Stablecoins and Security Law
An unwelcome paradox already affects the newest wave of cryptocurrencies: the more securely a so-called “stablecoin” enters the market, the more likely it will face the restrictions set forth by the US government for “securities.”
What is a security?
In the purview of the US Securities and Exchange Commission (SEC), a security at its most basic level is an entity which is held or traded for its speculative value. Also known as an “investment contract,” a security binds investors to a “contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
What may or may not constitute a security is of special interest to anyone who’s been following cryptocurrency this year. In particular, a dizzying variety of projects have been announced under the umbrella of “stablecoins” in the crypto sphere.
Why are stablecoins subject to security law?
A stablecoin is a currency whose mechanisms protect it from the mercurial inflation that plagues non-stable coins. In spite of their safety relative to former coin iterations, Valeria Szczepanik, a high-ranking advisor for digital assets in the US government, warned on Friday that some stablecoins may fall under the SEC’s definition of securities.
Szczepanik singled out stablecoins like Dai which rely on algorithms (as opposed to real assets or fiat money) as equally vulnerable to SEC regulation. This type of stablecoin blurs the line between centralized and decentralized — if control of the stablecoin can be traced back to a party which controls the pricing mechanism, the SEC is likely to see that operation as a security.
It’s likely the US government will categorize at least some stablecoins as securities — not because they behave the same way as stocks, but because it is more convenient to classify them as such. The SEC is notorious for an itchy trigger finger. It seems the regulatory uncertainty surrounding new stablecoins has two sides: the more difficult a stablecoin is to classify, the more likely it will face sweeping measures from the US government.
Should stablecoins be considered securities?
As recently as December 2018 a project called Basis shut down for the pre-emptive reason that US securities law would severely hamper business. The founders pulled the plug on Basis despite having raised more than $133 million in investments. Other coins could befall the same fate if their founders accept Szczepanik’s broad definition of what could constitute a security.
Why might companies follow the example of Basis and fold so early in the game? The lack of a legal framework puts immense stress on projects bursting into the stablecoin scene. The longer a project remains in regulatory limbo, the more resources it must devote to keeping the stablecoin flexible enough to comply with possible strictures.
In short, any project with measures in place to regulate supply and demand figures to draw scrutiny from the SEC. What’s frustrating for US citizens is that stablecoins give them a greater degree of price stability. In other words, citizens of other countries can invest in stablecoins with the confidence that these coins help rather than hurt the total market.
What’s ahead for stablecoins?
If the SEC decides to classify stablecoins as regulated securities, a number of dominos are likely to fall. For one thing, projects issuing stablecoins may have to register their offerings according to SEC standards; likewise, companies which host stablecoin transactions likely will have to register as a broker-dealer.
Nearly every kind of stablecoin carries risk. Stablecoins backed by fiat currency could be rendered obsolete should the US government release its own digital coin, and those which rely on predictive protocols in theory could collapse into a depression.
Then there is Element Zero (EZO), the first 4th-protocol stablecoin. In theory, a non-profit stablecoin — one that’s free from the volatility associated with fiat, algorithms, or real assets — can protect itself against market volatility even a hundred years into the future. Time will tell whether EZO, a non-collateralized coin, represents the best option.
