Locating Stablecoins within the Regulatory Perimeter

Howell E. Jackson is the James S. Reid, Jr., Professor of Law at Harvard Law School and Morgan Ricks is Professor of Law and Enterprise Scholar at Vanderbilt University Law School.

Stablecoins are suddenly very much front and center in the minds of policy makers. Last month, Secretary of the Treasury Janet Yellen assembled the President’s Working Group on Financial Markets (PWG) to explore this increasingly important form of cryptocurrency, and, in a subsequent press release, the Department indicated that in coming months the PWG will release a report exploring how stablecoins fit into our current regulatory framework along with recommendations for addressing any regulatory gaps. [1]

In analyzing stablecoins, one of the first challenges facing the Treasury Department staff will be to determine where, if at all, stablecoins fit within our current regulatory framework. Do these instruments fall within existing regulatory perimeters, making them already subject to some established system of financial regulation? Or is new legislation required to deal with stablecoins? To a considerable degree, early forms of cryptocurrencies, such as Bitcoin, have escaped primary oversight from financial regulators and Congress has so far failed to expand our regulatory perimeters to reach these first-generation cryptocurrencies in a coherent manner.

But stablecoins are fundamentally different from Bitcoin and earlier forms of cryptocurrencies, which are generated through algorithmic mining and maintained in a dispersed manner through distributed ledger technologies. Stablecoins are issued through a clearly identifiable legal entity. Firms like Tether accept funds from customers in exchange for their stablecoin tokens. In addition—and critically—stablecoins are designed to maintain a consistent value, with stablecoin tokens typically denominated in US dollars and backed by a pool of assets. Stablecoin sponsors assume responsibility to maintain an appropriately sized pool of assets and stand ready to redeem tokens at face value. This combination of pooled reserves and convertibility is what stabilizes the value of the tokens and is also what makes stablecoins a much more attractive medium of exchange than first generation cryptocurrencies with their dizzying gyrations in price. But these differences are also features that have important implications for locating stablecoins within our regulatory perimeters.

While many state and federal regulatory provisions might arguably apply to stablecoins, the PWG might well begin by considering whether stablecoins are covered by one of the surviving provisions of the Glass-Steagall Act: Section 21(a)(2). [2] That provision makes it unlawful for anyone “to engage, to any extent whatever…., in the business of receiving deposits subject…to repayment…upon the request of the depositor” unless the entity receiving the deposits is subject to regulatory oversight by federal or state authorities under three expressly enumerated exceptions, one of which makes reference to banking regulations and the other two of which contemplate other forms of federal or local supervisory oversight. [3] Under section 21(b), those who violate the provision are subject to criminal sanctions, including both fines and imprisonment of up to five years. The question for Tether and other stablecoin issuers, in other words, is whether they are engaged “to any extent whatever” in the business of receiving “Glass-Steagall” deposits.

What is clear from the text of Section 21(a)(2) is that Glass-Steagall deposits represent a wider range of instruments than the class of liabilities issued by chartered depository institutions commonly known as deposits. Section 21(a)(2)’s three enumerated exemptions sanction the issuance of Glass-Steagall deposits by such regulated entities, and so the regulatory perimeter of Section 21(a)(2) logically must be broader than simply deposit liabilities of chartered depository institutions. Otherwise, the provision would be a nullity as all Glass-Steagall deposits would be exempt. [4]

The legislative history of section 21(a)(2) confirms that the provision was intended to “prohibit[]…unregulated private banking so far as practicable.” [5] Over the years, federal authorities accepted this view and have taken a functional approach to defining deposits under Section 21. [6] The best known illustration of this process came in the late 1970s as federal authorities took up the question of whether SEC-sanctioned money market mutual funds should be considered Glass-Steagall deposits governed by section 21. In a letter issued in December of 1979, Assistant Attorney General Philip Heymann did not concern himself with the absence of the word deposit. Instead, he delved into the intricacies of the legal structure of money market mutual funds and concluded that the instruments did not create the kind of debtor-creditor relationship necessary to constitute Glass-Steagall deposits for the purposes of section 21, opining instead that a holder of money market mutual funds was “a holder pro tanto of the fund” subject to market fluctuations, both up and down, based on the performance of the underlying assets. [7] While in retrospect one can question the completeness of the analysis in the Heymann letter, [8] the important point here is that the letter proceeded on the assumption that Section 21 should be applied to novel financial innovations, even if not offered by traditional depository institutions, and that application of the provisions should turn on a nuanced examination of the product in question and the relationship between contracting parties. The formulation of the Heymann Letter was quickly embraced by federal authorities in both the banking and securities fields. [9]

