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Legal Status of Stablecoins and their Transformation into Electronic Money

Throughout the history of cryptocurrencies, their high volatility has remained one of their signature characteristics, opening great possibilities for trading, yet making them lack stability to be used as an everyday mean of payment. That was until stablecoins saw the light of day. They were designed to combat what many think is the biggest flaw of digital currencies – their volatility.

So, what are stablecoins? Stablecoin is a record in a blockchain, tied to another asset, which in turn reduces its price volatility and fixes its price. Just like with any virtual asset, its legal status is mainly defined by its economic content. Depending on the design of a stablecoin, it can be either fiat-backed (Tether, TrueUSD), cryptocurrency-backed (BitShares, Dai, Havven), or algorithmic (Ampleforth, Basis).

Both fiat- and cryptocurrency-backed (together sometimes referred to as “asset-backed”) stablecoins are designed in a way, where an asset with a defined value (e.g. USD, BTC, gold) supports its exchange rate. The exchange rate of an algorithmic stablecoin, on the other hand, is supported by an algorithm, that automatically corrects the supply of the latter in an event of its shortage or surplus. This process is also known as “seigniorage”.

As with any blockchain-based asset, the question as to whether a stablecoin falls under any effective legislation is crucial for the purposes of regulatory compliance. Generally speaking, if a person purchases stablecoins with an expectation of profit, a stablecoin can constitute security. Therefore, fiat-backed stablecoins are likely not to fall under the definition of security in most of the jurisdictions. This is because expectation of profit does not usually arise in relation to stablecoins pegged to a fiat currency.

On the contrary, stablecoins backed by precious metals like gold and those that constitute shares in an algorithmic seigniorage system, will most likely be bought with an expectation of profit, thus being investments, and fall under the scope of securities legislation.

However, issuing stablecoins backed by fiat currencies is still considered a regulated activity and requires a license. For example, in September 2018, the New York State Department of Financial Services has authorized Gemini and Paxos to issue a price-stable cryptocurrency pegged to the U.S. dollar. TrueUSD is another example of a company that has received a U.S. authorization, operating under the Money Services Business license issued by the Financial Crimes Enforcement Network.

As one might argue, “backing” a blockchain asset by a fiat currency not only brings in some degree of centralization (even more so, if a business requires a license to do it) but also leads to such stablecoins representing a claim on the underlying currency. This thesis is supported by the fact that some companies choose to apply for the Electronic Money Institution license (e.g. Monerium). Electronic money generally constitutes a right to claim, rather than “money” in its traditional meaning.

Some believe that stablecoins are the “Holy Grail of Cryptocurrency” and we should definitely expect the rise in their popularity in 2019.

In our earlier article, you can read about our plans to introduce stablecoins as means for payment for services on our Platform.

Nik Kliapets, Legal Counsel of Legal Nodes

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