There have been a number of developments swirling around stablecoins over the past month, including, earlier this week, the recent introduction in the US Senate of a invoice (the “Responsible Financial Innovation Act”) which would establish a regulatory framework for digital assets and enact certain requirements and consumer protections regarding stablecoins. The topic of the usefulness and risk of stablecoins has been in the headlines and on the minds of state and federal lawmakers and financial regulators. In a timely move, the New York Department of Financial Services (NYDFS), published his “Tips on Issuing US Dollar-Backed Stablecoinsintended to establish fundamental criteria for USD-backed stablecoins issued by DFS-regulated entities on issues of redeemability, asset reserves and certifications regarding such reserves. The NYDFS is the first state regulator to issue such guidelines. With the fate of congressional action on stablecoins this year uncertain (and equally uncertain whether federal agencies or banking regulators will step in to offer some guardrails), it will likely be up to the states (and the industry itself). itself) to establish certain baselines that offer consumer protection and stability without hindering innovation. Given NYDFS’ experience in the virtual currency space and its importance, its latest guidance may have influence on other regulators across the country.
Stablecoins are digital assets designed to maintain stable value by pegging the digital asset to a national currency or other reference asset (i.e. a commodity like gold or silver). By using benchmark assets to stabilize price, stablecoins seek to become a less volatile payment mechanism for bitcoin and other cryptocurrencies, and have also been used to facilitate trading and lending of other assets. in many decentralized financial (DeFi) transactions. Algorithmic stablecoins, on the other hand, typically use an algorithm or smart contract to manage the supply of tokens and steer their value towards a reference asset (e.g. US Dollar); these stablecoins generally do not attempt to gain value by holding fiat reserves that approximate a value in a 1:1 relationship to the value of the stablecoin. Proponents note that a well-designed stablecoin can enable faster and more efficient payment options for a multitude of customers; however, regulators, such as the Federal Financial Stability Supervisory Board, have previously warned that these digital assets pose potential systemic risk due to the lack of consistent stablecoin risk management standards and their operational complexity.
NYDFS is no stranger to regulating the virtual currency industry. In 2015 he released his final BitLicense Rulesbecoming the first state to enact a comprehensive regulatory framework for virtual currency-related businesses. Since 2018, NYDFS has also imposed requirements and controls on stablecoins issued by its regulated entities. As noted in the guidelines, the agency carefully reviews a company’s product offerings (including all stablecoin-related products) when evaluating a BitLicense application, and going forward, BitLicenses and New York State Limited Purpose Trust Companies that engage in virtual currency business must obtain written approval from DFS before introducing any materially new product, service or activity (including issuance of stablecoins).
Specifically, NYDFS issued these guidelines to “outline certain requirements that will generally apply to U.S. dollar-backed stablecoins that are issued under the oversight of DFS.” [For further insight, see an interview with NYDFS Superintendent Adrienne Harris about the new stablecoin guidance]. The main issues covered by the guidelines are backing and redeemability, requirements for asset reserves and certifications regarding the backing of these reserves:
- Guarantee and Refund: According to the guidelines, a stablecoin must be “fully backed” by a reserve of assets (as opposed to algorithmic stablecoins not fully backed by fiat reserves), such that the “market value of the reserve is at least equal to the value nominal value of all outstanding units of the stablecoin at the end of each business day.He goes on to state that the stablecoin issuer must adopt “clear and visible redemption policies, approved in advance by DFS in writing”, which allow holders the right to redeem stablecoin tokens from the issuer (as opposed to a third-party intermediary) “in a timely manner at par for the US dollar,” less any applicable fees. The guidelines include model language for customer terms, including a definition of refund and what “timely” means in normal and extraordinary circumstances.
- Reservations: The guidelines require that reserve assets be segregated from the issuer’s proprietary tokens and held at a chartered institution. It also requires that the reserve consist only of certain types of assets, including cash held in U.S. deposit accounts, U.S. Treasury bills maturing within three months, and certain other listed Treasury bills. Notably, the guidelines do not list commercial paper among permitted reserves.
- Certificate: The guidelines require, among other things, that the reserve be subject to a review of management assertions at least once a month by an independent public accountant (“CPA”) applying the certification standards of the American Institute of Certified Public Accountants (“AICPA”). , and also submit an annual attestation report to NYDFS.
Finally, the guidelines state that the above are not the only regulatory requirements placed on the issuance of stablecoins and that NYDFS will consider a range of other risks before allowing a regulated virtual currency entity to issue a coin. stable, including risks related to cybersecurity and network design and AML compliance, among others. Additionally, NYDFS notes that the guidelines do not apply to USD-backed stablecoins listed, but not issued, by exchanges regulated by DFS.