The Texas Department of Banking Has Become Untethered

Suggests the Exchange of a Stablecoin Backed by a Sovereign Currency is Money Transmission

Is Texas Reminting Its Pro-Crypto Stance?

In 2014, the Texas Department of Banking was at the vanguard of cryptocurrency regulation, protecting Bitcoin and other cryptocurrencies from stifling state-law money transmission laws. In Supervisory Memorandum 1037, entitled “Regulatory Treatment of Virtual Currencies Under the Texas Money Services Act,” Texas became the first state to exempt the exchange of “virtual currencies” from “money transmission” licensing requirements. Several states followed Texas’s deregulatory lead.

In 2018, the Texas State Securities Board was at the forefront of protecting consumers from perceived fraud associated with cryptocurrencies, issuing sixteen Enforcement Orders.

Now, in 2019, the Texas Department of Banking is once again leading states in digital currency regulation – revising and replacing its 2014 “Supervisory Memorandum” – to clarify that Texas money transmission laws apply to stablecoins backed by sovereign currency. Is Texas leading in the right direction? After 5 years, is the Department of Banking still pro-crypto?

To be clear, while its new policy “revises and supersedes” its previous guidelines, the Department of Banking emphasizes that its Supervisory Memorandum applies exclusively to sovereign-backed stablecoins and not other virtual currency, which will continue to be exempt from state licensing requirements for money transmission.

What is a Stablecoin?

To define stablecoins within its Memorandum, the Texas Department of Banking first broadly defines virtual currency (synonymous with cryptocurrency within this blog post) as “an electronic medium of exchange typically used to purchase goods and services from certain merchants or to exchange for other currencies, either virtual or sovereign.” In turn, the Memorandum defines sovereign currency as a government-issued currency with legal tender status.

A stablecoin, the Texas Department of Banking explains, represents a “centralized virtual currency,” which means that it has been “created and issued by a specified source” that “relies on an entity with some form of authority or control over the currency.” A subclass of centralized virtual currencies, stablecoins denote a specific kind of centralized cryptocurrency backed by their issuer with either conventional currency, precious metals, or another cryptocurrency. Because stablecoins are secured by an underlying asset, in theory they should retain a somewhat stable value.

Sovereign-backed stablecoins may have a “redemption right,” which allows the coin’s holder to redeem the coin for sovereign currency from the issuer. If a stablecoin provides its holder a redemption right for sovereign currency, the Texas Department of Banking’s “licensing analysis” will hinge on whether the stablecoin grants the holder a redemption right for sovereign currency, effectively “creating a claim that can be converted into money or monetary value.”

Are Sovereign-Backed Stablecoins Money?

The Texas Department of Banking emphasizes that it does not wish to create new regulatory schemes to govern the proliferation of modern technologies. Rather, it leans on existing statutory guidance. In the case of stablecoins, the Department has opted to reinterpret the Texas Money Services Act, determining that a stablecoin “may be considered money or monetary value” for purposes of the Act, and therefore, “receiving it in exchange for a promise to make it available at a later time or different location may be money transmission.”

Most cryptocurrencies, including the largest and most dominant—Bitcoin and Monero—will not be affected by the Department of Banking’s Memorandum. However, the issuance or exchange-hosted transmission of sovereign-backed stablecoins like Tether, currently the most widely used stablecoin measured in trading volume and availability, is now likely to implicate Texas’s money transmission laws. The Department of Banking’s Memorandum also applies to other types of stablecoins such as the Gemini Dollar, the Paxos Standard Dollar, the TrueUSD, and the USD Coin.

In order to comply with Section 151.307 of the Texas Finance Code, exchanges must satisfy a minimum net worth requirement of $500,000, and Section 151.001 of the Texas Finance Code, the Texas Money Services Act. These requirements are largely the same as those applicable to traditional, non-virtual monetary exchanges. Exchanges involving sovereign-backed stablecoins should take further note that in many instances, Section 151.303 of the Finance Code prohibits any advertising, soliciting, or representing that the entity engages in the business of money transmission in this state unless a license is first obtained.

The Department of Banking’s final licensing requirement aligns with the goals of its sister-agency, the Texas State Securities Board, by imposing strong consumer protections against hacking. Addressing common fears over virtual currency’s susceptibility to cyberattacks—notably publicized by both the infamous “Mt. Gox” disappearance of 450 million dollars-worth of Bitcoin and the 55-million-dollar hack on Ethereum—the Commissioner requires that license applicants handling virtual currencies in the course of money transmission must conduct and present a third-party security assessment of their relevant computer systems. Regarding the assessment’s prescribed scope, the Memorandum presents a list of pertinent concerns, including:

• Network security;
• Website and web application security;
• Application server security;
• Virtual currency wallet infrastructure security and controls;
• Information security policy assessment; and
• Application development controls and policy assessment.

The Future of Cryptocurrency Regulation in Texas

Does the Department of Banking’s recent Memorandum signal a departure from its arguably pro-crypto ideological bent? We think not. The Department’s continued hands-off approach to the regulation of non-sovereign backed, non-stablecoin cryptocurrencies reflects a willingness to let a nascent market develop without stifling regulations. In fact, the stability of virtual currencies like Bitcoin could even stand to benefit.