Federal authorities should approach stablecoins in precisely the same manner. Quite clearly, it would seem, stablecoin issuers are attempting to produce a deposit-like product, with a value tied to the U.S. dollar. Not surprisingly, some knowledgeable observers have already concluded that stablecoins are “bank-like,” [10] but federal authorities should engage in a more systematic review of the range of stablecoin products entering the market and determine which of these products pose the kinds of policy concerns that Section 21(a)(2) was designed to police. [11] As they approach this analysis, one question that federal authorities will need to consider is whether legal formalities—such as the structuring of stablecoins as pro rata interests in asset pools—should preclude the conclusion that these instruments constitute Glass Steagall Act deposits, especially to the extent that marketing materials emphasize that the pools will be managed to ensure tokens retain a constant value and that the tokens will deliver what their names suggest: price stability. The failure of the Heymann letter to recognize practical realities of this sort does not preclude federal authorities from taking a different approach today. In our view, the capacity for destabilizing regulatory arbitrage in this area is substantial and we would counsel for a more flexible and capacious approach to interpreting section 21(a)(2). [12]

Denominating stablecoins as Glass-Steagall deposits is not tantamount to banning them. Instead, it simply means that issuers of these tokens need to satisfy one of the three statutory exemptions that the provision provides. Defining the scope of these exemptions is another area where federal authorities must focus their efforts. Currently a number of state authorities are experimenting with chartering and licensing arrangements for stablecoin issuers and it is possible that some federal agencies, like the OCC, might follow suit. Which of these arrangements satisfy the requirements for supervision and regulation that section 21(a)(2)’s exemptions require is something that the federal authorities should address. To date, the relationship between federal and state oversight of digital assets has been murky terrain, but at least with respect to stablecoins, section 21(a)(2) offers a path forward whereby federal authorities can determine a national framework and then private firms can choose which approved regulatory structure provides the most appropriate approach for their particular business models. [13]

Finally, a word on institutional structure. While Secretary Yellen has invoked the President’s Working Group to commence an initial investigation of stablecoins, the PWG is not a statutory body and historically has limited itself to writing reports, many of which have not resulted in concrete actions. The task of interpreting section 21(a)(2) and addressing the appropriate scope of permissible exemptions will be an ongoing task requiring coordination with a variety of regulatory authorities as well as, potentially, with the Department of Justice for purposes of updating the Heymann Letter. [14] In our view, a working committee of the Financial Stability Oversight Council (FSOC) would be a more appropriate vehicle for work of this sort. [15] FSOC is charged with monitoring gaps in regulatory coverage (of which stablecoins are clearly a prominent case in point). [16] In addition, the Council has formal linkages with state regulators and the capacity to make recommendations to member agencies was well as Congress. [17] While details of institutional design are perhaps best left for a later day, the emergence of stablecoins demonstrates the value of creating a standing inter-agency mechanism for monitoring the application of regulatory perimeters to new financial innovations.

Stablecoins present an excellent first assignment for such a working group.


1See U.S. Department of the Treasury. Readout of the Meeting of the President’s Working Group on Financial Markets to Discuss Stablecoins (July 19, 2021) (https://home.treasury.gov/news/press-releases/jy0281)(go back)

212 U.S.C. § 378(a)(2).(go back)

3Section 21(a)(2) provides as follows: To be lawful, an entity taking Glass Steagall deposits “(A) shall be incorporated under, and authorized to engage in such business by, the laws of the United States or of any State, Territory, or District, and subjected, by the laws of the United States, or of the State, Territory, or District wherein located, to examination and regulation, or (B) shall be permitted by the United States, any State, territory, or [D]istrict to engage in such business and shall be subjected by the laws of the United States, or such State, territory, or [D]istrict to examination and regulations or, (C) shall submit to periodic examination by the banking authority of the State, Territory, or District where such business is carried on and shall make and publish periodic reports of its condition, exhibiting in detail its resources and liabilities, such examination and reports to be made and published at the same times and in the same manner and under the same conditions as required by the law of such State, Territory, or District in the case of incorporated banking institutions engaged in such business in the same locality.” 12 U.S.C. § 378(a)(2) (emphasis added).(go back)

