Full text of the U.S. SEC stablecoin regulation: What kind of stablecoin is not a security?

Original Title: “Statement on Stablecoins”

Author: Division of Corporation Finance, U.S. Securities and Exchange Commission

Compiled by: Aki Chen, Wu Says Blockchain

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 specific types of crypto assets (commonly referred to as "stablecoins") [2]. This statement only addresses stablecoins that meet the following criteria:

1. Designed to ensure a 1:1 peg to the U.S. dollar (USD),
2. Supported by a 1:1 redeemability for USD (i.e., 1 stablecoin can be exchanged for 1 dollar),
3. Backed by low-risk and highly liquid reserve assets, with the dollar valuation always covering the redemption demand for the circulating stablecoins.

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

Overview of Stablecoins

Stablecoins are a type of crypto asset designed to maintain a stable value relative to a reference asset (such as the U.S. dollar or other fiat currencies, gold, or a basket of assets). Generally, stablecoins track the value of the reference asset at a 1:1 ratio. Stablecoins may employ different methods to maintain their value stability: in some cases, stablecoins are backed by reserve assets 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 market demand [3].

Given 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 U.S. dollar, the issuer sells 1 stablecoin for 1 dollar; if fractional amounts are supported, the value remains at 1:1 (e.g., 0.5 stablecoins correspond to 0.50 dollars). When users redeem, issuers typically utilize reserve assets to exchange stablecoins back to the reference asset at a 1:1 ratio.

1) Position of the Division of Corporation Finance on Covered Stablecoins [4]

Based on the operational model and applicable conditions described in this statement, the Division of Corporation Finance believes that the issuance and sale of Covered 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 of 1934 [5].

Therefore, relevant parties participating in the "minting" (i.e., creation) and redemption of Covered Stablecoins do not need to comply with the registration requirements of the Securities Act with the U.S. Securities and Exchange Commission (SEC), nor do they need to apply the exemptions under the Securities Act regarding registration.

2) Core Characteristics of Covered Stablecoins

1. Covered Stablecoins are a type of crypto asset intended for payment settlement, funds transfer, or to meet storage needs. These stablecoins are designed to maintain a rigid 1:1 peg to the U.S. dollar (USD) by holding sufficient U.S. dollars and other assets deemed low-risk and highly liquid, ensuring that the issuer can fulfill redemption obligations on demand.[6]

These supporting assets are held in reserve accounts valued in U.S. dollars, with a total value equal to or exceeding the redemption value of the circulating Covered Stablecoins. The issuer of Covered Stablecoins can mint and redeem them at a 1:1 ratio with the U.S. dollar, without quantity limitations. In other words, the issuer is always prepared to mint one stablecoin for 1 dollar (or the corresponding ratio) and redeem one stablecoin for 1 dollar (or the corresponding ratio), with no upper limit on the quantities minted or redeemed.

Through this fixed price, unlimited minting and redemption mechanism, the market price of Covered Stablecoins can maintain a stable peg to the U.S. 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 may directly mint and redeem stablecoins with the issuer at a 1:1 ratio equivalent to the U.S. 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 with the issuer; their only means of acquiring or disposing of stablecoins is through secondary market transactions, which may include trades with designated intermediaries.

3. The trading price of Covered Stablecoins in the secondary market may 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, helping to keep the market price close to the redemption price.

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

Market Activities Covered by This Statement Regarding Covered Stablecoins [7]

The market positioning of Covered Stablecoins is solely for commercial purposes, i.e., as a means of payment, funds transfer, or storage, 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. Additionally, such stablecoins are often likened to "digital dollars."

Market participants may also explain that Covered Stablecoins have the following characteristics:

1. Designed to be equivalent to or stable against the U.S. dollar (USD) (e.g., one Covered Stablecoin corresponds to one dollar).
2. Do not confer any rights to interest, profits, or other returns to holders.
3. Do not represent an investment or other ownership interest in the issuer or any third party.
4. Do not confer any governance rights over the issuer or the stablecoin itself to holders.
5. The economic interests or losses of holders are not affected by the financial performance of the issuer or any third party.

As described below, we believe that stablecoins launched in the following ways indicate that Covered Stablecoins are not issued or sold as securities.

