On April 4, US Securities and Exchange Commission (SEC) Commissioner Caroline A. Crenshaw, the sole Democrat serving as a Commissioner, issued a statement critiquing the Division of Corporation Finance’s analysis in its conclusion that stablecoins are not securities.

The Division’s statement attempted to provide clarity specifically on certain stablecoins, deemed “Covered Stablecoins.” The Division defined Covered Stablecoins as stablecoins designed (1) to maintain a stable value relative to the US Dollar (USD) on a one-for-one basis, (2) to be redeemed for USD on a one-to-one basis, and (3) to be backed by assets held in a reserve that are considered low-risk and readily liquid with a USD-value that meets or exceeds the redemption value of the stablecoins in circulation.

Commissioner Crenshaw’s statement argues that the Division’s analysis severely underestimates the risks associated with these coins and misrepresents the relationship between issuers and retail holders, particularly regarding redemption rights and the role of intermediaries. The Commissioner’s critique centers around issuers’ reserves and stablecoin holders’ ability to access them in the case of redemption.

Key Points:

1. Intermediary Role: The statement highlights that over 90% of USD-stablecoins are distributed to retail purchasers through intermediaries, such as crypto trading platforms, rather than directly from issuers. Holders of stablecoins purchased through intermediaries can only redeem their coins through these intermediaries. Thus, if an intermediary is unable or unwilling to redeem the stablecoin, the holder has no other route of redemption as he cannot recover from the issuer. Intermediaries who can redeem stablecoins are not obligated to redeem them at the par value of $1. They may instead redeem the stablecoins at market value which may mean a smaller payout to the holder. The Division’s analysis fails to consider the significant risks this market structure introduces.
2. Issuer Reserves: The statement challenges the Division’s claim that issuer reserves are a risk-reducing feature designed to satisfy redemption obligations. Commissioner Crenshaw argues that retail holders have no direct access to these reserves, and the reserves do not guarantee redemption at any price, especially during market stress. Holders, who purchased their stablecoins through an intermediary, have no right to access an issuer’s reserves. Further, the Commissioner notes that “proof of reserves” cannot be relied on due to lack of regulatory oversight and reliability of these reports.
3. Market Risks: The Commissioner warns of potential “run” scenarios where issuers and intermediaries may be unable to honor redemption requests during market stress. An issuer’s reserve does not necessarily mean the issuer is solvent, in good financial health, or has enough reserves to satisfy unlimited redemption requests at any point in the future. The Commissioner emphasizes that major run events have already occurred for USD-backed stablecoins and that these runs had significant consequences to the broader stablecoin market and traditional banking system.
4. Legal and Practical Issues: The statement asserts that the Division’s analysis is legally flawed under the Reves test, which enumerates risk-reducing features as one factor against a security determination. The Reves test lists certain risk-reducing features that should be considered, such as collateralization, insurance, and federal regulatory oversight. The Commissioner criticizes the Division’s analysis that an issuer’s reserve is one of these risk-reducing factors under Reves. She also questions the practical applicability of the Division’s criteria for “Covered Stablecoin.” Specifically, the Commissioner is concerned the criteria is fundamentally flawed because it assumes retail coin holders have redemption rights against issuers, when they in fact do not. She emphasizes that it is the intermediaries’ actions, not the issuers’, that matter to the extent that distribution and redemption affect retail market price. The Division failed to address the practices and obligations of these intermediaries.

Commissioner Crenshaw concludes that the Division’s statement does a disservice to USD-stablecoin holders and crypto investors by perpetuating a misleading narrative about the stability and safety of these products, especially by using the term “digital dollar” to describe USD-stablecoins. The Commissioner calls for a more accurate and comprehensive assessment of the risks associated with stablecoins to better protect crypto holders and the public interest. 

For our client alert on the Division’s statement concluding Covered Stablecoins are not securities, see here: SEC’s Division of Corporation Finance: Stablecoins Are Not Securities