does not change or revise existing law, nor does it create new legal obligations for any party.

[3] 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.

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

Stablecoins designed to anchor the value of non-US dollar reference assets (such as non-US dollar fiat currencies, commodities, other crypto assets, etc.).

Stablecoins that achieve value anchoring through other stability mechanisms (such as algorithmic mechanisms).

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

and stablecoins with yield characteristics (commonly referred to as "yield-bearing stablecoins"), including stablecoins that provide holders with yields, interest, or other passive income, regardless of whether such yield takes the form of periodic payments, reward mechanisms, or is achieved through a "re-basing" mechanism, which is a mechanism that automatically adjusts the total supply of the stablecoin.

[5] The views of this department are not conclusive and cannot ultimately determine whether a particular stablecoin (including asset-backed stablecoins) constitutes a security. The determination of whether a stablecoin is a security must 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 circumstances of a particular stablecoin differ from those described in this statement, the department's determination of whether it constitutes a security may also differ.

[6] 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 cryptocurrencies are not included.

[7] As stated in the "Legal Analysis" section below, in determining whether an issuer or promoter has engaged in the issuance or sale of securities, federal courts will examine the marketing methods used.

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

[9] Reves v. Ernst & Young， 494 U.S. 56 （1990）。 The Federal Court applied the standard established in Reves, not only to the analysis of "notes" but also to other financial instruments with a debt character. See, for example, In re Tucker Freight Lines, Inc., 789 F. Supp. 884, 885 (W.D. Mich. 1991) (the court held that "the approach in Reves applies to all debt instruments, including debentures"). Since the issuer of the asset-backed stablecoin is obligated to fulfill the redemption obligation, the stablecoin can be considered a debt of the issuer. Although asset-backed stablecoins do not have all the characteristics of a typical note (e.g., no definite term, no agreed interest payment, etc.), the Department would like to make it clear that even if the asset-backed stablecoin is recognized as a note or a debt certificate, its issuance and sale does not constitute the issuance and sale of securities, which is the Department's view.

[10] SEC v. W.J. Howey Co., 328 U.S. 293 (1946). In cases where the 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 applied both the Reves and Howey tests to evaluate the loan participations involved.

[11] Reves, 494 U.S. Pages 64–66.

[12] Same as above, page 65. The notes excluded from the definition of "securities" include:

(1) Notes related to consumer financing;

(2) Notes secured by a mortgage on housing;

(3) Short-term notes secured by small businesses 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. [13] Same as above, pages 66-67.

[14] See, for example: SEC v. J.T. Wallenbrock & Associates, 313 F.3d 532, 537 (9th Cir. 2002): "The failure to meet one factor is not dispositive; all four factors should be considered as a whole."

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

[16] In relevant circumstances, we believe that the buyer's motive should be given greater weight. See, for example, the Pollack case, page 813 (the court found that in circumstances including the buyer "seeking to invest funds in safe, conservative investments," the notes should still be recognized as securities, even if the seller's motives are different).

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

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

[19] Same as above, pages 68–69.

[20] Same as above, page 61. In the Reves case, the court found that there were no risk mitigation factors because the notes were "unsecured and uncollateralized," and pointed out that "if the Securities Act and the Exchange Act do not apply, these notes will be completely outside the federal regulatory scheme" (page 69). See also Pollack, 27 F.3d at 814 (noting in the analysis of the fourth factor of Reves that "the amended complaint clearly states that the mortgage interests involved are 'unsecured' and 'uncollateralized' ").