July's "Crypto Week" yielded a landmark piece of legislation – the Guiding and Establishing National Innovation for U.S. Stablecoins ("GENIUS") Act (referred to herein as the "GENIUS Act" or the "Act"). The Act establishes a comprehensive federal framework for the regulation of payment stablecoins and their issuers.
The structure of the Act is discussed in detail below. However, key provisions, include:
- The Act regulates and permits the issuance of "payment stablecoins", but its provisions cover all offers or sales of stablecoins in the U.S.
- Dual regulation. The Act establishes a dual regulatory framework reminiscent of the dual banking system, allowing issuers to elect to be qualified and primarily regulated and supervised by either state or federal regulators. Existing state and federal bank regulatory agencies will be responsible for qualifying, regulating, and supervising permitted payment stablecoin issuers.
- Reserve requirements. Permitted payment stablecoins must be backed, on a 1 to 1 basis, by reserves in the form of U.S. currency and certain other liquid financial assets backed by short-term Treasury securities, and permitted payment stablecoin issuers are prohibited from pledging, rehypothecating, or using assets held as reserves backing outstanding payment stablecoins, except in very narrow circumstances.
- Interest prohibition. The Act prohibits permitted payment stablecoin issuers from directly paying any form of interest or yield to holders of their coin;
- Deposit insurance. Payment stablecoins are not eligible to be treated as insured deposits under the Federal Deposit Insurance Act; and
- BSA/AML compliance. Permitted payment stablecoin issuers will be subject to Bank Secrecy Act and sanctions compliance requirements.
What is a stablecoin?
A stablecoin is a type of digital asset that is designed to maintain a stable value relative to an identified reference asset by attempting to anchor the supply of the tokens to the supply of the reference asset. Various mechanisms can be used to achieve this anchoring, including promises or assurances that the tokens are backed by assets maintained in a reserve, or algorithms that automatically expand or contract the of tokens in response to demand.
The GENIUS Act formally establishes new stablecoin classifications intended to subsume all stablecoins offered or sold in the U.S. and bring all U.S. stablecoin activity under the purview of federal law. The Act is chiefly concerned with what it refers to as "payment stablecoins", a term that encompasses any digital asset that is, or is designed to be, used as a means of payment or settlement, and for which the permitted stablecoin issuer is obligated to convert, redeem, or repurchase for a fixed amount of monetary value. "Digital asset" is defined to include any digital representation of value that is recorded on a cryptographically secured distributed ledger. Notably, the definition of "payment stablecoin" provided in the Act excludes any digital asset that qualifies as a deposit under the Federal Deposit Insurance Act, as a security under the Securities Act of 1933, or is a national currency. The Act also amends Section 1a(9) of the Commodity Exchange Act to provide that the term "commodity" does not include a payment stablecoin issued by a permitted payment stablecoin issuer.
Issuance
The Act states that, three years from the date of its enactment, it shall be unlawful to offer or sell a payment stablecoin in the U.S. unless the payment stablecoin was issued by a permitted stablecoin issuer, or one of the limited exceptions provided for in the Act applies. A "permitted payment stablecoin issuer" (hereinafter, "Permitted Issuers") is an entity that is formed in the U.S., and is either (A) federal qualified payment stablecoin issuer, which is either a (1) a subsidiary of an insured depository institution that has been approved to issue payment stablecoins under the Section 5 of Act; (2) a federal qualified payment stablecoin issuer; or (3) a state qualified payment stablecoin issuer. It is unlawful for a foreign payment stablecoin issue to offer, sell, or otherwise make payment stablecoins available in the U.S. unless they qualify for an exception under Section 18 of the Act and comply with the terms of any reciprocity agreement between their home jurisdiction and the U.S.
Any person who is not a Permitted Issuer and issues a payment stablecoins in violation of the Act will be subject to civil monetary fines and possible jail time. Furthermore, any stablecoins issued in violation of the Act cannot be treated as cash or as a cash equivalent for purposes of accounting treatment, or as margin and collateral for futures commission merchants, derivatives clearing organizations, broker-dealers, swap dealers, or registered clearing agencies. Payment stablecoins issued in violation of the Act also are not acceptable as a settlement asset to facilitate wholesale payments between banking or payments organizations.
The Act also endows the Secretary of the Treasury with a general authority to provide limited safe harbors that are consistent with the Act, limited in scope and impact only a de minimis volume of transactions. The Act also permits the Secretary of the Treasury to issue safe harbors if there are unusual or exigent circumstances that warrant such relief from the requirement that only permitted payment stablecoin Issuers can issue a payment stablecoin in the United States.
