Paxos has noted that stablecoins are becoming core infrastructure for the global financial sector. They aim to enable faster settlement, economical cross-border payments as well as efficient on- and off-ramps between traditional and digital markets. Paxos pointed out that as adoption accelerates, so do the queries from financial institutions.
Paxos pointed out that FIs may want to know more about what makes one stablecoin safer than another. And perhaps which issuance models are “most aligned” with global banking standards.
According to a blog post by Paxos, the answer comes down to the regulatory framework that is responsible for overseeing issuance (or lack thereof) and the strength of the reserves backing the particular stablecoin (if any at all).
Paxos has explained that trust company-issued stablecoins – digital tokens fully backed by cash and U.S. Treasuries, “held in bankruptcy-remote trust accounts and supervised by state or federal banking regulators – stand apart as the most regulated and safest form of issuance, providing banks and global enterprises with confidence in the integrity of the instrument.”
As noted in the update, it’s vital to differentiate between being licensed or registered and being “supervised by a regulator.”
The blog post also mentioned that a state money transmitter license, like those held by USDC’s issuer Circle, mandates adherence to “specific state rules for offering products to state residents.”
As clarified in the update, state licensors do not actually oversee the stablecoin product or its reserves.
According to the insights, this lack of comprehensive regulatory supervision over reserves “allows issuers to invest them as they see fit.”
In addition to this, registration of the issuer does not equal regulatory supervision of the token.
As stated in the update, most stablecoin issuers are registered with FinCEN, requiring them to properly “onboard customers and file Suspicious Activity Reports with the US government.”
Although FinCEN serves a key role in combating financial crime via these rigorous anti-financial crime hygiene standards, it does “not guarantee the security or 1:1 backing of reserve funds with US dollars.”
Paxos further noted that registration with FinCEN is “a fundamental requirement for any financial service provider, demonstrating adherence to crucial anti-financial crime measures, but it does not constitute regulation of the digital asset itself.”
They added that the registration of an issuer, therefore, “does not equate to the supervised regulation of the token.”
Paxos further explained that a trust company is “a special purpose financial institution chartered and supervised by state or federal banking regulators in the US.” Trust companies, particularly those regulated under the Office of the Comptroller of the Currency (OCC) and the New York Department of Financial Services (NYDFS), are held “to rigorous prudential standards designed to protect client assets.”
Trust company-issued stablecoins have critical safeguards that others do not:
- Bankruptcy remoteness: Reserves are held in trust, segregated from the issuer’s corporate balance sheet. Holders of a trust-issued stablecoin have a direct legal claim to the reserves. In the event of insolvency, these stablecoin holders will be able to recoup funds at par value with the dollar. Additionally, the issuer cannot lend out any customer assets and the regulator monitors that the trust company adheres to these practices.
- Rigorous regulatory oversight: Trust companies are subject to capital requirements, compliance examinations and ongoing supervision. The regulator consistently examines all aspects of the company to ensure it is adhering to the rules and laws.
- Transparent and high-quality reserves: Trust company charters require reserves to be held in cash and short-term U.S. Treasuries—assets with near-zero credit and liquidity risk. There is a limited list of financial instruments that the trust company can invest the reserve, which ensures consumer safety.
Most stablecoins in the US market today are issued by entities that are not regulated as trust companies – neither Circle nor Tether currently “issue their stablecoins in the US from trust companies.”
Instead, they may operate as money service businesses (MSBs), money transmitter licensees (MTLs), limited liability corporations or entities registered under “no clear regulatory regime.”
Although these issuers claim to back tokens “with high-quality reserve assets, a regulatory regime is not ensuring this is the case.”
Key concerns with non-trust company issuers include:
- Weaker risk management: Within the US, stablecoin issuers operating as MSBs or using MTLs to offer services in specific states are not required to operate with stringent risk management practices. Oversight is often limited to anti-money laundering compliance rather than prudential supervision and soundness of reserves.
- Unclear recourse: In the event of insolvency, these stablecoin holders may be considered unsecured creditors, leaving them without direct legal claims to reserves. This means the end consumer is unlikely to recoup funds at par value with the dollar or any recoup would be significantly delayed.
- Opaque reserves: Reserves may include riskier assets, long-dated instruments or securities that are not always liquid or held in bankruptcy-remote accounts. These issuers do not have regulations they must follow for how the reserves can be invested.
During the U.S. regional banking crisis in March of 2023, USDC and USDT temporarily “lost their 1:1 peg to the dollar.”
USDC fell as low “as $0.87” after Circle disclosed that $3.3 billion of its reserves were held at Silicon Valley Bank (SVB), which had collapsed and entered FDIC receivership.
Market participants were concerned that those funds may be unrecoverable, creating panic selling pressure.
Meanwhile, USDT briefly traded below $1 as investors “rotated into other assets and overall market confidence in stablecoins weakened.”
These dislocations indicted how reserve composition and counterparty exposure directly tend to impact stablecoin stability—and why holding “reserves in high quality liquid assets, under a trust framework, provides stronger protection in times of systemic stress.”
As global FIs evaluate how to integrate stablecoins into their ecosystem, the issuance model becomes a key factor.
Trust company-issued stablecoins should aim to provide the following:
- Regulatory confidence: Backed by a bank-grade supervisory regime.
- Legal certainty: Holders retain direct claims to reserves in the event of issuer distress.
- Market credibility: Transparent reserves eliminate the risks of hidden leverage or illiquidity.
For banking service providers as well as enterprises looking to operate at an international scale, only trust company-issued stablecoins—like those from Paxos—(reportedly) provide the security, compliance and transparency “necessary to build durable financial infrastructure.”
Stablecoins are no longer fringe instruments—they are “becoming embedded in the pipes of global finance.”
However, the risks of weak regulatory structures and opaque reserves are said to be quite real.
For banking and other larger institutions worldwide, the safest path is seemingly clear: stablecoins issued via a regulated trust company, “fully backed by cash and short-term U.S. Treasuries.”
This is the model Paxos started with in 2018 and it is also said to be the model that reportedly meets the standards of the world’s FIs.