Will your crypto rewards withstand the forthcoming CLARITY law? A straightforward overview of Section 404.

The Digital Asset Market Clarity Act, commonly referred to as the CLARITY Act, was intended to establish clear distinctions regarding crypto assets and the authority of regulators.

CryptoSlate has previously guided readers through the broader framework of the bill prior to the January markup, detailing what modifications were made, what issues remain unresolved, and why jurisdiction and state preemption might be as significant as the prominent definitions.

The aspect currently garnering the most attention is more specific and intricate: it pertains to who can compensate consumers for maintaining dollars in a certain location.

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This contention became increasingly difficult to overlook after Coinbase indicated it could not endorse the Senate draft in its current state, leading the Senate Banking Committee to delay a planned markup. Subsequently, the bill has entered a phase where staff are revising language, and lawmakers are assessing the authenticity of a new coalition.

Senate Democrats have stated they will continue discussions with industry representatives regarding their concerns, while the Senate Agriculture Committee referenced a parallel timeline, which includes their draft scheduled for January 21 and a hearing set for January 27.

To grasp why stablecoin rewards became a contentious issue, set aside the catchphrases and visualize a single screen: a user observes a dollar balance marked as USDC or another stablecoin alongside an offer to earn something for keeping it there. In Washington, that “something” translates to interest. In banking terms, “there” serves as an alternative to deposits.

In the Senate draft, the conflict is encapsulated in Section 404, titled “Preserving rewards for stablecoin holders,” which essentially instructs platforms on what they are permitted and prohibited from doing.

The line Congress is trying to draw

Section 404 stipulates that digital asset service providers are prohibited from offering any form of interest or yield that is “solely in connection with the holding of a payment stablecoin.”

This targets the most straightforward rewards product: depositing a payment stablecoin on an exchange or in a hosted wallet and receiving a stated return that accumulates over time without any further action required. Lawmakers view this as interest and see it as a direct funding rival to banks reliant on deposits.

The crucial phrase here is “solely in connection with the holding,” as it ties the ban to causality. If a user receives value solely because they hold the stablecoin, the platform is in violation. However, if a platform can credibly associate the value with another factor, the draft provides a way forward.

CLARITY attempts to outline that avenue by permitting “activity-based rewards and incentives,” followed by a list of acceptable activities: transactions and settlements, utilizing a wallet or platform, loyalty or subscription programs, merchant acceptance rebates, providing liquidity or collateral, and even “governance, validation, staking, or other ecosystem participation.”

In simpler terms, Section 404 distinguishes between compensation for merely holding and compensation for active participation. This prompts a subsequent debate over what qualifies as participation, since fintech has spent years mastering the art of transforming economic incentives into user engagement with minimal effort.

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The parts users will actually notice

Many readers will zero in on the yield ban and miss the dimension that could transform the user interface of stablecoin offerings: marketing and disclosures.

Section 404 forbids marketing that implies a payment stablecoin is equivalent to a bank deposit or is FDIC insured, that rewards are “risk-free” or comparable to deposit interest, or that the stablecoin itself is responsible for paying the rewards. It also encourages standardized plain-language disclosures stating that a payment stablecoin is neither a deposit nor government-insured, along with transparent attribution of who is funding the reward and what actions a user must undertake to receive it.

Banks and credit unions are concerned about public perception since it influences deposit flows. Their argument is that passive stablecoin yields may lead consumers to view stablecoin balances as safe cash, potentially accelerating the migration of deposits, which would first impact community banks.

The Senate draft acknowledges this concern by mandating a future report on deposit outflows and explicitly identifying deposit flight from community banks as a risk to be examined.

Conversely, crypto firms assert that stablecoin reserves already produce income, and they desire the flexibility to share some of that value with users, particularly in offerings that compete with bank accounts and money market funds.

The most pertinent question here is what remains after the bill is enacted and in what format.

A fixed APY for holding stablecoins on an exchange presents a high-risk scenario, as the benefit is “solely” connected to holding, necessitating platforms to establish a legitimate activity incentive to maintain that offering.

Cashback or points for utilizing stablecoins is considerably safer, as merchant rebates and transaction-linked rewards are specifically allowed, favoring cards, commerce perks, and various other “use-to-earn” strategies.

Rewards based on collateral or liquidity may be feasible since “providing liquidity or collateral” is included in the list, but the user experience burden increases because the risk profile resembles lending more than payments. Theoretically, DeFi pass-through yield within a custodial framework remains a possibility.

However, platforms will not escape the requirement for disclosures, and disclosures introduce friction, as they will need to clarify who provides the funding, what qualifies, and what risks exist in a manner that will be scrutinized in enforcement and legal contexts.

The key takeaway is that Section 404 encourages rewards to shift away from idle balance yields toward incentives that resemble payments, loyalty, subscriptions, and commerce.

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The issuer firewall and the phrase that will decide partnerships

Section 404 also contains a provision that may seem insignificant until viewed alongside actual stablecoin distribution agreements. It states that a permitted payment stablecoin issuer is not considered to be providing interest or yield merely because a third party independently offers rewards, unless the issuer “directs the program.”

This clause is the bill’s effort to prevent issuers from being classified as interest-paying banks due to added incentives from an exchange or wallet. It also cautions issuers to be cautious about how closely they engage with platform rewards, as such proximity could be interpreted as direction.

“Directs the program” is the pivotal term here. Direction may imply formal control, but the challenging cases involve influence that resembles control externally: co-marketing, revenue-sharing linked to balances, technical integrations intended to facilitate a rewards system, or contractual stipulations regarding how a platform presents the stablecoin experience.

In light of Coinbase’s objections and the delay in markup, this ambiguity has become the focal point of contention, as late-stage bill revisions often hinge on whether a single term is narrowed, expanded, or defined.

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The most likely outcome is, regrettably, not a clear win for either party. The market will probably witness the introduction of a new regime where platforms continue to provide rewards, but these will be structured through activity-based programs that resemble payments and engagement mechanics, while issuers maintain a distance unless they are ready to be regarded as participants in the compensation framework.

This is why Section 404 holds significance beyond the current news cycle. It concerns which rewards can be offered on a large scale without stablecoins being marketed as deposits under a different guise, and which partnerships will be classified as crossing the boundary from distribution to direction.

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