Permissible and Non-Permissible Activities
Under the Act, Permitted Issuers are authorized only to issue payment stablecoins, redeem stablecoins, manage related reserves (including purchasing, selling, and holding reserve assets or providing custodial services for reserve assets), provide custodial or safekeeping services for payment stablecoins, and undertake other activities that directly support any of the activities otherwise authorized. Importantly, Permitted Issuers are strictly prohibited from paying any form of interest or yield (whether in cash, tokens or other consideration) the holder of a payment stablecoin solely in connection with the holding, use, or retention of such payment stablecoin. The Act does not however prohibit third parties from offering interest, yield or incentives to holders of stablecoins. This was a point of contention during the drafting of the Act and it will be interesting to see if it is a gap that later regulations close.
Permitted Issuers are prohibited from providing services to a customer on the condition that the customer obtain an additional paid product from the Permitted Issuer or any of its subsidiaries, or agree to not obtain an additional product or service from a competitor. These restrictions are similar to the anti-tying rules applicable to banks. Permitted Issuers also cannot use deceptive or misleading names, including any combination of terms relating to the U.S., such as "United States", "United States Government", and "USG", or any similar abbreviations in the name of a payment stablecoin. Also, public companies, whether in the U.S. or abroad, that are not predominately engaged in one or more financial activities, as defined in section 4(k) of the Bank Holding Company Act, may not issue payment stablecoins unless the public company receives unanimous vote from the Stablecoin Certification Review Committee, a rulemaking body established under the Act.
Officially, payment stablecoins are not guaranteed by the U.S. government, they are not subject to deposit insurance by the Federal Deposit Insurance Corporation, nor are they subject to share insurance by the National Credit Union Administration. As such, misrepresenting payment stablecoins status in consideration of the foregoing is expressly prohibited by the Act and considered a violation of the Federal Deposit Insurance Act.
Capital and Reserve Requirements
The Act requires Permitted Issuers to maintain identifiable reserves, backing the outstanding payment stablecoins, on at least a 1 to 1 basis, in the form of either United States currency, money standing to the credit of an account with a Federal Reserve Bank, funds held as demand deposits at an insured depository institution, Treasury bills, notes, or bonds with a remaining maturity of 93 days or less, repurchase and reverse repurchase agreements backed by Treasury bills, notes, or bonds, and any other similarly liquid instruments backed by Federal government issued asset approved by the primary payment stablecoin regulator. The Act prohibits Permitted Issuers from directly or indirectly pledging, rehypothecating, or reusing any of the reserves backing outstanding payment stablecoins, except for very narrow operational purposes related to satisfying their obligations is issuers.
The Act also incorporates certain transparency conditions into the reserve requirements. A Permitted Issuer must publicly disclose its redemption policy, including the procedures for timely redemption and any fees associated with purchasing or redeeming payment stablecoins. A Permitted Issuer is also required to publish on its website the monthly composition of its reserves, including the total number of outstanding shares, and the amounts, types, geographic locations, and average tenor of the reserves held by the Permitted Issuer. In addition to the public disclosure requirements, a Permitted Issuer must organize the information disclosed about its reserves into a monthly report that must then be submitted for examination by a registered public accounting firm. The Permitted Issuer's CEO and CFO must also certify to its primary regulator that the information included in the monthly report is accurate.
Permitted Issuers with more than $50,000,000,000 in consolidated total issuance, that are not subject to reporting requirements under section 13(a) or 15(d) of the Securities and Exchange Act of 1934 (15 U.S.C. 78m, 78o(d)), must produce annual financial statements that are prepared in accordance with generally accepted accounting principles and include the disclosure of any related party transactions. This annual financial statements must be audited by a registered public accounting firm, and the audited statements must be made publicly available on the Permitted Issuer's website and submitted to its primary Federal payment stablecoin regulator.
Custody
An entity may only provide custody or safekeeping services for payment stablecoin reserves, payment stablecoins used as collateral, or the private keys used to issue permitted payment stablecoins (hereinafter, referred to collectively as "Custody Assets"), if the entity is subject to the supervision or regulation of a primary state or federal banking agency, the SEC, of the CFTC. Custody Assets must be segregated and not be commingled with the custodian's assets, except that Custody Assets may be commingled in an omnibus account as deposit liabilities or held as cash on deposit at certain depository institutions in accordance with Federal rules and regulations. The prohibition on commingling does not apply to a person who merely provides hardware or software to facilitate its customers' custody or safekeeping of their own payment stablecoins or private keys.
Regulatory Supervision
In the United States, the financial services industry operates under a dual regulatory framework allowing for the chartering, licensing, and primary supervision of financial service providers by either federal or state authorities. This dual regulatory framework is also embodied in the approach to regulation and supervision adopted in the GENIUS Act. Subject to certain limitations and requirements, Permitted Issuers with less than $10,000,000,000 in consolidated total outstanding issuance may elect to be qualified, regulated, and supervised primarily by the Office of the Comptroller of the Currency ("OCC"), or by a state regulator under a regulatory regime that is substantially similar to the Federal regulatory framework, as determined by the Secretary of the Treasury.
