On April 4, the Division of Corporation Finance of the US Securities and Exchange Commission (SEC) issued a statement providing clarity on the application of federal securities laws to stablecoins, specifically those designed to maintain a stable value relative to the US Dollar (USD).

This statement outlines the characteristics of “Covered Stablecoins” and asserts that their offer and sale do not constitute securities under the Securities Act of 1933 or the Securities Exchange Act of 1934.

Stablecoins Overview

Stablecoins are a type of crypto asset designed to maintain a stable value relative to a reference asset, such as USD, other fiat currencies, commodities such as gold, or a pool of assets. Issuers typically offer and sell stablecoins on a one-for-one basis corresponding with the reference asset (e.g., 1 stablecoin = 1 USD). They may use various mechanisms to maintain stability, including algorithms used to adjust supply in response to demand. The risks associated with stablecoins vary based on their stability mechanisms and reserve maintenance.

The Division’s View on Covered Stablecoins

The Division has determined that the offer and sale of Covered Stablecoins, as described in the statement, do not involve the offer and sale of securities. Consequently, transactions involving the minting and redeeming of Covered Stablecoins do not need to be registered with the SEC under the Securities Act, nor must they fall within any exemptions from registration.

Characteristics of Covered Stablecoins

Covered Stablecoins are designed and marketed for use as a means of making payments, transmitting money, or storing value. They maintain a stable value relative to USD and are backed by either USD or any other low-risk, readily liquid assets held in a reserve. These assets meet or exceed the redemption value of the stablecoins in circulation. Covered Stablecoin issuers ensure price stability by minting and redeeming these stablecoins on a one-for-one basis with USD. There is no limitation on the amount of Covered Stablecoins an issuer can mint or redeem. Stablecoins may be offered directly from the issuer or through a designated intermediary. If the holder of the coin purchases through an intermediary, that holder cannot redeem directly with the issuer. The holder must redeem their coins with the intermediary who then redeems with the issuer. The Division notes that designated intermediaries eligible to deal directly with issuers can engage in arbitrage to keep market prices stable relative to redemption prices.

Marketing of Covered Stablecoins

Covered Stablecoins are marketed solely for use in commerce and not as investments. Marketing materials emphasize their stability, reliability, and accessibility for making payments and storing value. They are often likened to a “digital dollar” and do not offer any interest, profit, or ownership rights. Marketing stablecoins as a value-storing device is an indication that stablecoins are not securities.

The Reserve

Proceeds from the sale of Covered Stablecoins are used to acquire assets held in a pooled account called a “Reserve.” These assets are used solely to honor redemptions and are not commingled with the issuer’s assets or used for operational purposes. The Reserve is designed to fully back the outstanding Covered Stablecoins on a one-for-one basis. Issuers may publish reports called “proof of reserves” reports which demonstrate the issuer has enough reserve to redeem their stablecoins.

Legal Analysis

The Division analyzed Covered Stablecoins under the Reves v. Ernst & Young [1] and SEC v. W.J. Howey Co. [2] tests and concluded that Covered Stablecoins are not securities.

The Reves Test

Because the Division likens stablecoins with a debt instrument, it started its analysis with the Reves test. The Reves test considers factors such as the motivations of the seller and buyer, the plan of distribution, the reasonable expectations of the investing public, and risk-reducing features. All factors are given equal weight. Under the Reves factors, the Division determined Covered Stablecoins are not securities because they are not marketed as investments and are used for commercial purposes.

The Howey Test

Although the Reves test indicated Covered Stablecoins are not securities, the Division also performed an analysis under Howey, the test most used to determine whether something is an “investment contract” and thus a security. The Howey test examines whether there is an investment of money in a common enterprise with an expectation of profits derived from the efforts of others. The Division concluded that Covered Stablecoins are not securities under the Howey test because buyers are not motivated by an expectation of profit when purchasing stablecoins. Rather, buyers use these Covered Stablecoins for consumer purposes and as a value-storing device.

Conclusion

The Division’s statement clarifies that Covered Stablecoins, as described, are not considered securities under federal securities laws. This determination provides greater regulatory clarity for issuers and users of stablecoins designed to maintain a stable value relative to USD. However, note that the statement represents the views of the staff of the Division of Corporation Finance and does not have legal force or effect. It does not alter or amend applicable law and creates no new or additional obligations for any person.

For our client alert addressing SEC Commissioner Caroline Crenshaw’s criticism of the Division’s statement concluding that Covered Stablecoins are not securities, see here: SEC Commissioner Crenshaw Critiques Stable Coin Analysis: Understates the Risks