1) Reserve Accounts

The issuer of Covered Stablecoins will use the proceeds from their sales to purchase specific assets, which are held in a pool of assets referred to as a "Reserve." The assets held in reserve include U.S. dollars (USD) or other assets deemed low-risk and highly liquid, ensuring that the issuer can fulfill all redemption requests on demand.[8]

The reserve assets at any time support the number of circulating Covered Stablecoins at a ratio of no less than 1:1. Reserve assets are only used to pay redemption requests; although the issuer may earn income from them (such as interest), the following conditions apply:

1. Reserve assets may be sold during the redemption process but must always be managed separately from the issuer's or any third party's other assets.
2. Reserve assets may not be used for the issuer's operations or general business purposes.
3. Reserve assets may not be loaned, pledged, or re-pledged.
4. The manner of holding reserve assets should ensure that they do not become subject to claims by third parties.

Based on the above arrangements, the issuer may 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 Covered Stablecoins.

In some cases, the issuer may publish "Proof of Reserves" as an auditing or verification means to demonstrate that the issued stablecoins are supported 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 "securities" by enumerating various financial instruments, including "stocks," "notes," 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 Reves case, the U.S. Supreme Court held that since "notes" are one of the instruments listed in the definitions of "securities" in the Securities Act and the Exchange Act, all notes are generally presumed to be securities [11]. However, this presumption can be rebutted by demonstrating that the note is highly similar to several notes issued in typical commercial transactions, thereby appropriately excluding it from the definition of "security" [12]. This so-called "family resemblance test" includes the following four factors:

1. Analysis of the true intent of the parties involved in the transaction: examining the motivations that lead rational sellers and buyers to engage in the transaction.
2. The manner of circulation of the security: examining whether the financial instrument is used for "general trading for speculative or investment purposes."
3. The reasonable expectations of the investing public: examining whether ordinary investors would reasonably expect the note to be a security regulated by federal securities laws.
4. Risk mitigation characteristics: examining whether the note possesses certain characteristics (e.g., being subject to other regulatory mechanisms) that significantly reduce the risk of the note, thereby diminishing the necessity for the application of the Securities Act and the Exchange Act [13].

Federal courts apply a balanced test when applying the Reves test, and each factor should not be considered in isolation to determine whether the note constitutes a security or not [14].

1) True Intent of the Transaction Parties

If the seller's purpose is to raise funds for the overall operation of their business or significant investments, while the buyer primarily focuses on the expected profits from the note, then the note is likely to be viewed as a security [15]. Conversely, if the purpose of the note exchange is to serve actual commercial scenarios or consumer uses, then the note is less likely to be classified as a security.

As previously mentioned, buyers of Covered Stablecoins purchase them due to their stability and their use as a means of payment or value storage in commercial transactions. Since Covered Stablecoins neither pay nor promise to pay interest, nor confer any payment or asset rights other than redeeming for USD at a 1:1 ratio, buyers are not purchasing and holding the stablecoins with profit expectations [16]. The issuer of Covered Stablecoins uses the proceeds from sales to bolster the reserve account, and while they may utilize the income generated from the reserves to support their business operations, both the issuance and purchase are primarily for commercial purposes, not investment purposes [17].

2) Manner of Circulation of the Security

In the Reves case, the U.S. Supreme Court noted that this factor examines whether there is "general trading for speculative or investment purposes." When a financial instrument is "issued and sold to the general public," this factor is satisfied, and Covered Stablecoins meet this condition [18].

However, the price-stable design of Covered 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 their market price deviates from the redemption price, such opportunities will be effectively limited due to the issuer's ability to redeem on demand and mint at a 1:1 ratio with the U.S. dollar at any time.

3) Reasonable Expectations of the Investing Public

This factor aims to examine the marketing and sales methods of the relevant financial instruments. In the Reves case, the court explicitly stated: "The advertising of the notes in this case describes them as 'investments,'… and there are no countervailing factors sufficient to cause a reasonable public to question that characterization." [19]

As previously stated, 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 Characteristics

In the Reves case, this factor focuses on risk mitigation characteristics, including whether the notes are supported by collateral, insured, or subject to other regulatory mechanisms, thereby "significantly reducing the risk of the financial instrument, making the application of securities laws unnecessary" [20]. The issuer of asset-backed stablecoins maintains a reserve mechanism designed to fully meet redemption obligations [21], with the reserve consisting of U.S. dollars and/or other assets deemed low-risk and highly liquid, ensuring that the issuer can fulfill all redemption requests at any time.

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

1. The issuer uses the proceeds from sales 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 behavior;
3. A rational buyer would not reasonably expect such stablecoins to be investment instruments;
4. The continuous provision of sufficient reserves, readily available to fulfill redemption obligations, constitutes a substantial risk mitigation mechanism.

In summary, the issuance and sale of asset-backed stablecoins are intended for commercial or consumer purposes, not for raising investments.