4Cf. United States v. Jenkins, 945 F.2d 167 (2nd Cir. 1991) (“[T]he plain language of section 378(a)(2) [the provision of the U.S. Code that codifies Section 21(a)(2)] does not require the government to prove the existence of an actual bank in order to obtain a conviction.”).(go back)

5See Senate Report No. 1007, 74th Cong., 1st Session 15 (1935). This report accompanies the Banking Act of 1935, which substantially amended the text of section 21(a)(2). See Banking Act of 1935, ch. 614, title III, § 303, 49 Stat. 707 (1935). In the original, 1933 version of the provision, unregulated private banks were subject to examination by either Federal Reserve District Banks or the OCC. See Banking Act of 1933, ch. 89, § 21, 48 Stat. 189 (1933). Finding this allocation of responsibilities impractical and potentially misleading, the 1935 Act amendments required regulation of such entities under existing supervisory mechanisms through three explicit exemptions that survive, in slightly amended form, in the current version of section 21(a)(2).(go back)

6In an analogous context at the state level, officials have similarly used a functional definition of deposit-taking to determine which entities are considered to be engaged in the business of banking and thus subject to state banking laws. See Michael S. Barr, Howell E. Jackson & Margaret E. Tahyar, Financial Regulation: Law and Policy ch. 1.3 (Foundation Press 3rd ed. 2021) (hereinafter Barr-Jackson-Tahyar).(go back)

7See Letter from Assistant Attorney General Philip Heymann, Criminal Division, to Martin Lybecker, Associated Director, SEC Division of Marketing Management (Dec. 18, 1979). While the Heymann letter focused on not Section 21(a)(2) but Section 21(a)(1), which prohibits entities that receive Glass-Steagall deposits from “engag[ing] in the business of issuing, underwriting, selling, or distributing…securities,” its analysis of “deposit” applies equally to Section 21(a)(2). In addition, the letter that prompted Assistant Secretary Heymann’s response expressly raised section 21(a)(2) as a statutory barrier to money market funds. See Money Market Mutual Funds: Hearings Before the Subcommittee on Financial Institutions of the Senate Committee on Banking. Housing and Urban Affairs, 96th Cong., 2nd Sess. 472-80 (1980) (reproducing Oct. 18, 1979, letter from Bowery Savings Bank to New York and federal authorities).(go back)

8Somewhat surprisingly, the Heymann letter does mention a critical design feature of all money market mutual funds at the time, which is fixed net asset value, typically set at $1 per share, under the terms of SEC Rule 2a-7, 17 C.F.R. § 270.2a-7 (1921). The reported value of MMMF shares therefore to not fluctuate as long as the value of underlying assets stay within proscribed boundaries. More understandable is the letter’s inability to foresee that the asset management industry (with the SEC’s blessing) would establish a practice of buying out non-performing assets in money market funds whenever those valuations threatened to force an MMF to “break the buck” and that both the Treasury Department and the Federal Reserve would intervene to support money market funds when financial crises made impractical for sponsors to provide adequate support. See Barr, Jackson & Tahyar, supra note 3. Ch. 12.3. We discuss below how the holding of the Heymann Letter might be restated in light of subsequent experience to tie the lawfulness of money market funds under section 21 to the existence of effective SEC oversight.(go back)

9John A. Adams, Money Market Mutual Funds: Has Glass-Steagall Been Cracked?, 99 Banking L.J. 4 (1982).(go back)

10Stablecoins Come with Bank-Like Risks, Fin. Times (July 27, 2021).(go back)

11A preliminary and quite helpful effort along these lines has been attempted recently in Gary B. Gorton and Jeffery Zhang, Taming Wildcat Stablecoins (July 17, 2021) (avail. at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3888752). See also James J. McAndrews & Lev Menand, Shadow Digital Money (March 2020) (avail. at https://ssrn.com/abstract=3554006); Dan Awrey, Bad Money, 106 Cornell L. Rev. 1 (2020).(go back)

