Legal Control over Stablecoins (Taiwan)

2019.6.17
Sean Liu

There has been incessant news about Facebook’s intention to set foot in the blockchain domain and issue a stablecoin since the end of 2018.   A while ago, Facebook finally released a white paper codenamed Libra and is expected to launch a stablecoin backed by low volatility assets in the first half of 2020[1].  Today in 2019, stablecoins are no longer anything new.  In addition to the long-existing Tether (USDT) and Dai, which has been a steadily growing decentralized stablecoin since 2018, the so-called “compliant” stablecoins, e.g., TUSD, PAX, USDC, etc., have emerged since the second half of 2018.

Although stablecoins have been developed and used for a certain period of time and  well-known cryptocurrency exchanges in Taiwan have at least listed Tether (USDT), still cryptocurrencies in Taiwan are traded in a niche market to date.  Not only coverage of stablecoins by mainstream media is rare, but also the competent authority has not stated any opinion on the control over stablecoins.  However, if Facebook can successfully promote its stablecoin, the market effect in the future can be staggering in light of Facebook’s market penetration and the size of its Libra project.  Perhaps, like the development of mobile payment in the past few years, technologies and market power may conversely pushed the competent authority to prepare or clarify necessary laws and regulations as promptly as possible.

However, in comparison with laws and regulations relating to mobile payment, legal issues concerning stablecoins are obviously more complex.  Stablecoins which claim to be legally compliant such as TUSD, PAX, and USDC are all issued by US companies in the US.  An observation of the provisions of their usage agreements shows that fiat is deposited by the users in exchange for cryptocurrencies, and the deposited fiat is placed under the custody of a cooperative trust company or in designated bank accounts.  The holders of such collateralized currencies can exchange their fiat back.[2]  Although such compliant stablecoins can be used in the cryptocurrency exchanges in the majority of states in the US, still there are US lawyers who believe that such stablecoins may meet the definition of a demand note under the Securities Exchange Act or of an option under the Futures Exchange Act of the US.  However, the Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) just choose to withhold any opinion for the time being.[3]

Previously, Valerie Szczepanik, a senior advisor to the US SEC, openly remarked that stablecoins may fall within the definition of a marketable security, particularly those whose issuing entities adjust and control the value of the stablecoins through specific mechanisms.[4]  In this regard, it is generally perceived that she was referring to Basis (a type of stablecoin not backed by fiat or assets with its value controlled purely through a supply and demand adjustment algorithm),[5] a stablecoin project that had been canceled due to SEC’s warning in December 2019.  However, isn’t it true that other types of stablecoin are definitely not securities?  As previously explained, this is not necessarily true.  To make a determination, it is still necessary to revert back to relevant securities and futures laws and regulations.

Moreover, in terms of consumer protection, significant issues currently loom in the stablecoin market as well.  Currently in this industry, the stablecoin market is actually dominated by Tether with its issuance USDT market capitalization in excess of US$3.53 billion, accounting for 70% to 80% of the total value of the stablecoin market.[6] However, it is precisely Tether that is also the most controversial.

Unlike other stablecoins, the assets backing Tether have never been officially certified and audited by certified public accountants, and no one really knows that status of such assets.  In addition, the investigation conducted by the New York State Attorney General in April this year showed that Tether had utilized its reserve assets in the amount of US$850 million and lent it to Bitfinex, a cryptocurrency exchange and Tether’s affiliate.[7] It was at this point in time that the public suddenly realized why its user agreement on the company’s website had expanded its collateralized assets to include “other assets and receivables from loans.”  Tether as an untimely bomb may never explode.  However, if it does, it is very difficult to estimate the damage to the cryptocurrency market, relevant operators and the consumers.

Another regulating challenge is how to qualify Dai, which is a decentralized stablecoin.  Dai is a stablecoin issued on the Ethereum blockchain through a smart contract.  It functions by using other types of cryptocurrencies to secure the borrowing of Dai.[8]  Although the pledger that borrows the Dai needs to return the Dai with interest to recover the collateral, still a third party that indirectly obtains Dai may view it as a currency with stable value in free circulation for market trading.  In contrast to the above-mentioned stablecoins which are backed by fiat or assets and guarantee their value as stablecoins through contract and laws and regulations, the generation and operation of Dai are purely based on open source smart contract, decentralized crypto assets and MakerDao, which is a decentralized non-profit organization.  Therefore, Dai is highly innovative and realizes the ideal of trustless blockchain to a great extent.  If such mechanisms are in fact highly transparent and reliable with no one needing special protection, what is the justification for legal intervention?  Is it still necessary for the law to jump in and declare that Dai is or is not a marketable security?  These are issues that require prudent considerations by regulators and lawmakers.

As previously stated, if Facebook successfully launches a stablecoin, there will be significant demands in the global market, making it imperative to regulate it in Taiwan.  Moreover, Tether, which is currently traded in mainstream exchanges in Taiwan, is actually the stablecoin that is the mostly likely to become problematic.  To diversify risks, it is believed that other so-called “compliant” stablecoins and Dai may need to be listed in cryptocurrency exchanges in Taiwan.  The competent authority in Taiwan is advised to pay close attention to the current development of all kinds of mainstream stablecoins and to prepare all kinds of accommodating control strategies in advance.

[1] https://libra.org/en-US/wp-content/uploads/sites/23/2019/06/LibraWhitePaper_en_US.pdf

[2] https://www.trusttoken.com/terms-of-use/; https://support.usdc.circle.com/hc/en-us/articles/360001233386-Circle-USDC-User-Agreement; https://www.paxos.com/general-terms-and-conditions/

[3] https://www.coindesk.com/will-fiat-backed-stablecoins-pass-legal-muster-with-the-sec-and-cftc

[4] https://bitcoinexchangeguide.com/secs-valerie-szczepanik-many-stablecoins-currently-might-be-violating-various-securities-laws/

[5] https://unhashed.com/cryptocurrency-news/top-funded-crypto-stablecoin-basis-shuts-down-due-sec-regulatory-constraints/

[6] https://stablecoinindex.com/marketcap  (last visited on 06/24/2019)

[7] https://en.wikipedia.org/wiki/Tether_(cryptocurrency)

[8] Currently, it can only be backed by Ether.  In the future, other cryptocurrencies will be added. See https://medium.com/makerdao/update-the-road-to-multi-collateral-dai-2d4c48092270