#3 Legal Analysis of USDT

This article is a continuation of our article series on top 12 cryptocurrencies and their legal framework within the EU and the US. Though the current list of top 12 cryptocurrencies has changed quite a lot from the beginning of the year, we continue with the list as it was originally presented in February. Thus, this time we cover Tether (USDT).

USDT in a Legal Nutshell

USDT is a stablecoin pegged to the value of the US dollar, meaning that one USDT is worth one US dollar. For clarity, the purpose of stablecoins is to create stability and safety in an otherwise unstable (cryptocurrency) market.

USDT is the most used stablecoin in cryptocurrency transactions, and it is issued by a Hong Kong based company named Tether. Originally USDT was built solely on the Bitcoin blockchain, but nowadays it functions also on Ethereum, EOS, Tron, Algorand and OMG.

Tether has during recent years been surrounded by controversy in regard to whether Tether actually has in its possession the fiat reserves backing the circulating supply of USDT. Tether claims that every USDT is always backed by their reserves, which include traditional currency and other assets. Unlike with USDC (the second-largest stablecoin), Tether’s reserves are not audited by neutral third parties, and thus, there are widespread rumors and doubts that Tether would not in reality have 70 billion dollars in their reserve matching the 70 billion circulating supply of USDT. Also, unlike with USDC, the holders of USDT do not have any guarantee for redemption or exchange of USDT to fiat currency by Tether.

U.S. Regulation of USDT

As stated in our previous articles, there is no uniform regulation or regulatory authority for cryptocurrencies in the U.S. and each state has their own regulatory regime. The Financial Crimes Enforcement Network (FinCEN) has stated that based on their interpretation, the Bank Secrecy Act applies to cryptocurrencies. This also means that FinCEN has interpreted that its money services business regulations apply to cryptocurrency exchanges and administrators. U.S. states have also applied their own regulations on money transmission to cryptocurrencies and created cryptocurrency specific regulation. For example, New York and Louisiana have their own cryptocurrency licences, which are a stricter way of regulating cryptocurrency exchange operations.

The Office of the Comptroller of the Currency (OCC) has stated that national banks and federal savings associations supervised by the OCC are authorized to receive deposits from stablecoin issuers, including deposits that are considered stablecoin reserves, and may engage in activities that are incidental to accepting deposits from stablecoin issuers. The OCC has emphasized that the banks and federal savings associations must be vigilant with anti-money laundering regulations and Know-Your-Customer procedures prescribed under the Banking Secrecy Act and other federal banking laws. This OCC statement is, however, limited to stablecoins associated with one fiat-currency and redeemable by the holder with a 1:1 ratio, whereby it applies to USDT among others.

The Securities and Exchange Commission (SEC) has stated that stablecoins may be characterized as securities depending on the facts and characteristics of the stablecoin, and whether market participants may structure and sell a digital asset in a way that it does not constitute a security. SEC mainly determines assets as securities if they fulfill the so-called Howey conditions, which determine whether a transaction represents an investment contract, whereby such transactions are also considered as securities subject to applicable securities regulation.

Calls for a more comprehensive regulation scheme on stablecoins have increased lately as different government officials, including the SEC and the Federal Reserve, have called for stricter regulation for stablecoins in light of the already large stablecoin market growing rapidly, and the fact that stablecoins might have a significant part in facilitating payments in the near future. This stricter regulation might include mandatory regular audits or even bank-like regulations.

EU Regulation of USDT

In the EU, the regulation of cryptocurrencies is somewhat more straightforward and will most likely remain so for a while. Cryptocurrencies (including stablecoins) are defined in the Fifth Money Laundering Directive (5AMLD, EU 2018/843) as a digital representation of value i) that is not issued or guaranteed by a central bank or a public authority, ii) that is not necessarily attached to a legally established currency and does not possess a legal status of currency or money but is accepted by natural or legal persons as a means of exchange, and iii) that can be transferred, stored, and traded electronically. Thus, the EU’s anti money laundering regulations including customer due diligence, risk assessments, fit & proper test for directors and other regulations apply to cryptocurrency exchange operators and custodian wallet providers.

Based on the 5AMLD, some Member States have established a stricter license system for cryptocurrencies, and some Member States just require entities to follow general anti-money laundering regulations. The state of cryptocurrency regulation within the EU will, however, change significantly if/when the EU’s preliminary proposed cryptocurrency regulation (MiCA Regulation) is passed. As per the draft regulation, the definition of cryptocurrency will be amended (e.g. stablecoins shall be separately defined), stricter regulations to cryptocurrency operators will be implemented and new measures to prevent cryptocurrency market manipulation will be introduced.

The EU Commission has also introduced a new legislation package for preventing money laundering and terrorist financing that will also change cryptocurrency regulation in the EU. The extensive regulatory package seeks to extend the KYC obligations of cryptocurrency exchanges as well as to prohibit anonymous cryptocurrency wallets (which most likely is technically impossible). The package is, however, not finalized and thus might be subject to change during the legislative process.

As always, we shall keep you posted on the regulatory changes of cryptocurrencies.

Finally, our article series is approaching its final stages, whereby the only remaining cryptocurrencies are the original crypto heavy-hitters Ethereum and Bitcoin. Thereby stay tuned for the two remaining articles.

02.11.2021 MAX