Permitted Issuers whose consolidated total outstanding issuance exceeds the $10,000,000,000 threshold provided for under the Act are generally ineligible for state regulation. State-regulated Permitted Issuers who exceed the threshold must either, (i) within 360 days after reaching the threshold, transition to the Federal regulatory framework; or (ii) cease issuing new coins until its consolidated total outstanding issuance falls below the threshold. Alternatively, a state-regulated Permitted Issuer may receive a waiver from federal regulators allowing it to remain under the primary supervision of its qualifying state regulator despite its total outstanding issuances exceeding the $10,000,000,000 threshold.
The Act charges federal payment stablecoin regulators with responsibility for establishing a process and framework for the licensing, regulation, examination, and supervision of issuers seeking federal qualification that prioritizes the safety and soundness of such entities. It also orders the Secretary of the Treasury to establish rules for determining whether a State-level regime is substantially similar to the Federal regulatory framework under the Act. State-level regulators must receive an initial certification from the Secretary of the Treasury and an annual recertification in order to exercise their qualification authorities under the Act.
When evaluating an application for federal qualification to issue payment stablecoins, federal regulators will consider the following factors:
- The ability of the applicant (or, in the case of an applicant that is an insured depository institution, the subsidiary applicant), based on financial condition and resources, to meet the requirements set forth in section 4 of the Act;
- Whether an individual who has been convicted of a felony offense involving insider trading, embezzlement, cybercrime, money laundering, financing of terrorism, or financial fraud is serving as an officer or director;
- The competence, experience, and integrity of the officers, directors, and principal shareholders of the applicant, its subsidiaries, and parent company;
- Whether the applicant's redemption policy complies with the Act; and
- Any other factors deemed necessary by federal payment stablecoin regulators.
A Permitted Issuer will also be subject to any additional prudential requirements imposed by its primary regulator, including tailored, risk-based capital and buffer requirements, liquidity stand-ards, reserve asset diversification requirements, and other standards for managing deposit con-centration risk, interest rate risk, information technology risk, and anti-money laundering risk.
Bank Secrecy Act, Anti-money Laundering, and Sanctions Compliance
The Act treats Permitted Issuers as "financial institutions" for purposes of the Bank Secrecy Act. As such, Permitted Issuers are subject to all federal laws applicable to other financial institutions located in the United States with respect to to economic sanctions, prevention of money laundering, customer identification and due diligence, and any other requirements related to the prevention, detection, and reporting of suspicious financial activity under the Bank Secrecy Act. The GENIUS Act also charges the Secretary of the Treasury with adopting rules which are tailored to the size and complexity of Permitted Issuers to ensure that they are effective captured under the Bank Secrecy Act compliance regime.
Insolvency
The Act amends the U.S. Bankruptcy Code to establish three baseline priorities for the treatment of Permitted Issuers in insolvency proceedings: 1) the claim of a person holding payment stablecoins has priority, on a ratable basis, with the claims of other holders, over the Permitted Issuer with respect to required payment stablecoin reserves; 2) any person holding a payment stablecoin issued by the Permitted Issuer is deemed to hold a claim; and 3) the priority of holders is limited to claims arising directly from the holding of the payment stablecoins.
What's Next
Stablecoins have long been touted as a means of quickly and directly transferring monetary value that has the potential to benefit both financial and non-financial institutions, as well as ordinary consumers.
When considered alongside the provisions of the Act that render payment stablecoins eligible to be held as collateral, and carve them out of the regulatory regimes applicable to securities and commodities, it is clear that there are several features that will likely make innovation, even within the limits of the newly-defined regulatory perimeter, an attractive prospect. However, it remains to be seen whether the proposed use cases will justify broad acceptance and adoption of these instruments. The tokenization of collateral, "tokenized deposits", and other recent financial innovations will challenge the adoption of stablecoins. Permitted payment stablecoin issuers may also need to develop and offer permissible incentives to expand the adoption of stablecoins in the U.S. financial system.
Beyond the question of use cases and adoption, there are also several other significant outstanding questions about how the regulatory regime for which the GENIUS Act establishes a foundation will actually function in practice. The Act clearly contemplates, and indeed mandates, the adoption of implementing policies at both the state and federal levels. The OCC, State regulators, and other U.S. banking agencies are tasked in the Act with the development of further regulation to ensure payment stablecoins do not impact the safety and soundness of the U.S. financial system. However, as of yet, there are very few indications about the ultimate form that those implementing policies will take.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
