Why Washington Worries About Stablecoins

What is a stablecoin?

A stablecoin — stablevalue coin, if you’re feeling proper — is a type of cryptocurrency that is typically pegged to an existing government-backed currency. To promise holders that every $1 they put in will remain worth $1, stablecoins hold a bundle of assets in reserve, usually short-term securities such as cash, government debt or commercial paper.

Are they all equally risky?

Stablecoins are not all created equal. The largest stablecoin, Tether, says it is roughly half invested in a type of short-term corporate debt called commercial paper, based on its recent disclosures. The commercial paper market melted down in March 2020, forcing the Fed to step in to fix things. If those types of vulnerabilities strike again, it could be difficult for Tether to quickly convert its holdings into cash to meet withdrawals.

What can regulators do?

The trouble with stablecoins is that they slip through the regulatory cracks. They aren’t classified as bank deposits, so the Fed and the Office of the Comptroller of the Currency have limited ability to oversee them. The S.E.C. has some authority if they are defined as securities, but that is a matter of active debate.

What are the government’s next steps?

Treasury, the Fed and other financial oversight bodies have a few choices. It’s not obvious what they will choose, but the issue is clearly top-of-mind: The President’s Working Group on Financial Markets, anchored by Treasury, is expected to issue a report on the topic imminently. An upcoming Fed report on central bank digital currencies could also touch on stablecoin risks.

  • Designate them as systemically risky. Because stablecoins are intertwined with other important markets, the Financial Stability Oversight Council could designate them a systemically risky payments system, making them subject to stricter oversight.
  • While the market may not be big enough to count as a systemic risk now, the Dodd Frank Act gives regulators the ability to apply that designation to a payments activity if it appears to be poised to become a threat to the system in the future. If that happened, the Fed or other regulators would then need up to come up with a plan to deal with the risk.
  • Treat them as if they were securities. The government could also label some stablecoins securities, which would bring bigger disclosure requirements. Mr. Gensler told lawmakers during a recent hearing that stablecoins “may well be 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 operate much like money market mutual funds, which also act as short-term savings vehicles that offer rapid redemptions while investing in slightly risky assets. But money funds themselves have required two government rescues in a little more than a decade, suggesting their regulation is imperfect.
  • “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 an unregulated bank.”
  • Treat them as if they were banks. Given flaws in money fund oversight, many financial regulation enthusiasts would prefer to see stablecoins treated as bank deposits. If that were to happen, the tokens could become subject to oversight by a bank regulator, such as the Office of the Comptroller of Currency, Mr. Gelzinis said. They could also potentially benefit from deposit insurance, which would protect individuals if the company backing the stablecoin went belly up.
  • Try to compete with central bank digital currency. Jerome H. Powell, the Fed chair, has signaled that outcompeting stablecoins could be one appeal of a central bank digital currency — a digital dollar that, like paper money, ties back directly to the Fed.
  • “You wouldn’t need stablecoins, you wouldn’t need cryptocurrencies, if you had a digital U.S. currency. I think that’s one of the stronger arguments in its favor,” Mr. Powell said during testimony this year.
  • But how a central bank digital currency is designed would be critical to whether it succeeded at replacing stablecoins. And industry experts point out that since stablecoin users prioritize privacy and independence from the government, a new form of government-backed currency might do little to supplant them.
  • Cooperate internationally. If there’s one point everyone in the conversation agrees on, it’s that different jurisdictions will need to collaborate to make stablecoin regulation work. Otherwise, coins will be able to move overseas if they face unattractive oversight in a given country.
  • The Financial Stability Board, a global oversight body, is working on establishing stablecoin-related standards and plans for cooperation, aiming for final adoption in 2023.

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Abiodun Ajayi

Abiodun Ajayi

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Abiodun Ajayi has more than 6 years of experience in Security and IT architecture. He consults and helps form strategies, perform project feasibility studies.