Leash, regulated or not?
Newbies to the crypto room are quickly confronted with a popular distinction between regulated stablecoin and unregulated stablecoin. But what’s the difference? Tether, the largest of the stablecoins, is often referred to as unregulated. However, Tether executives and supporters disagree with this claim. Who is right?
JP Koning, a CoinDesk columnist, worked as a stock researcher for a Canadian brokerage firm and as a financial writer for a major Canadian bank. He runs the popular moneyness blog.
Tether is the most popular medium of exchange in the crypto economy. With nearly $ 25 billion worth of US dollar tether stablecoins inventory, the company has become one of the world’s largest non-bank US dollar issuers. For context, there are approximately $ 32.5 billion in PayPal balances outstanding. It took PayPal more than 20 years to reach this level. Tether did it in just six!
Tether’s story is even more intriguing as it has been haunted for years by speculation that its reserves are deficient. In fact, New York Attorney General Letitia James is currently investigating Bitfinex, a subsidiary of Tether, for allegedly violating the New York Securities Act by using Tether’s reserves to cover losses.
It is easy for potential stablecoins users to get confused by these mixed signals. Tether’s incredible growth implies a high level of market confidence in the stablecoin, but ongoing rumors about its reserves say the opposite.
See also: Questions about tether just don’t go away. Is the crypto market interested?
One of the rules of thumb that anyone can use to build trust in a financial institution is that they have regulations in place. Is there a neutral government agency that oversees or regulates the finances of a financial institution? If so, this provides a layer of protection for users.
Unfortunately, regulation can also be confusing. Podcaster Laura Shin recently had a conversation with Gregory Pepin, Deputy CEO of Deltec, the banker of Tether. Pepin responded to recent allegations that Tether does not have sufficient dollars in his bank account for every Tether spent. The conversation turns to regulation at 8:50 p.m. when Shin Pepin asks if Tether is regulated or not:
Shin: Can you name a regulator for tether?
Pepin: The regulator in relation to Tether and in relation to Paxos and USD Coin and all of them are all FinCEN registered. And that’s what that means for AML and KYC [anti-money laundering and know your customer]And that’s the most important thing because if you look at all of Janet Yellen’s comments, it’s all about money laundering and terrorism. And at this level they are all regulated equally, they are all registered with FinCEN.
In his response, Pepin claims that tether is regulated. And he suggests that it is Tether’s registration with FinCEN that gives Tether regulated status, putting it on par with its stable coin competitors like USD Coin, which are also registered with FinCEN. By the way, FinCEN is the Financial Crimes Enforcement Network, an office of the US Treasury Department that defines rules for combating money laundering.
Paolo Ardoino, Tether’s Chief Technology Officer, has made the same claim that Tether is on par with other stablecoins because it is “regulated under FinCEN”.
Tether’s General Counsel, Stuart Hoegner, made the same suggestion. When asked on Twitter about Tether’s regulation, Hoegner implied that it is Tether’s registration with FinCEN that qualifies Tether as a regulated financial institution:
So here we have a data point that could ease crypto newbies worries about tether backing. Tether is regulated so presumably users are protected.
Unfortunately, this claim is misleading.
Tether is not regulated by FinCEN. Rather, it is registered with FinCEN. These two R-words are very different. When an institution is registered with FinCEN, it means that FinCEN has provided it with an electronic account for uploading Suspicious Transaction Reports (SARs) and USD 10,000 Cash Transaction Reports (CTRs). According to the FinCEN requirements, a registered company must also take measures to record and verify the identity of customers.
While it’s commendable that Tether registers with FinCEN, gathers customer information, and regularly files SARs, there is nothing special about that status. Even Dale & Jackie’s Discount Liquor in Decatur, Illinois is registered with FinCEN:
By the way, take a look at the disclaimer that FinCEN puts at the end of the registration status of Dale & Jackie. “A company’s listing on the MSB Registrant Search website is not a recommendation, endorsement of legitimacy, or endorsement of the company by any government agency.” In other words, neither Dale & Jackies Discount Liquor nor Tether should advertise their registration with FinCEN as a legal seal of approval. However, this seems to be what Deltec and Tether executives are doing on Twitter and in podcasts.
What neophyte stablecoin users need to understand is that FinCEN does not provide a financial regulatory framework for money service providers like Tether, PayPal or Dale & Jackie’s. That said, FinCEN doesn’t care about the capitalization or assets of Dale & Jackie. It is not checked whether the dollars created by these issuers are 100% covered.
We have a separate group of government institutions that screen money service companies for capital adequacy and adequate support. In the United States, financial regulation of money services companies is performed by government financial services departments. (Here is a list).
See also: What Are Stable Coins?
PayPal, which I mentioned above, is regulated as a money services company in over 50 different US states. Circle and Coinbase, which together issue the second largest stablecoin, the USD coin, are licensed by several state financial services departments.
Each government financial services regulator has its own set of rules, but generally they all require that money service providers limit their investments to a range of eligible securities, provide a guarantee or letter of credit with the regulator as collateral, and / or maintain minimum asset requirements. Money services companies are also required to provide their government financial regulator with annual audited financial statements and audits as necessary. State regulators often mandate background checks on executives and directors to help prevent fraud.
Stablecoins Paxos Standard and Gemini Dollar are regulated slightly differently than USD coins. Issuers Gemini Trust and Paxos Trust are licensed as limited trust trust companies by a single state financial services division, the New York State Department of Financial Services (NYDFS). To qualify, they are required to meet the same standards that a bank would. (The requirements are here).
PayPal, Coinbase, Circle, Gemini Trust and Paxos Trust all have the distinction of being able to communicate to the public that the dollars they spend must comply with a certain financial regulatory framework designed for money services companies. That is, customers have some guarantee that a regulator is setting quality standards for the dollars produced by these issuers.
Tether, on the other hand, is not regulated by the NYDFS. It’s also not regulated by any other U.S. financial services division.
We know Tether has a connection to the Bahamas (Deltec is there, after all), but a quick check of the Central Bank of Bahamas (CBB) registry reveals that Tether is not licensed with the CBB as a money transfer company or as an e-money Service provider. Tether is incorporated in the British Virgin Islands, but a search by the British Virgin Islands Financial Services Commission, which regulates BVI-based banks and money services companies, does not show that Tether is one of their regulated entities.
See also: Nic Carter – Nationalizing Stable Coins Won’t Improve Financial Access
So, if Pepin, Ardoino and Hoegner are to allay public concerns about Tether’s reserves by claiming that Tether is operating under a financial envelope, they have to tell us, what exactly is the government agency that acts as a financial regulator?
The FinCEN registry should not be used in a debate about how financially secure Tether is. When it comes to questions about a money services company’s reserves, the relevant regulator would be something like NYDFS or another state financial services division or the Central Bank of the Bahamas (which has a monetary services company licensing framework). Only these regulators make it their business to review a monetary services company’s financial statements, veterinarians and directors, and establish rules for permitted investments. FinCEN not.
It is not a sin to be an unregulated financial institution. There are many well-run and legitimate money services companies that do not operate under a specific framework for financial oversight. However, it is a sin for a financial institution to claim that its finances are regulated – and to point to FinCEN’s registration as evidence – when in fact it does not adhere to a specific framework for financial supervision. This is fake advertising.