New York was the first state to put a regulatory framework in place for cryptocurrencies with its Bitlicense, and now it is doing the same for stablecoins.
New York State Department of Financial Services (DFS) Superintendent Adrienne Harris announced on Wednesday (June 8) that the agency has issued guidance that provides “clear criteria for virtual currency companies looking to issue USD-backed stablecoins in New York.”
Specifically, it requires that stablecoins issued in New York be 100% backed by reserves of dollars and four different types of treasuries, have those reserves audited monthly and be redeemable on demand.
None of this is particularly controversial, following the $45 billion collapse of the non-currency-backed TerraUSD stablecoin, which sent the already strong movement to regulate these particular digital assets into overdrive.
In several important ways, it matches the regulatory requirements Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., proposed for stablecoins in their June 7 Responsible Financial Innovation Act, which seeks to create a broad regulatory framework for the cryptocurrency industry as a whole.
At this point, it covers three stablecoins: Paxos’ USDP and BUSD, Gemini’s GUSD, and the GMO-Z.com Trust Company’s smaller USDZ. Of those, Paxos is the most noteworthy, as Meta recently announced that its WhatApp messaging service would use the Pax Dollar as a means of payment.
Show Us the Money
The core of the announcement is that stablecoins must be dollar-backed, rather than algorithmic stablecoins like TerraUSD that use methods like arbitrage with a second token to support their dollar peg.
It has three main components.
First, the new guidance calls for a reserve of assets whose market value “is at least equal” to the value of outstanding stablecoins at the end of each day. This means that if any part of it is in non-fiat investments, it would likely be necessary to have a bit extra stored away.
It adds that those stablecoins must be redeemable “in a timely fashion” from the issuer.
Second, the reserves can consist of dollars stored in “deposit accounts at U.S. state or federally chartered depository institutions,” or four types of treasuries: T-bills with a three-month or less maturity, reverse repurchase agreements fully collateralized by U.S. Treasury bills, U.S. Treasury notes or U.S. Treasury bonds on an overnight basis.
These must be held in a deposit account at a U.S. state or federally chartered depository institution.
In that it dives — indirectly — into the question of whether state-chartered banks should be allowed to issue stablecoins. The President’s Working Group on Financial Markets’ (PWG) November Stablecoin Report recommended that only federally-insured banks be allowed to issue the dollar-pegged cryptocurrencies, setting off howls of protest in Congress that state-chartered banks should be able to do so as well.
Third, the reserves must be audited and published every month by an independent, U.S.-licensed CPA “applying the attestation standards of the American Institute of Certified Public Accountants.”
That said, the announcement noted that the DFS will look at other standards and requirements when approving a stablecoin. These include cybersecurity; network design and maintenance; Bank Secrecy Act/anti-money laundering (“BSA/AML”) and sanctions compliance; consumer protection; soundness of the issuing entity; and the stability and integrity of the payment system.
Tethered to the Dollar
Beyond the TerraUSD collapse, a clear factor in these standards is the reserves of the leading stablecoin, Tether’s USDT, with a market capitalization of nearly $80 billion.
Tether was sued by the New York Attorney General in February 2021, accusing it of having claimed to be 100% backed when it was not. That was settled for $18.5 million and a related suit by the Commodity Futures Trading Commission was settled for $42.5 million in October of that year.
Beyond that, when it finally did reveal the nature of its reserves — and in a formal audit — as a result of that settlement, it was discovered to have less than 2% in actual dollars, and the majority in less liquid corporate paper. Tether said it is selling off that corporate paper, claiming that it now is less than 25% of the reserves.
It has been widely criticized for the opaqueness of its reserves, most recently by U.S. Treasury Department Under Secretary for Domestic Finance Nellie Liang. That was a factor in USDT very briefly losing its peg at the height of the TerraUSD run.
Speaking at the House Financial Services Committee’s February hearing on the PWG’s Stablecoin Report, Liang said there were credit risks with corporate paper, and when asked directly if she believed any uncollateralized USDT had been issued, Liang said, “I expect that is the case. They are not regulated … based on what I understand, they may not be able to deliver a dollar.”
Made in New York
In some ways, the fact that this is the first state regulatory regime for stablecoins is less noteworthy than that it comes from the DFS.
New York put crypto regulations in place back in 2015, well before the need for a clear legal framework was as big a national issue as it is now. The result was the Bitlicense, which is, by any measure, a double-edged sword.
On the one hand, the Bitlicense is by far the gold standard for regulatory compliance in the U.S. crypto industry.
When PayPal announced that people who had bitcoin and other cryptocurrencies would be able to transfer them to outside digital wallets, opening PayPal’s closed crypto-buying ecosystem, its success in acquiring a Bitlicense was high up in the press release.
Also announcing that it had been granted a full Bitlicense, the company said that signaled its “commitment to responsible innovation and expanding the accessibility and utility of digital currencies while fully complying with regulatory guidelines and best practices.”
On the other hand, the Bitlicense has been harshly criticized within the crypto industry as being so strict that it strangles innovation. Kraken, an important U.S. crypto exchange, decamped to California over the issue, and if you dig into many crypto industry offerings, you’ll find a “not available in New York” disclaimer.