Federal Reserve, Treasury, and other regulators worry that technology promising stability could actually lead to turmoil.
Stablecoins may be the most ironically named innovation in cryptocurrency, at least according to Washington policymakers and regulators.
They promise to keep their value, which is usually pegged to a currency like the euro or dollar, by relying upon stable financial backing such as bank reserves and short term debt. Because they offer a convenient and inexpensive way to transact cryptocurrency, they are rapidly gaining popularity. In a matter of years, stablecoins have gone from virtually nonexistence to an over $120 billion marketplace. The bulk of that growth has been in the last 12 months.
Many of these are more risky investments than they appear to be. They are already falling through the regulatory cracks.
The most talked about topic in Washington financial circles this fiscal year is the rush to supervise stablecoins and the industry lobbying push to avoid regulation or get on the profitable side. The way officials deal with sticky questions regarding a relatively new phenomenon will establish the precedent for technology that is likely lasts and grows. This will effectively write the first draft of the rule book that will govern future money.
Another hot topic is whether the Federal Reserve should offer its own digital currency. Depending on its features, a Fed offering might be able to compete with private sector stablecoins. The industry is already anticipating this possibility.
Here’s a quick overview of stablecoins, their risks, possible regulatory solutions, and the likely next steps for the government when it comes time to police them.
What is a stablecoin exactly?
Stablecoin, or stablevalue coin, is a type cryptocurrencies that can be pegged to existing government-backed currencies. Stablecoins promise that each $1 invested will be worth $1. They hold a variety of assets in reserve. These include cash and short-term securities like commercial paper or government debt.
Because they enable people to transact in cryptocurrencies that can be used as investments like Bitcoin, stablecoins are very useful. They act as a bridge between crypto-currencies and old-world currency.
Many stablecoins have short-term debt backing that can be volatile and make it difficult or impossible to trade in times of need. The stablecoins promise to be perfectly safe despite their uncertain backing.
They are the financial products “macroeconomic catastrophes often come from,” Morgan Ricks, a Vanderbilt University Law School professor and former policy advisor at the Treasury Department. “The stakes here are really, really high.”
Some people, including George Selgin (director of the Center for Monetary and Financial Alternatives, Cato Institute), argue that stablecoins may be less susceptible to investor attempts to withdraw all their funds at once. Even if their backing is questionable, most people won’t want to deal with the taxes and paperwork involved in changing stablecoins into real dollars.
It is difficult to determine who is right, as the technology is still so new. Regulators are concerned that they might find out the hard-way.
Are they all equally dangerous?
There are many stablecoins. Tether, the largest stablecoin, claims that it has roughly half of its assets in short-term corporate debt, called commercial paper. This is based on most recent disclosures. In March 2020, the commercial paper market collapsed. The Fed was forced to intervene to stabilize things. Tether could have a difficult time converting its cash holdings into cash for withdrawals if these types of vulnerabilities occur again.
Different stablecoins have different backings, which can lead to different risks. However, there are many questions as to whether stablecoins really have the reserves they claim.
Circle had stated its U.S.D. The U.S.D.C. , also known as Coin, was backed by cashlike holdings 1:1. However, it revealed in July that 40% of its holdings were in U.S. Treasurys and certificates of deposit, corporate bonds, and municipal debt. According to a Circle representative, U.S.D.C. As of now, all U.S.D.C. reserves will be in cash and short-term Treasurys.
New York attorney General investigated Bitfinex and Tether, a cryptocurrency exchange. He claimed that Tether had at times obscured the reserves of stablecoins. The state agreed to pay a fine and make transparency improvements as part of the settlement.
Tether stated in a statement that it had never refused redemptions and that it had amended its disclosures following the investigation by the New York attorney General.
One thing unites them all is the difficulty in determining exactly what is behind a stablecoin without standard reporting or disclosure requirements.
It can also be difficult to determine how stablecoins have been used.
Stablecoins “may facilitate those seeking to sidestep a host of public policy goals connected to our traditional banking and financial system: anti-money-laundering, tax compliance, sanctions and the like,” Gary Gensler, who heads the Securities and Exchange Commission, told Senator Elizabeth Warren in a letter this year.
What can regulators do to help?
Stablecoins can slip through regulatory cracks. Stablecoins are not classified as bank deposits. The Fed and the Office of the Comptroller of the Currency don’t have the ability to supervise them. The S.E.C. The S.E.C. has some authority if they’re defined as securities. However, that is matter for active debate and professional advice.
Although state-level regulators have been able to provide some oversight, the fact that Tether and other significant offerings are located overseas may make it more difficult for the federal government’s to exercise its authority. Regulators are exploring their options right now.
What are the next steps for the government?
There are a number of options available to Treasury, the Fed, and other financial oversight agencies. Although it is not clear what they will choose to do, the issue is top of mind. The President’s Working Group on Financial Markets, which is anchored by Treasury is expected to release a report on this topic soon. A Fed report on central bank digital currencies may also address stablecoin risk.
The most important regulatory options:
- They should be considered systemically dangerous. Stablecoins can be linked to other markets and the Financial Stability Oversight Council may designate them as a systemically dangerous payments system. This would make them more subject to tighter oversight.Although the market is not large enough to pose a systemic threat now, the Dodd Frank Act allows regulators to assign that classification to payments activities if they believe it could be a threat to the system. The Fed and other regulators would need to develop a plan to address the risk if that happens.
- These stablecoins securities should be treated as securities. Some stablecoins could be classified as securities by the government, which would require more disclosure. During a recent hearing, Mr. Gensler stated that stablecoins “may well be securities”, which would allow his institution to have broader oversight.
- You should regulate them as money market mutual funds. Stablecoins are similar to money market mutual funds. They can be used as short-term savings vehicles and offer quick redemptions, while also investing in risky assets. However, money funds have needed two government rescues within a little over a decade. This suggests that their regulation is flawed.Gregg Gelzinis, who works at the Center for American Progress on financial markets regulation and policy, said that “Stablecoins aren’t new.” “I view them as either an unregulated mutual fund for money or unregulated bank.
- As if they were bank deposits. Many financial regulator enthusiasts would prefer that stablecoins be treated like bank deposits, given the flaws in money funds oversight. The tokens could be subject to supervision by a bank regulator like the Office of the Comptroller of Currency. Mr. Gelzinis stated that such an outcome would happen. Deposit insurance could be a benefit, which would protect them if the stablecoin company goes under.
- Compete with central bank digital currencies. Fed Chair Jerome H. Powell has indicated that a central bank digital currency could have one appeal — a digital dollars that, just like paper money, can tie back to the Fed.If you had a digital U.S currency, you wouldn’t need to have stablecoins. During testimony this year, Mr. Powell stated that he believes that was one of the strongest arguments in favor of it.However, it is crucial to know how a central bank digital currency design is made in order to replace stablecoins. Industry experts note that stablecoin users value privacy and independence from government so a new currency backed by the government might not be able to replace them.
- International cooperation is a must. Everyone in the conversation agreed on one thing: Different jurisdictions must collaborate to ensure stablecoin regulation works. If there is no attractive oversight in a country, coins can move abroad.The Financial Stability Board is a global oversight body that works to establish stablecoin-related standards. It also plans to cooperate, with the ultimate adoption expected in 2023.