Crypto-banking matures – Breaking the TRUST law

Crypto-assets may have started as an attempt to build a trustless ecosystem that didn’t need traditional financial intermediaries such as banks, payment processors and other centralized institutions, but the reality has become a bit more nuanced. Even though bitcoin and other decentralized cryptocurrencies continue to attract retail and institutional investors, one of the main avenues of mainstream adoption has been a more centralized option; stablecoins. Stablecoins may have started as an offshoot of the original cryptocurrencies, but have quickly grown in importance and the level of attention given to these instruments by regulators.

At the heart of the idea, stablecoins represent the best of both worlds, with the stability of fiat currencies backing the instruments combined with the speed and transparency of blockchain-based transactions. With this potential, however, many questions and issues have also been raised by market players and policy makers that have yet to be effectively addressed. Specifically, issues around regulatory approval, custody of the underlying assets, and how stablecoins will fit into existing payment infrastructure are not idle concerns. Such problems can slow innovation within the sector and drive the best ideas and concepts out of US markets. This is why smart and well-thought-out regulation around stablecoins is essential, and why recent activities are a positive step forward for the industry.

Recently released by Senator Toomey’s office, the Stablecoin Reserve Transparency and Secure Transaction Standardization (TRUST) Act represents a step in the right direction. Let’s look at some of the important elements and implications of this draft regulation.

Stablecoins are not securities. One of the most pressing issues that continues to cause concern and problems for market participants is the uncertainty and ambiguity regarding whether or not crypto-assets are securities. The Securities and Exchange Commission (SEC) has apparently adopted a regulatory approach by amendment or by lawsuit, with numerous cases having been initiated and settled since 2020. Despite these settlements and analyzes that have resulted from these cases, official and binding directives n has not yet been issued.

Without definitive and clear guidance on which regulator oversees the crypto-asset space, the sector will continue to struggle to fully develop. One of the key provisions of the TRUST Act is that it explicitly states that payout stablecoins are not securities and would be exempt from securities registration.

As positive as that statement is, there is an additional delineation that is also included in this bill.

Refine stablecoin definitions. An additional point integrated into this law is the creation of a definition of the payment stablecoin, which includes the definition of the essential characteristics of these assets. These include, but are not limited to, convertible virtual currency intended for use as a medium of exchange, which can be exchanged for the underlying fiat asset in question, does not necessarily pay any interests to the holders of this instrument, and whose transactions are recorded on a public blockchain register.

In addition to these specific characteristics, the law also defines how these payment stablecoins must be reserved, including what types of assets will be considered sufficiently liquid and safe to do so. These tips would answer some of the questions regarding how some of the most widely traded stablecoins are currently reserved or supported. Reinforcing this proposed direction, the law also requires stablecoin issuers to submit to annual attestations to provide a reportable and consistent set of data for external users to review.

When combined, clarifying the characteristics of stablecoins, how stablecoins are reserved, and the process by which reservations are verified, this law could possibly answer many of the most important questions facing the space. .

Expand the market. An additional key factor contained in this law is that the types of organizations able to participate in the stablecoin industry have been expanded. Although the law rightly calls for oversight of stablecoin issues by the Office of the Comptroller of the Currency (OCC), it seems to indicate that it may not be necessary to bring issuers into an existing federal insurance framework. At first glance, this would seem potentially naïve and an almost guaranteed way to increase the risk of this business model, but on closer inspection it reveals a fuller perspective.

While insurance for any organization is clearly a good idea, if the other measures of the law are adopted and embraced by the industry, it would mitigate a significant portion of the operational risk associated with this space. For example, if a stablecoin issuer has reserves – as defined by law – on a 1:1 basis for each stablecoin issued, and if those reserves are evidenced in a consistent, transparent, and market-driven manner, repayment risk issues would be reduced.

Regulating a rapidly changing industry is no easy task, and regulators around the world face an unenviable task as the sector continues to grow and mature. Despite the periodic bursts of partisan debate that characterize politics in any country, there are signs that the debate over crypto regulation in the United States is (slowly) maturing and catching up with market developments. No legislation is a panacea for the crypto space, but legislation such as that contained in the TRUST Act is an important step in the right direction.