Howey Test Analysis

If asset-backed stablecoins are not viewed as 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, further analysis of their issuance and sale must be conducted based on the "investment contract" standard, i.e., the Howey Test. This test focuses on "economic substance" to assess whether arrangements or instruments not listed 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 is led to expect profits primarily from the efforts of others (typically the promoters) [23]. Since the Howey case, the Supreme Court has distinguished between the motivations of investors (i.e., being attracted by the "prospect of investment returns" [24]) and those of consumers (i.e., for the purpose of "using or consuming the purchased item") [25]. Federal securities laws apply only to transactions involving investment behavior, not to consumer transactions [26].

As previously mentioned, buyers of asset-backed stablecoins do not purchase these stablecoins based on expectations of profits from the entrepreneurial or managerial efforts of others. The instrument is not marketed in the market as an investment product, nor does it emphasize any profit potential [27]. Instead, buyers purchase asset-backed stablecoins to use them as "digital dollars" for payment or storage, similar to using U.S. 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 URL to contact the Office of the Chief Counsel of this department:

https://www.sec.gov/forms/corpfininterpretive

[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 referred to as "tokens," "digital assets," "virtual currencies," and "coins," and relies on cryptographic protocols to function. Additionally, the term "issuer" refers to the issuer itself and its affiliates.

[2] This statement represents the views of the staff of the Division of Corporation Finance of the U.S. Securities and Exchange Commission (hereinafter referred to as "this department"). This statement does not constitute rules, regulations, guidance, or formal statements of the U.S. Securities and Exchange Commission (hereinafter referred to as "the Commission"), nor has the Commission approved or disapproved its content. Like all staff statements, this statement does not have legal effect: it does not change or amend existing law, nor does it impose new legal obligations on 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.

[4] This department only expresses views on Covered Stablecoins as described in this statement. This statement does not comment on other types of stablecoins, including but not limited to the following categories:

1. Stablecoins intended to peg the value of non-U.S. dollar reference assets (such as non-U.S. fiat currencies, commodities, or other crypto assets).
2. Stablecoins that achieve value pegging using other stabilization mechanisms (such as algorithmic mechanisms).
3. Stablecoins that, while pegged to the U.S. dollar, do not redeem for U.S. dollars upon redemption.
4. And stablecoins with yield characteristics (i.e., so-called "yield-bearing stablecoins"), including those that provide holders with yields, interest, or other passive income, regardless of whether such income is in the form of periodic payments, reward mechanisms, or achieved through "re-basing," which is a mechanism that automatically adjusts the total supply of stablecoins.

[5] The views of this department do not have decisive effect and cannot ultimately determine whether a stablecoin (including asset-backed stablecoins) constitutes a security. The determination of whether a stablecoin is a security must be based on the specific characteristics of that stablecoin and the specific context of its issuance and sale. If the actual circumstances of a stablecoin differ from those described in this statement, the department's determination regarding whether it constitutes a security may also differ.

[6] Examples of such low-risk and highly liquid assets include: U.S. dollar cash equivalents, demand deposits at banks or other financial institutions, U.S. 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 excluded.

[7] 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 examine the marketing methods employed.

[8] Some asset-backed stablecoin issuers may be subject to state law regulation, 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). Federal courts applying the standard established in Reves analyze 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 method in Reves applies to all debt instruments, including evidence of indebtedness"). Since the issuer of asset-backed stablecoins bears the obligation to fulfill redemption requests, stablecoins can be viewed 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 wishes to clarify that even if asset-backed stablecoins are recognized as notes or evidence of indebtedness, their issuance and sale do not constitute the issuance and sale of securities, according to the views held by this department.

[10] 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 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 determine the loan participations involved.

[11] Reves, 494 U.S. at 64-66.

[12] Id. at 65. Notes excluded from the definition of "securities" include:

(1) Notes related to consumer financing;

(2) Notes secured by housing mortgages;

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

(4) Notes used for "character loans" to bank customers;

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

(6) Notes used to record book debts arising from commercial transactions;

(7) Loan notes provided by commercial banks for the daily operations of businesses. [13] Id. at 66-67.

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

[15] Reves at 60; Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 812 (2nd Cir. 1994).

[16] In relevant circumstances, we believe that the buyer's motivation should be given greater weight. See, for example, Pollack, at 813 (the court found that even if the seller's motivation differs, the note should still be classified as a security in cases where the buyer "seeks to invest funds in a safe, conservative investment").

[17] For example, asset-backed stablecoin issuers typically offer 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. at 68.

[19] Id. at 68-69.

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