Why Washington Is Worried About Stablecoins

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Stablecoins might be the most ironically named innovation of the cryptocurrency era, at least in the eyes of many regulators and policymakers in Washington.

These digital currencies promise to maintain their value, which is usually tied to a government currency like the dollar or the euro, by relying on stable financial support like bank reserves and short-term debt. They are exploding in popularity as they are a convenient and inexpensive way to transact in cryptocurrency. Stablecoins have grown from a virtual non-existence to a market of over $ 120 billion in just a few short years, most of that growth in the past 12 months.

But many are built more as slightly risky investments than the dollar and penny cash they claim to be. And so far, they’re slipping through regulatory loopholes.

The rush to oversee stablecoins – and industry lobbying to avoid regulation or side with profitability – could be the most important conversation in Washington financial circles this year. How officials deal with the thorny questions about a relatively new phenomenon will set the precedent for a technology that is likely to endure and develop, effectively writing the first draft of a rulebook that will govern the future of the industry. money.

The debate over how to deal with stablecoins is also inevitably linked to another hot conversation: Should the Federal Reserve be offering its own digital currency. A Fed offer could rival stablecoins in the private sector, depending on its characteristics, and the industry is already preparing for this possibility.

Below is an overview of what stablecoins are, why they can be risky, possible regulatory solutions, and the government’s likely next steps regarding their control.

A stable coin – a coin of stable value, if you’re feeling right – is a type of cryptocurrency that is typically pegged to an existing government backed currency. To promise holders that every $ 1 they invest will stay at $ 1, stablecoins hold a set of assets in reserve, typically short-term securities such as cash, government debt, or commercial paper.

Stablecoins are useful because they allow people to transact more transparently in cryptocurrencies that work like investments, like Bitcoin. They form a bridge between old world money and new world crypto.

But many stablecoins are backed by types of short-term debt that are prone to bouts of illiquidity, which means they can become difficult or impossible to trade in times of trouble. Despite this somewhat fragile support, the stablecoins themselves promise to function as perfectly safe holdings.

This makes it the type of financial product that “macroeconomic disasters typically stem from,” said Morgan Ricks, a professor at Vanderbilt University law school and a former policy adviser in the Treasury Department. “The stakes are really, really high here. “

That said, some people – including George Selgin, director of the Center for Monetary and Financial Alternatives at the Cato Institute – argue that because stablecoins are used as a niche currency and not as an investment, they may be less prone to downgrades. races in which investors try to withdraw their funds all at once. Even if their support is questioned, people won’t want the taxes and potential red tape that come with converting stablecoins to real dollars.

Since the technology is so nascent, it’s hard to know who is right. But regulators fear finding out the hard way.

Not all Stablecoins are created equal. The largest stablecoin, Tether, says it’s roughly half-invested in a type of short-term corporate debt called commercial paper, based on its recent disclosures. The commercial paper market melted in March 2020, forcing the Fed to step in to fix things. If these types of vulnerabilities were to recur, it could be difficult for Tether to quickly convert its holdings to cash to cope with withdrawals.

Other stablecoins claim different backing, which gives them different risks. But there are big questions about whether stablecoins actually hold the reserves they claim.

The Circle company had said its USD coin, or USDC, was backed 1: 1 by cash holdings – but then revealed in July that 40% of its holdings were actually in US Treasuries, certificates of deposit, commercial paper, corporate bonds and municipal bonds. debt. A Circle representative said that USDC will hold all reserves in cash and short-term U.S. Treasuries starting this month.

The New York Attorney General investigated Tether and Bitfinex, a cryptocurrency exchange, partly alleging that Tether at one point concealed what the coins had in store. The companies’ settlement with the state included a fine and improvements in transparency.

Tether, in a statement, noted that he had never refused a buyout and that he had changed his disclosures following the New York attorney general’s investigation.

The common thread is that without standard disclosure or reporting requirements, it’s hard to know exactly what’s behind a stablecoin, so it’s hard to assess the risk involved.

It is also difficult to keep track of how much use stablecoins are used.

Stablecoins “can make it easier for those looking to sidestep a host of public policy objectives tied to our traditional banking and financial system: anti-money laundering, tax compliance, sanctions, etc.,” said Gary Gensler, who heads the Securities and Exchange Commission. Senator Elizabeth Warren in a letter this year.

The problem with stable coins is that they fall through the cracks of regulation. They are not classified as bank deposits, so the Fed and the Office of the Comptroller of the Currency have limited ability to monitor them. The SEC has some authority if they are defined as securities, but it is a subject of active debate.

State-level regulators have been successful in exercising some oversight, but the fact that major deals – including Tether – are based abroad could make it more difficult for the federal government to exercise authority. Regulators are now examining their options.

The Treasury, the Fed, and other financial watchdogs have a few choices. It is not clear what they will choose, but the issue clearly looms large: The President’s Treasury-based Financial Markets Task Force is expected to release a report on the matter shortly. An upcoming Fed report on central bank digital currencies may also address the risks of stablecoins.

Here are some of the main regulatory options:

  • Designate them as systemic risk. Since stablecoins are closely linked to other important markets, the Financial Stability Supervisory Board could designate them as a systemic risk payment system, subjecting them to more stringent oversight.

    While the market may not be large enough to be considered a systemic risk at this time, the Dodd Frank Act gives regulators the flexibility to apply this designation to a payments business if it appears to be on the verge of becoming a payment business. threat to the system in the future. If that were to happen, then the Fed or other regulators would have to develop a plan to deal with the risk.

  • Treat them as if they were titles. The government could also label some stable titles, which would result in more extensive disclosure requirements. Mr Gensler told lawmakers at a recent hearing that stable coins “Maybe securities”, which would give his institution broader oversight.

  • Regulate them as if they were money market mutual funds. Many financial experts point out that stablecoins work much like money market mutual funds, which also act as short-term savings vehicles offering quick payouts while investing in slightly risky assets. But the money market funds themselves have required two government bailouts in just over a decade, suggesting their regulation is flawed.

    “Stablecoins don’t look new,” said Gregg Gelzinis, who focuses on financial markets and regulation at the Center for American Progress. “I see them either as an unregulated money market mutual fund or as an unregulated bank.”

  • Treat them as if they were banks. Given the loopholes in the oversight of money market funds, many financial regulatory enthusiasts would prefer stablecoins to be treated as bank deposits. If that were to happen, the tokens could come under the oversight of a banking regulator, such as the Office of the Currency Controller, Gelzinis said. They could also potentially benefit from deposit insurance, which would protect individuals if the company backing the stablecoin goes bankrupt.

  • Try to compete with the central bank’s digital currency. Jerome H. Powell, the chairman of the Fed, pointed out that competing with stablecoins could be one of the attractions of a central bank digital currency – a digital dollar that, like paper money, is directly tied to the Fed.

    “You wouldn’t need stablecoins, you wouldn’t need cryptocurrency, if you had an American digital currency. I think that’s one of the strongest arguments in its favor,” he said. Mr. Powell said during his testimony this year.

    But how a central bank digital currency is designed would be key to whether it succeeds in replacing stablecoins. And industry experts point out that since stablecoin users prioritize government privacy and independence, a new form of government-backed currency might not do much to supplant them.

  • Cooperate internationally. If there’s one point everyone in the conversation agrees on, it’s that different jurisdictions will need to work together for stablecoin regulation to work. Otherwise, coins will be able to move abroad if they are under unattractive surveillance in a particular country.

    The Financial Stability Board, a global watchdog, is working to establish standards and cooperation plans related to stablecoins, with final adoption in 2023.


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