red 
On June 8, the New York Department of Financial Services (NYDFS) issued guidance on US dollar-backed stablecoins related to virtual currency businesses regulated by the NYDFS.
It is the latest in a series of major regulatory developments around stablecoins that follows similar initiatives from Great Britain, the EU and Japan. Moreover, it comes as the US Congress is considering a number of legislative proposals to manage the issuance of stablecoins.
The timing of the NYDFS guidance is not surprising. The recent depegging of Terra/UST stablecoins has created an urgency among regulators to introduce oversight of stablecoin activities. In fact, the NYDFS press release notes that it “has been in close contact with New York State regulated virtual currency entities in light of recent developments in the stablecoin market” – a clear reference to the Terra/UST debacle.
The NYDFS guidelines contain several features that are emerging as the global regulatory standard for stablecoin issuance and will likely influence how other jurisdictions outside of New York develop stablecoin regulations.
In its guidelines, the NYDFS makes clear that the virtual currency businesses it oversees must:
- request his written approval before issuing stable money; and
- that any business not currently under the supervision of the NYDFS must obtain a license before starting stablecoin activities in the state.
There are currently three NYDFS-approved stablecoin issuers whose stablecoins are covered by the guidelines: Paxos (issuer of BUSD and USDP); Gemini (GUSD issuer); and GMO-Z.com Trust Company (issuer of ZUSD). However, other companies licensed by the NYDFS to provide virtual currency services – such as PayPal – have expressed interest in launching stablecoins in the future, so that would require additional NYDFS sign-off in New York State.
The guidelines set out three basic requirements that stablecoin issuers subject to NYDFS oversight must meet.
1. Support and redemption option
According to the NYDFS, a USD stablecoin must be fully backed by an asset reserve. The issuer must also have clear redemption policies approved in advance by the NYDFS that ensure holders can redeem their stablecoin for USD at parity.
The purpose of this requirement is to prevent bank run-type events on asset-backed stablecoins that could lead to losses for owners if the issuer has inadequate reserves. The risk outlook of stablecoin launches is one of the primary concerns raised by the President’s Task Force on Financial Markets – a collection of US federal regulators – in its November 2021 report on stablecoins.
That report highlighted regulators’ fears that stablecoin work could have a broader impact on financial markets if stablecoin markets continue to grow significantly. It explained: “A fire sale of reserve assets could disrupt critical funding markets, depending on the type and volume of reserve assets involved.
A run could spread contagiously from one stablecoin to another or to other types of financial institutions believed to have a similar risk profile. Risks to the broader financial system could also increase rapidly, particularly in the absence of prudential standards.” The NYDFS guidelines are a direct response to these types of concerns.
Other jurisdictions have mapped out a similar approach to the NYDFS. Britain’s HM Treasury has proposed that stablecoin issuers provide one-to-one reserve support, and the EU’s Markets in Crypto Assets (MiCA) regulatory framework will also impose similar reserve requirements on stablecoin issuers in Europe after be adopted.
This is a core principle that is also embedded in the stable currency bills introduced by prominent US lawmakers such as Senator Pat Toomey, as well as the Responsible Financial Innovation Act (RFIA) proposal by Senators Cynthia Lummis and Kirsten Gillibrand .
2. Required reserves
The NYDFS also defines the steps that stablecoin issuers must take to ensure the protection and risk management of reserve funds to protect coin owners.
Under the guidelines, reserves must be segregated from the issuer’s equity assets and must be held at a state or federally authorized financial institution insured by the Federal Deposit Insurance Corporation (FDIC), or with a qualified custodian, subject to NYDFS approval. This mirrors the proposed requirements set out in the UK, where stablecoin issuers will be included in the payment services and e-money regime, requiring similar protection of customer funds.
The NYDFS also specifies the type of assets that can hold stablecoin reserves, limiting them to low-risk assets such as Treasury bills, government money market funds, and deposit accounts at U.S. depository institutions.
These requirements are a direct result of concerns about the transparency of stablecoin issuers’ reserves and whether they consist of appropriate low-risk assets. For example, in July 2021, the head of the US Comptroller of the Currency (OCC) acknowledged that US regulators were concerned about the composition of reserves held by Tether – the issuer of the USDT stablecoin – which claimed at the time that a significant portion of its reserves were held in commercial records.
Tether was previously the subject of a $41 million settlement with the Commodity Futures Trading Commission and was forced to cease trading in New York by the state’s attorney general for making false statements about the status of its reserves.
3. Attestation requirements
To ensure that issuers maintain adequate reserves, NYDFS guidelines also require that an independent certified public accountant (CPA) conduct a monthly review.
The CPA must verify facts such as the issuer’s claims about the value of the reserve, whether the reserve was adequate to fully support stable money, and whether the issuer complied with all requirements imposed by the NYDFS regarding the composition of assets.
Third-party review of stablecoin arrangements is an important principle that can help resolve regulatory issues. However, it is important to note that the NYDFS requirement is for confirmation only, which includes a review of the issuer’s management claims, but does not require a more rigorous and complete independent review of reserves.
The above three principles are at the core of the NYDFS expectations regarding the issuance of stablecoins. However, it should be carefully pointed out that they are not exhaustive requirements.
For example, the guidelines emphasize that stablecoin issuers must also comply with NYDFS anti-money laundering (AML) and sanctions requirements. This may include the use of block analysis solutions to enable AML and sanctions risk management. In guidance released in April, the NYDFS stated that the crypto companies it oversees should implement blockchain analytics capabilities to manage financial crime risks.
At Elliptic, we have experience working with stablecoin issuers – enabling them to leverage our enterprise blockchain analytics capabilities to ensure compliance with regulatory expectations. By leveraging our capabilities, stablecoin issuers can demonstrate that they are able to identify financial crime risks affecting their stablecoins and can appropriately mitigate those risks.
Contact us for a demo to learn more about how Elliptic’s solutions can help your stablecoin project achieve regulatory compliance.
Key takeaways
- Make sure your compliance team understands the new regulatory requirements for stablecoins in New York State or other jurisdictions where you operate.
- Make sure you’re ready to respond to regulatory expectations around three key areas that are becoming the standard for stablecoin compliance: one-to-one reserve assurance, reserve risk management and third-party review.
- Introduce blockchain analytics capabilities to ensure compliance with AML requirements and stablecoin sanctions.
Stablecoins compliance with crypto regulation
