In the fast-paced world of digital assets, stablecoins stand out as a pivotal player, offering a bridge between traditional finance and the dynamic realm of digital assets. Despite recent challenges, such as those faced by the LUNA-backed TerraUSD, the appeal of stablecoins — especially those pegged to traditional assets like currencies, commodities and real-world assets — remains strong due to their high transactability.
This article delves into the diverse applications of stablecoins, the current regulatory landscape in the United States and key tax considerations shaping this evolving ecosystem.
Understanding stablecoins: Stability in a volatile world
At its core, stablecoins are designed to provide price stability by pegging their value to traditional currencies or other real-world assets. This positions stablecoins as a reliable tool for various financial applications, bridging traditional finance players to the digital asset economy.
Whether pegged to fiat currencies such as the dollar like the USDC; backed by commodities such as gold or crops, or governed by sophisticated algorithms, stablecoins are a digital store of value transferred on a secure and efficient network without the need for intermediaries. The ability to redeem these tokens for a pegged value mitigates the inherent volatility of other digital assets, making them attractive for decentralized applications (DApps) that offer secure storage and exchange mediums.
Exploring use cases: More than just a stable value
Stablecoins aim to address the issue of volatility in the digital asset market with transparency, security and efficiency. Notable applications include:
Efficient cross-border transactions
Stablecoins streamline global transactions, offering a faster, cost-effective and secure alternative to traditional banking methods. They are ideal for global business transactions, payments and remittances.
Decentralized finance (DeFi)
In the DeFi ecosystem, stablecoins provide a virtually volatility-free medium for various financial activities. such as investing, lending and borrowing, which use stablecoins to underpin the financial contracts offering yields and/or interest payments.
Tokenization of real-world assets (RWAs)
Stablecoins facilitate easier and fractional trading of digitized real-world assets including securities, commodities, real estate and collectible art, enhancing market liquidity and accessibility for traditionally illiquid assets.
Hedging and risk mitigation
During periods of crypto market declines, stablecoins act as a financial haven. They allow investors to swiftly move crypto assets into a stable medium to mitigate potential losses and convert and hold assets at a known value with almost no volatility.
U.S. regulatory landscape
The challenge to establishing comprehensive digital asset policies and regulations in the U.S. lies in the ongoing debates and deliberations over the authority of federal agencies, governments and their differing classification of digital assets, which currently includes stablecoins as securities, commodities, property or perhaps a unique asset class of their own.
Federal level regulations
At the federal level, the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and the Internal Revenue Services (IRS) offer contrasting viewpoints or rulings.
SEC Chairman Gary Gensler previously stated that “crypto products that are priced off of the value of securities and operate like derivates…are subject to the securities laws and must work within our securities regime.” This perspective hinges on the potential for stablecoins to impact broader market dynamics and the need for investor protections typically associated with securities regulation. One viewpoint is clear —since stablecoins are not issued by a central government, they are not considered legal tender.
Conversely, the CFTC, which has declared that “Bitcoin and other virtual currencies”1 are commodities, approaches stablecoins from a different angle. By initiating enforcement actions against stablecoin issuers for violations of the Commodity Exchange Act (CEA), the CFTC has signaled a solid stance on treating stablecoins as commodities. This approach stems from the viewpoint that stablecoins derive value from an underlying market or reference point, aligning them more closely with commodities.
The IRS recently expanded its definition of digital assets to include convertible virtual currency and crypto currency, stablecoins and non-fungible tokens (NFTs). For federal income tax purposes, digital assets are treated as property and are subject to general tax principles applicable to property transactions. The IRS’s classification as property has remained unchanged since the issuance of IRS Notice 2014-21.
State level regulations
Amidst this federal tug-of-war, state-level regulations present an additional layer of disparity. Jurisdictions such as Texas, New York and California have established unique frameworks for regulating stablecoin issuers.
Texas, for example, has integrated stablecoins into its existing money transmission laws under the Money Services Act, treating stablecoins backed by sovereign currencies as claims convertible into currency and fall within the definition of “money” or “monetary value.”
New York has opted for a more institution-centric approach, allowing stablecoin issuers to operate under a BitLicense or state-chartered trust company regulations, which include options like limited purpose trust companies.
California enacted the Digital Financial Assets Law (DFAL) on October 13, 2023, requiring license approval for stablecoin issuers and other “digital financial asset business activity”.3 Under the DFAL, starting on July 1, 2025, stablecoin issuers must be licensed or be a bank, trust company or national association engaged in a trust banking business and must always own eligible securities having a market value of not less than the aggregate amount of all its outstanding stablecoins issued or sold.