12To the extent that federal authorities accept the position that equity-like stablecoins are not Glass Steagall Act deposits, there remain other regulatory perimeters to consider, most notably the definition of securities under federal securities laws in their current form or as amended in the future. See Remarks of SEC Chair Gary Gensler Before the Aspen Security Forum (Aug. 3, 2021) (avail. at https://www.sec.gov/news/public-statement/gensler-aspen-security-forum-2021-08-03). The FSOC working group we propose here could also provide expert guidance on the SEC’s regulatory perimeter without the need for further legislation.(go back)

13Conceivably, a reinvigorated interpretation of section 21(a)(2) could raise questions about the applicability of the provision to established payment firms like PayPal or Venmo, some of which currently operate under state money transmitter rules and also comply with FinCen requirements with respect to anti money laundering statutes. If so, federal authorities could clarify that these businesses qualify under the subsection (B) exemption for firms “permitted by the United States [or] any State…to engage in such business and…subjected by the laws of the United States, or such State,…to examination and regulations.” In a similar spirit, the old Heymann letter could be reformulated to authorize money market mutual funds not because they are not Glass Steagall deposits, but because they are currently adequately authorized by the SEC’s rule 2a-7 and associated supervisory mechanisms. Importantly, entities that issue Glass-Steagall deposits not only must meet one of the three exemptions in Section 21(a)(2) but, per Section 21(a)(1), must also refrain from “engag[ing] in the business of issuing, underwriting, selling, or distributing…securities.” This latter provision, in our view, would not present an issue for payment companies unless they ventured into the investment banking business. A reinvigorated interpretation of section 21(a)(2) could have regulatory implications for such companies under the Bank Holding Company Act’s definition of “bank” if such companies also engage “in the business of making commercial loans.” 12 U.S.C. § 1841(c).(go back)

14There are a variety of ways in which coordination with the Department of Justice could be structured. Perhaps most simply, the Treasury Department’s general counsel could negotiate with Justice, most likely with the Deputy Attorney General, to memorialize an understanding on this matter. Memoranda of agreement of this sort are common in areas where multiple agencies have overlapping responsibilities and expertise. See Daphna Renan, Pooling Powers, 115 Columbia L. Rev.221 (2015) (describing numerous examples). The Department of Justice would not need to be actively engaged in deliberations of the FSOC working group or to sign off in advance on each determination. Rather it would be sufficient for DOJ simply to acknowledge in the memorandum of agreement that it would take into account, as expert assessments, the working group’s determinations as to whether an activity, such as the issuance of stablecoin tokens, constituted the issuance of Glass Stegall deposits and also whether the supervisory regime governing such activities qualified under the three exemptions set forth in section 21(a)(2). DOJ recognition of the FSOC working group processes in this way should be sufficient to give the necessary assurances to financial firms. Such a division of responsibilities would also be consistent with the codification of section 21(a)(2) in a portion of the U.S. Code allocated to the Federal Reserve.12 U.S.C. § 378, and also resonate with the role that the Federal Reserve and the OCC were assigned in the 1933 Act version of section 21(a)(2). See supra note 4. The memorandum of agreement could also specify whether DOJ and perhaps also other FSOC member agencies has the authority to pursue civil enforcement actions under Section 21. Although Section 21 expressly refers only to criminal penalties, courts have located implied public rights of action, including actions seeking injunctive relief, even when criminal penalties exist. See, e.g., Wyandotte Transportation Co. v. United States, 389 U.S. 191 (1967).(go back)

15FSOC is expressly authorized to establish special committees “as may useful in carrying out the functions of the Council” and these committees may consist of Council members or other persons. See Dodd-Frank Act of 2010, § 111, 12 U.S.C. § 5321(d).(go back)

16Dodd-Frank Act of 2010, § 112, 12 U.S.C. § 5322(a)(2)(G). FSOC is also the body charged with identifying emerging threats to financial stability, and for designating both firms and financial utilities as systemically important and subject to supplemental regulation by the Federal Reserve Board. Id. § 5322(a)(1)(A). While it is debatable whether stablecoins are yet at a scale to constitute systemic risks, the products do have systemic risk potential. A further advantage of having FSOC involved in establishing and overseeing the section 21(a)(2) exemptions made available to stablecoins is that this responsibility will mean that the Council will be well-positioned to monitor the growth of stablecoins and reevaluate their systemic importance over time.(go back)

17For a legislative proposal to comprehensively update of Section 21(a)(2), see Morgan Ricks, The Money Problem: Rethinking Financial Regulation ch. 9 (2016).(go back)

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