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Securities and Exchange Commission Chairman Gary Gensler ruffled feathers in the cryptocurrency community when he declined to rule out regulating stablecoins as securities during a hearing before the Senate Banking Committee on Tuesday. But stablecoin issuers will have larger regulatory headaches than the SEC, if reformers get their way.
Republican Sen. Pat Toomey of Pennsylvania asked Gensler whether he believes stablecoins, or cryptocurrencies designed to maintain their value relative to the U.S. dollar
DXY,
are securities under the Supreme Court’s definition of an investment contract called the Howey Test. Gensler declined to give a specific answer, saying “they may well be securities.”
Stablecoins have become integral in the market for cryptocurrencies like Tether
USDTUSD,
and USD Coin
USDCUSD,
which facilitate trading between popular digital assets, including bitcoin
BTCUSD,
and ether
ETHUSD,
but financial regulators have expressed concern that they pose a threat to financial stability. Investors use them as cash substitutes, similar to bank deposits or money market mutual funds, though they remain lightly regulated.
In July, Treasury Secretary Janet Yellen convened the President’s Working Group on Financial Markets to address the threat posed by stablecoins to financial stability, emphasizing “the need to act quickly to ensure there is an appropriate regulatory framework in place.”
Critics of Gensler, however, argue that the SEC chief is rushing to assert his agency’s authority over these instruments with scant legal justification.
“Gensler is very clear in wanting the SEC to have unlimited powers with respect to crypto,” Dean Steinbeck, general counsel for the blockchain platform Horizen told MarketWatch in an interview. Steinbeck added that he agreed with Toomey’s analysis of the Howey Test: because those who purchase a stablecoin don’t have a reasonable expectation of profit, stablecoins fail the Howey Test and are not a security.
Gensler, however, noted that while the Howey Test is an important doctrine for determining whether some cryptocurrencies are securities, there are dozens of other financial instruments that count as securities under federal law that are distinct from Howey.
“In defining the scope of the market that Congress wished to regulate, Congress painted a broad brush,” Gensler said. “It actually included about 35 different things inside that definition of a security.”
Rohan Grey, assistant professor of law at Willamette University and president of the Modern Money Network, suggested in a tweet that stablecoins could be considered among other things evidence of indebtedness, a note, or a certificate of deposit — all securities under federal law.
Gary Gorton, a professor of finance at the Yale School of Management, has conducted research that shows that the debate over whether a stablecoin is a security is likely moot and that regulators at the Treasury Department and Federal Reserve will likely swoop in to regulate these instruments in a way that could transform them.
“Cryptocurrencies are all the rage, but there is nothing new about privately produced money,” Gorton wrote in a July paper, coauthored with Jeffery Zhang, an attorney at the Board of Governors of the Federal Reserve.
Gorton likened stablecoins to private bank notes that circulated as the dominant form of currency in mid-19th century America prior to the creation of national banks during the Civil War. This system of competing private currencies was economically inefficient because the diverging values of various private money made transactions and legal contracts difficult to enact. “There was constant haggling and arguing over the value of notes in transactions,” Gorton wrote. “Private bank notes were hard to use.”
A uniform national currency emerged from the need to finance the Civil War, when Congress began issuing so-called greenbacks that were not backed by gold and eventually taxed private bank notes out of existence. In the decades following, the federal government created the Federal Reserve system to manage a new national currency and desposit insurance to stamp out bank runs that exacerbated financial panics. Gorton argues that a similar evolution must be forced upon stablecoins if policymakers want to avoid the pitfalls of the private currencies of the past.
If crypto enthusiasts think that Gensler is a thorn in their side, just wait until the Federal Reserve and the Treasury Department begin crafting new rules. Statements made by Yellen, Fed Chairman Jay Powell and his key lieutenants on the Board of Governors suggest these powerful officials agree that stablecoin regulation is needed, and fast, whether the SEC dubs them securities or not.
