Stablecoins Need Legislative Action Now, Regulators Say

Top regulators think major consumer and systemic financial risks are at stake

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Stablecoins have the potential to put the entire financial system at risk and that’s why their issuers need to be regulated like banks, said a report by the country's top financial regulators this week. Stablecoins are digital assets designed to maintain a more stable value than the typical cryptocurrency because they are usually pegged to a fiat currency or other reference assets.

Key Takeaways

  • Congress should establish a new bank-like regulatory framework for stablecoins, whose market cap has ballooned to more than $127 billion over the last 12 months, a government report said.
  • Stablecoins are cryptocurrencies with value pegged to a fiat currency such as the U.S. Dollar or the Euro.
  • Stablecoins are vulnerable to speculation, fraud and illicit activity and can pose a systemic risk to financial markets, the report said.
  • However, some argue that strict regulation could stifle innovation in a burgeoning market.

In July, U.S. Treasury Secretary Janet Yellen convened the President's Working Group on Financial Markets (PWG) comprising top financial regulators to make recommendations on the regulatory framework required for stablecoins. The group includes officials from the Federal Reserve, the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.

While stablecoins are considered more stable in value, the PWG said in its report that they can still be risky. For example, people can trade them speculatively, manipulate them, or use them for illicit transactions, which can introduce risk to the entire financial system, the report said. As a payment form, stablecoins also can wreak market havoc if people don’t honor a request to redeem a stablecoin, confidence in the stablecoins falls and a run occurs, or if the payment chain is disrupted, it said.

For all these reasons, the group recommended Congress pass legislation to provide regulators with a framework for bank-like oversight for stablecoin issuers. Stablecoin market capitalization has soared nearly 500% over the last 12 months to more than $127 billion as of October. Popular stablecoins include Tether, Dai, USD Coin, and Binance USD.

"The rapid growth of stablecoins increases the urgency of this work," the report said. "Failure to act risks growth of payment stablecoins without adequate protection for users, the financial system, and the broader economy."

Some of the legislation the group advocated to mitigate risk includes:

  • allowing only FDIC-insured depository institutions such as banks to issue stablecoins, which could prevent a run on the assets 
  • establishing federal oversight for stablecoin issuers or exchanges that offer custodial wallet services to monitor risk-management systems and protect the payment system 
  • restricting affiliations of stablecoin issuers and custodial wallet providers to help limit concentration of economic power to a few major players.

The group said some regulatory bodies like the SEC and CFTC may already have some broad enforcement, rulemaking, and oversight  powers to deal with some of these concerns. However, since Congress may take awhile to pass more legislation, it recommends the Financial Stability Oversight Council, to consider steps to regulate stablecoins. Such steps might include designating some activities linked to stablecoins as systemically important payment, clearing and settlement activities.

The CFTC has already fined Tether for misleading consumers into thinking its stablecoin was 100% backed by corresponding fiat assets, including U.S. dollars and euros, when it wasn’t. Separately, it also fined Bitfinex, which runs a cryptocurrency trading platform, for illegal, off-exchange financed retail commodity transactions with people who were not eligible contract participants. Regulators have also frowned upon the very close relationship between Tether and Bitfinex. In its order, the CFTC noted that Tether also transferred some of its reserves to Bitfinex when the latter needed help during a “liquidity crisis.”

Even though bank associations like the Independent Community Bankers of America and American Bankers Association and consumer groups like the Consumer Financial Protection Bureau and National Community Reinvestment Coalition applauded the PWG’s recommendations, others were concerned too much legislation could stifle innovation in this burgeoning market.

“Digital assets have the potential to be as revolutionary as the internet,” said Senator Pat Toomey in a statement. “It’s important lawmakers and regulators alike work to continue America’s longstanding tradition of fostering technological innovation—not stifling it.”

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