House STABLE Act Must Address State Interference in Stablecoins

The Bottom Line

• The STABLE Act, the House’s counterpart to the Senate’s GENIUS Act, similarly seeks to establish a clear regulatory framework for stablecoins, encouraging new market entrants.
• Under the current version of the bill, state regulators may indirectly limit the circulation of stablecoins by ordering licensed intermediaries to stop supporting them.
• To better achieve the bill’s goals, the House could use this opportunity to further preempt state discretion to restrict payment stablecoins issued by federally approved issuers.

The House’s STABLE Act seeks to “establish a clear regulatory framework for the issuance of payment stablecoins” that will protect consumers, create guardrails, and promote “innovation in the US through a tailored approach that supports new entrants into the marketplace.”

Similar to the Senate’s GENIUS Act, the bill preempts and supersedes state money transmitter regimes, creating a single regulatory framework for prospective issuers. The bill also excludes payment stablecoins from federal securities laws, which have historically encumbered stablecoin adoption across the US.

However, the bill may not go far enough. As currently drafted, state regulators could retain the power to restrict which stablecoins an exchange or other licensed intermediary may support. Since the inception of stablecoins more than a decade ago, most issuers have relied on exchanges for distribution to the public. They will likely continue to do so. Among other benefits, exchanges provide an accessible platform to buy, hold, and sell stablecoins, simplifying blockchain transactions.

The impact of state regulatory power is undeniable. Restrictions by New York regulators on licensed intermediaries, including exchanges, have effectively ended the circulation of some of the world’s most prominent stablecoins in the state.

Given the expected importance of intermediaries, it may be prudent for lawmakers to limit state discretion to restrict support of payment stablecoins, provided they have been issued by federally approved issuers. States would otherwise remain free to license intermediaries, fulfilling important consumer protection functions, with the change only affecting which digital assets such intermediaries may support.

Extending preemption to this effect would better align with the aim of creating a uniform regulatory framework. Further state review of stablecoins issued by federally approved issuers may be redundant and could frustrate lawmakers’ primary goal of encouraging stablecoin growth throughout the US.

Current Regulatory Regime

In large part, two main regulatory regimes have influenced the growth of stablecoins and other digital assets in the US: federal securities laws and state money transmitter laws.

Under federal securities laws, some digital assets have been deemed securities under the catch-all investment contract framework. The Howey test defines an investment contract as an investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of a third party. If a digital asset meets the definition of an investment contract and is therefore a security, market participants wishing to facilitate transactions in such assets, including exchanges, would incur SEC registration requirements.

While stablecoins may not seem to come squarely within the four corners of the Howey test, the SEC has previously taken the position that the Howey test captures such assets when offered with the expectation of future yield. In early 2023, the SEC targeted UST, an algorithmic stablecoin, alleging that purchasers were promised yields reaching 20% for staking them on a lending protocol. A federal court agreed, classifying UST as a security.

Following the UST complaint, the SEC sought to push the boundaries of the Howey test even further. In mid-2023, the SEC targeted the world’s largest cryptocurrency exchange, as well as its partner, a New York-based limited-purpose trust company. The SEC alleged the exchange’s stablecoin was an investment contract because it and its partner planned to split interest accrued from investments of stablecoin collateral.

A year later, a federal court rejected this theory, noting that the SEC failed to allege purchasers were offered a share of, or even knew about, the issuers’ plan to generate a profit. Without such knowledge, the SEC couldn’t support a theory that the purchasers had made their acquisitions with investment intent under the Howey test.

Despite the eventual failure of the SEC’s claims, the complaints targeting the exchange’s stablecoin and other digital assets contributed to market fear that practically any digital asset could meet the Howey test. Due to the risks of unintentionally operating as unregistered securities market participants, many intermediaries have reconsidered their support for digital assets.

State money transmitter laws, which vary greatly in terms of scope, have also influenced the growth of stablecoins. Where state regulators interpret stablecoins to be a form of “money,” prospective issuers may need a money transmitter license to operate in such states. Many states also require issuers to hold a license to custody collateral. Applying for individual licenses can take months, or even years, requiring significant resources.

Of all the states, however, New York exercises the most influence over stablecoins through its BitLicense regime. It uses two regulatory tools that other states, such as California, are in the process of incorporating into their own regulatory regimes.

First, New York’s BitLicense prohibits most digital asset activities, generally requiring both issuers and exchanges to obtain a license from the New York State Department of Financial Services prior to conducting any such activity. The application process gives NYDFS discretion to screen out applicants it views as a risk to state residents or markets.

Second, NYDFS retains the power to restrict which digital assets a licensee may support. For instance, following concerns with how a foreign issuer of USDT accounted for collateral, NYDFS effectively banned licensees from supporting the asset, limiting its circulation in the state. NYDFS has taken similar actions against other stablecoins, likewise bringing their widespread circulation to an end.

