Stablecoins To Become ’Pillar’ Of US Payment System Following PayPal Entry

August 9, 2023
PayPal has become the first US payments company to launch a dollar-backed stablecoin, following a crucial step towards new legislation that could bring stablecoins under federal regulation.

PayPal has become the first US payments company to launch a dollar-backed stablecoin, following a crucial step towards new legislation that could bring stablecoins under federal regulation.

As announced this week, PayPal has launched PayPal USD, a new payment stablecoin backed by US dollar deposits, short-term US Treasury bills and cash equivalents.

PayPal USD will be issued on the ethereum blockchain by New York-based Paxos Trust Company, and will be redeemable 1:1 for US dollars via Paxos.

From this week onwards, PayPal customers will be able to fund purchases using PayPal USD by selecting the stablecoin option at checkout, and will be able to send peer-to-peer (P2P) payments using PayPal USD.

They will also be able to transfer PayPal USD between their PayPal account and other ethereum-compatible wallets, or convert any cryptocurrency available on PayPal to or from PayPal USD.

In a statement, PayPal said that regulated stablecoins have the potential to “transform” payments in web3 and digitally native environments.

"The shift toward digital currencies requires a stable instrument that is both digitally native and easily connected to fiat currency like the US dollar," said Dan Schulman, president and CEO of PayPal.

"Our commitment to responsible innovation and compliance, and our track record of delivering new experiences to our customers, provides the foundation necessary to contribute to the growth of digital payments through PayPal USD."

Lawmakers’ and investors’ reception

In the US Congress, lawmakers made similar statements about the impact of PayPal’s entry into the market for payment stablecoins.

Representative Patrick McHenry (R-NC), chair of the House Financial Services Committee, mentioned PayPal by name following the launch of the stablecoin.

“This announcement is a clear signal that stablecoins — if issued under a clear regulatory framework — hold promise as a pillar of our 21st century payments system,” he said.

“Clear regulations and robust consumer protections are essential to enabling stablecoins to achieve their full potential.

“That’s why it’s more important than ever that Congress enact legislation to provide comprehensive digital asset regulation, especially for stablecoins.”

Lauren Tierney, venture investor at Decasonic, a web3, blockchain and digital asset-focused firm based in Chicago, also said that PayPal’s “strong global brand” will help drive usage of regulated stablecoins.

"The launch of PayPal's stablecoin not only reinforces its standing as a global brand, but also offers a unique opportunity to educate merchants and consumers on the transformative potential of web3 and its impact on everyday transactions,” she told VIXIO.

"PayPal's introduction of their stablecoin represents a pivotal step towards bridging the worlds of traditional finance and web3, fostering the convergence of digital and physical economies."

Legislation getting closer

Last week, several days before the launch of PayPal USD, the House Financial Services Committee passed the bipartisan Clarity for Payment Stablecoins Act, which will now head to Congress for its final vote.

The act is the first piece of legislation to regulate stablecoins on a federal level, but as noted in Section 7(g), the act does not “pre-empt” or “supersede” state law as it pertains to stablecoin issuance.

In PayPal’s case, PayPal has held a BitLicense issued by the New York State Department of Financial Services (NYDFS) since June 2022, which serves as its authorisation to issue a stablecoin.

Similarly, Paxos holds a charter as a limited purpose trust company under New York Banking Law, which serves as an alternative route towards authorised stablecoin activity in New York state.

In 2020, Paxos also applied for a national trust bank charter, and received provisional approval in 2021.

Rules for issuers

According to McHenry, the Clarity for Payment Stablecoins Act builds on the “successful” rule sets laid out by state regimes, including New York’s.

The act aims to protect consumers from risky stablecoin offerings, while at the same time fostering innovation and creating a structured path for new entrants to the marketplace.

As per Section 3, payment stablecoin issuers must maintain reserves backing their stablecoin tokens on at least a 1:1 basis, with reserves comprising US dollar deposits or Treasury bills with a maturity of 90 days or less.

Other permitted reserves include central bank reserve deposits, Treasury bill repurchase agreements with a maturity of seven days or less, or other assets authorised by state or federal stablecoin regulators.

Issuers must publish a clear policy for redemption of stablecoin tokens, and must publish monthly third-party attestations showing their total issuances and redemptions.

From September onwards, PayPal said that Paxos will begin publishing third-party attestations of the value of PayPal USD’s reserve assets.

The attestation will be issued by an independent accounting firm and conducted in accordance with standards established by the American Institute of Certified Public Accountants (AICPA).

These requirements are spelled out in the act, as is a requirement for the CEO and CFO of all payment stablecoins issuers to sign off on their third-party attestations.

Another major element of the act is its prohibition of rehypothecation of reserves for any purpose other than to “create liquidity” to meet redemption requests.

This exception would cover, for example, the conversion of US dollars into Treasury bills, or vice versa, if advantageous to the issuer in light of liquidity and redemption demands.

The main reason for the prohibition on rehypothecation is so that stablecoin reserves are not “re-used” or “re-pledged”, which would effectively create a fractional reserve stablecoin.

Issuing a stablecoin without sufficient reserves is something that Binance has been accused of in New York with regard to its BUSD stablecoin, and which ultimately led the NYDFS to wind-up the stablecoin.

It was also at the heart of the collapse of TerraUSD, whose collateral token, LUNA, was an asset of no fixed value that could be purchased using a wide range of cryptocurrencies that were also of no fixed value.

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