What is forthcoming for Stablecoin Regulation?
As the stablecoin sector continues to flourish, the absence of a comprehensive national framework becomes increasingly conspicuous. In the backdrop of the growth and adoption of stablecoins globally, this regulatory vacuum underscores the need for a harmonized and comprehensive regulatory approach.
In response, the Organization for Economic Cooperation and Development (OECD), along with 48 countries and jurisdictions (including the U.S.), developed the Crypto-Asset Reporting Framework (CARF) to provide for the automatic exchange of tax-relevant information on crypto-assets, including stablecoins.
Reportable transactions under the current framework are related to exchanges and transfers between “relevant crypto-assets.” Of relevance is the exclusion of 1) crypto-assets that do not have the capacity of being used for payment or investment purposes, 2) central bank digital currencies (CBDCs) and, 3) Specified Electronic Money Products that may include stablecoins if they qualify under the definition.
Ultimately, the weight of implementing these reporting standards falls on the shoulders of the participating countries and jurisdictions and their respective interpretation and legal definition regarding various forms of digital assets. Meanwhile, the digital asset industry is pushing ahead with the hope and expectation that collaboration among regulatory agencies, industry stakeholders, and legislators will shape the regulatory environment soon.
U.S. tax considerations
Understanding the tax implications of transacting with stablecoins is essential for businesses and individuals navigating the digital asset space. As U.S. tax guidance specifically addressing transactions in this industry remains limited, it’s important to consider several key aspects:
Capital gains and losses
Fiat-backed stablecoins are increasingly being used to pay for goods and services and as an off-ramp for exiting positions in other crypto assets. The sale, exchange or transfer of stablecoins, treated as property, is a taxable event and may trigger capital gains tax or losses based on the FMV at the time of the disposition. Stablecoins derive their value, eponymously, from underlying fiat-based currencies and, as such, any gain or loss is expected to be marginal.
Foreign exchange gains and losses
Cross-border transactions with fiat-backed stablecoins, such as EUROC, which is pegged to the Euro, may trigger IRC Section 988’s provisions concerning foreign exchange gains or losses, treated as either ordinary income or loss. This determination depends on the classification of stablecoins as derivative instruments, due to their connection with non-U.S. currencies as the underlying property.
Furthermore, the treatment of central bank digital currencies (CBDCs), such as the Bahamas’ Sand Dollar, introduces further intricacies under Section 988 due to their status as legal tender issued by central banks. With the emergence of CBDCs across various nations, how tax rules distinguish between fiat-backed stablecoins and CBDCs remains to be seen.
Withholding income tax implications
Receipt of stablecoins from participation in liquidity pools or staking protocols will generally result in taxable income equal to the FMV of stablecoins received and be subject to U.S. tax based on the character of income. Notwithstanding, the character of the income may impact the source and, ultimately, the taxability of the income.
While some “staked” rewards are akin to passive earnings received from interest-bearing savings accounts, lending products, and token equity dividends, staking as a service may be viewed as compensatory and ordinary in nature. This differentiation in income character could lead to varying withholding tax obligations for foreign investors on U.S. sourced staking rewards, contingent upon whether the rewards are classified as effectively connected income (associated with a U.S. trade or business) or as fixed, determinable, annual or periodic (FDAP) income.
FATCA reporting
Holding significant amounts of stablecoins in foreign accounts may require U.S. taxpayers to report such holdings as “foreign financial assets” under the Foreign Account Tax Compliance Act (FATCA). As stablecoins are considered a digital asset and treated as property for U.S. income tax purposes, it is likely to be reportable on Form 8938, Statement of Specified Foreign Financial Assets.
In transacting in stablecoins, maintaining accurate transaction records is crucial to ensure compliance with U.S. tax regulations.
Navigating the stablecoin landscape
As the world of digital assets continues to expand and evolve, stablecoins emerge as a critical element, offering a unique blend of innovation and stability. Their ability to bridge the gap between traditional finance and the digital asset space positions them as an integral piece of the future of finance.
The regulatory environment in the United States, while gradually taking shape, remains a complex and shifting terrain. The interplay between global policies and federal and state regulations emphasizes the need for a harmonized approach to ensure the stability and integrity of the stablecoin market.
Amid these developments, one thing is clear: stablecoins are more than just a digital asset — they are a testament to the ongoing convergence of technology and finance, reshaping the way we think about money, transactions and the very fabric of the financial system.