While NYDFS has provided guidance on which digital assets a licensee may support, the regulator is clear that it “may, at any time and in its sole discretion, require [a licensee] to delist or otherwise limit New Yorkers’ access to coins that are not included on the Greenlist.” Currently, the Greenlist only lists nine “pre-approved” digital assets.

STABLE Act Framework

The House’s STABLE Act establishes a uniform regulatory framework that addresses much of the complexity and ambiguity associated with federal securities laws and state licensing regimes.

Notably, the bill effectively exempts payment stablecoins from the definition of a security, even if they might otherwise meet the definition of an investment contract under the Howey test.

To qualify as a payment stablecoin under the bill, a digital asset must be used or designed to be used as a means of payment or settlement. In contrast to the GENIUS Act, which requires both of the following, the STABLE Act requires the issuer to either be obligated to redeem the stablecoin for a fixed amount of monetary value or represent that the stablecoin will maintain a stable monetary value.

The STABLE Act also “preempt[s] any conflicting State law and supersede[s] any State licensing requirement for any nonbank entity or subsidiary of an insured depository” that is approved by its primary federal payment stablecoin regulator.

Under the bill, the primary federal regulator varies based on the type of entity seeking approval. In the case of national bank subsidiaries, for instance, the relevant regulator is the Office of the Comptroller of the Currency.

Once approved, payment stablecoin issuers are subject to ongoing supervision, including financial reporting, examinations, and potential cease-and-desist actions.

The STABLE Act further mandates the following:

Reserve Requirements: Issuers must maintain a 1:1 reserve ratio, backing their stablecoins with assets such as US currency and short-term Treasury securities.

Capital Requirements: Regulators must establish rules for capital, liquidity, and risk management tailored to the issuer’s business model and risk profile, including asset diversification and interest rate considerations.

Redemption Requirements: Issuers must publish a redemption policy and establish procedures for the timely redemption of outstanding payment stablecoins.

Bank Secrecy Act and Sanctions Compliance: Issuers are considered financial institutions under the Bank Secrecy Act, requiring anti-money laundering programs. The bill mandates specific program requirements, including an effective customer identification program to identify and verify initial holders of a payment stablecoin.

While operational requirements are significant under the bill, the STABLE Act nonetheless presents an attractive alternative, uniform framework for businesses seeking to issue stablecoins in the US. Once approved, such businesses will no longer need to contend with ambiguous federal securities laws or invest resources to apply for state licenses to operate throughout the country.

Further Enhancement

Still, despite its improvements over current regulations, the STABLE Act may not account for a state’s power to indirectly restrict the distribution of payment stablecoins. State regulators, like NYDFS, can exercise supervisory powers over critical market participants, ordering them to delist even federally regulated stablecoins.

Issuers typically rely on exchanges and other intermediaries to distribute stablecoins for three reasons.

First, issuers can streamline redemption obligations, which might otherwise be unworkable given the volume of secondary transactions and the number of individual holders.

Second, issuers can limit compliance and “Know Your Customer” functions to a small number of trusted counterparties, simplifying operations.

Third, and perhaps most importantly, intermediaries, particularly exchanges, provide an accessible platform for acquiring and using stablecoins.

These incentives will persist under the STABLE Act, ensuring intermediaries remain essential for payment stablecoin growth. While issuers must draft and disclose a redemption policy, they may mandate fees, among other transaction requirements, that effectively limit redemptions to a small group of reliable intermediaries.

Further, new anti-money laundering provisions, which mandate a customer identification program for initial stablecoin holders, continue to incentivize issuers to limit counterparties to trusted intermediaries. Finally, exchanges will likely remain the primary ecosystem for users to buy, hold, use, and sell stablecoins through web and mobile apps.

If intermediaries remain key distribution points for stablecoins, as expected, the success of the STABLE Act will depend on these intermediaries’ ability to support new stablecoins. However, as drafted, nothing in the bill prevents NYDFS, or other state regulators, from ordering intermediaries to delist payment stablecoins, potentially ending their circulation.

The solution doesn’t need to be complex. Lawmakers could preempt state discretion to restrict payment stablecoins provided they have been issued by a federally authorized issuer. States could continue to license digital asset trading activity, with the change only affecting the subject matter of such activity. In effect, the change would be analogous to automatically adding such stablecoins to New York’s Greenlist of pre-approved digital assets, thereby making each eligible for listing by licensed exchanges.

Addressing state discretion to restrict payment stablecoins would further congressional intent to create a single federal regulatory framework for stablecoin issuers. If a stablecoin is issued by a federally approved issuer, it seems rational that states shouldn’t be able to indirectly prevent its distribution by restricting intermediary support. Further, such action will help ensure that intermediaries can better support the growth of stablecoins throughout the US.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Nathaniel Reisenburg is a managing associate in the blockchain and virtual currency and financial & fintech advisory practices at Orrick.

Joseph Perkins is a partner in the blockchain and virtual currency practice and technology companies group at Orrick.

Ignacio Sandoval is a partner in the financial & fintech advisory practice at Orrick.

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