The volume of cryptocurrency transactions ballooned in 2021[1]. An integral component of the cryptocurrency market is stablecoins, which are coins claiming to be tied to a national currency – predominantly the US dollar. Stablecoin supply has therefore also increased at an exponential rate, with $127.9B in circulation on October 18, 2021 compared to only $21.5B on October 19, 2020[2]. Of that market, the largest stablecoin by far is Tether (USDT) at $72.6B, followed by USD Coin (USDC) at $33B[3]. Both coins, like most stablecoins, maintain their value with a promise or expectation that the coin can be redeemed for US Dollars at any time[4]. The President’s Working Group on Financial Markets, joined by the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), recently released a report on stablecoins[5]. The report largely focused on the risks that Dollar-backed stablecoins pose to crypto holders and the broader financial system and made specific recommendations to Congress for needed legislation to address the risks. It effectively contends that stablecoin accuses, two of which involve applying existing banking laws to stablecoins: requiring stablecoin issuers to be insured depository institutions and providing regulators the authority to require heightened risk-management from systemically important players.
The first recommendation is that stablecoin issuers be deemed insured depository institutions, as all banks are[6]. This would guarantee a holder’s right to redeem coins for US dollars upon request, provide federal insurance to each holder up to $250,000, and subject the issuer to supervision and regulation by the FDIC. The idea behind this recommendation is that stablecoin issuers are functioning like banks and should be regulated as such. Like banks before depository insurance, stablecoin issuers could be subject to a run[7] if their holders no longer believe they hold assets sufficient to cover all of the coin issued. This lack of confidence in redeemability could be caused by problems encountered in redemption, fluctuations or illiquidity in reserve assets, or operational risks in protecting the reserve assets. A run scenario could potentially impact other stablecoins by contagion or the market for the reserve assets, which could spread the crisis to the broader financial market[8].
Bank-like regulations are a welcome move for Circle, issuer of USDC, the second largest stablecoin. Circle has announced that it intends to become a “national digital currency bank” subject to federal regulation, beyond the less stringent state regulation with which it currently complies[9]. Circle regularly discloses its reserves breakdown through auditor Grant Thornton, claims to be meeting the Basel III international bank liquidity standards, and publicly supports banking regulation on stablecoin issuers[10]. On the other hand, the largest issuer, Tether, has never released an externally audited breakdown of its reserves and consistently faces accusations that it does not have the entire amount of assets it claims or sufficiently liquid assets[11]. Tether previously claimed that 100% of its assets were in cash, but revealed in an unaudited statement this year that less than 2% was in cash, with the majority of its holdings in cash equivalents[12].
The report also recommended Congress subject key participants in the stablecoin system, including issuers and wallet providers, to federal oversight and provide regulators with authority to require that any entity deemed “critical” to the system must meet risk-management standards. The report noted that because stablecoins are growing rapidly, a single issuer or wallet provider could become large or interconnected enough that, like certain banks and financial players, its distress or failure would adversely impact the broader stablecoin market and possibly the broader financial market. The additional oversight and risk management standards would reduce that risk of failure or distress[13]. Additionally, many stablecoin issuers have declared an intention for their coins to be used widely as payment systems in the real world. The report noted that while widespread adoption is unlikely, it could occur extremely quickly. Again, such payment systems may pose systemic risks which could be alleviated through applying risk management standards. In the absence of legislation, it also recommended the Financial Stability Oversight Council, created in the wake of 2008, use its existing authority to consider naming some stablecoin activities systematically important[14].
Overall, the report extensively detailed the risks discussed here and many others presented by stablecoins, with a focus on the need for new legislation to address them[15]. However, it also notes that stablecoins and activities it facilitates may qualify as securities, commodities or derivatives, and therefore fall under existing federal securities and commodities exchange law and the jurisdiction of the Securities Exchange Commission (SEC) and/or Commodities Futures Trading Commission (CFTC)[16]. This provides a route for the agencies to regulate to some degree in the absence of congressional action. Stablecoins’ rate of growth over the last year certainly warrants federal attention, however the report declined to make recommendations on decentralized finance (DeFi), which is the financial innovation driving the increase in stablecoins[17].
[1] https://www.theblockcrypto.com/data/crypto-markets/spot
[2] https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf
[3] Id.
[4] Id.
[5] Id.
[6] Id.
[7] A “bank run” is when many depositors simultaneously seek to withdraw their funds from a single institution due to fear that the institution will have insufficient funds to cover their deposit. Banks never hold cash equivalent to all deposits, so runs themselves guarantee the insufficiency of funds and cause bank failures. The FDIC was created to directly address bank runs during the Great Depression. https://www.history.com/topics/great-depression/history-of-the-fdic
[8] Id.
[9] https://decrypt.co/78059/circle-full-reserve-bank-usdc
[10] Id.
[11] https://www.bloomberg.com/news/features/2021-10-07/crypto-mystery-where-s-the-69-billion-backing-the-stablecoin-tether
[12] https://decrypt.co/70732/tether-reveals-reserves-breakdown-for-the-first-time-since-2014
[13] https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf
[14] Id.
[15] Id.
[16] Id.
[17] Id.