In case anyone had any doubts, a recent US regulatory report has made clear, in no uncertain terms, that stablecoins are in the crosshairs and that the authorities intend to bring them to heel.
What is happening?
US regulators want to clobber stablecoins with rules designed for traditional banks. This would be very difficult for stablecoin issuers to comply with, if that is what eventually happens.
The US President’s Working Group on Financial Markets and two federal banking regulators released a report on stablecoins on November 1, which highlighted several risks that they believe “urgently” justify imposing tough rules. The work builds on earlier regulatory reports.
The working group recommends that all stablecoin issuers should become insured depository institutions, and that custodial wallet providers and all entities performing functional activities within the realm of stablecoins should come under federal oversight.
This would be a huge ask for most stablecoin issuers and could crush them out of existence. Most of the individuals behind them probably would not be deemed by regulators as persons suitable to run banks, and meeting tough prudential requirements may kill off their business models.
Alternatively, the working group could have advised Congress to regulate stablecoins similarly to money market funds — indeed, both vehicles are similar in nature and this approach would mean less onerous rules for issuers. It is telling that regulators are instead pushing for tougher prudential-type rules.
Why is it happening?
Stablecoins, which operate differently to cryptocurrencies such as bitcoin, are simply digital tokens backed by assets such as fiat currencies, and are a deeply contentious issue for central bankers and policy-makers. Their list of concerns is long and profound. The most obvious sit around data issues, governance, payment failures, money laundering and cyber crime vulnerabilities. And those are just the obvious ones.
Central banks worry that stablecoins could usurp their monetary sovereignty — i.e. make monetary policy less effective. Prudential regulators fret that this new form of money could pose an insidious risk to financial stability because the composition of their assets is not always clear — for example, are they liquid enough to support mass redemptions and is there one-on-one backing for each individual dollar? If an issuer becomes too big to fail, that could be a major problem.
Stablecoins do not currently pose any obvious risk to financial stability, nor do they constrain monetary policy. They are mostly used by traders to park their cash in between cryptocurrency trades. However, their growth is so rapid that regulators have nightmares over stablecoins one day upending the financial system as they quickly replicate it and essentially operate beyond regulatory control.
What do the bankers say?
There will be few complaints from banks should stablecoin operators get saddled with bank-like prudential rules. Right now, a largely unregulated financial ecosystem is rapidly evolving based on stablecoins providing all kinds of new and innovative, as well as quite risky, financial products, and mostly without the help of banks.
For some banks in some jurisdictions, tougher rules may even be an opportunity for them to introduce their own stablecoins. Alternatively, well-regulated stablecoins issuers could help banks plough deeper into digital financial services.
Will it provide the incentives?
Imposing prudential regulations on stablecoins would be quite drastic and may see many of the US dollar-based ones simply disappear.
However, the report is not simply a stablecoin-bashing document. It does recognise that they could be used to perform cheaper global transactions and increase financial inclusion. Also, making stablecoins depository institutions should, in theory, mean that their users would have their funds guaranteed up to a certain amount if the issuer fails.
Of course, there is an obvious solution to stablecoins — and this may well be where the world is heading — which is to introduce central bank digital currencies (CBDCs), the digital manifestation of physical cash. For most functions they would arguably render stablecoins irrelevant as CBDCs with central banks sitting directly behind them are likely to be more trusted by the public. Maybe the real role of fiat-currency stablecoins is to show there is a gap in the market and to nudge central banks into creating their own version.
But listening to some of the conflicting noises coming out of the Federal Reserve, it is unclear whether it really wants to launch its own digital dollar. The Fed may end up being content with the private sector doing it or may simply tolerate it until it is completely certain that its own digital coin addresses all its various fears around stablecoins.
