On Friday, U.S. Treasury Secretary Janet Yellen said there would be a President’s Working Group on Financial Markets (PWG) meeting today to discuss stablecoins.
The PWG includes herself and the heads of the Federal Reserve, the SEC and the CFTC. Fed Chair Jerome Powell highlighted the need for better regulation of stablecoins during Senate testimony last week. The PWG said it would examine existing regulations, explore risks and make recommendations about how to address those risks.
The Boston Federal Reserve also recently highlighted the (poor) quality of the assets that back the Tether stablecoin, as well as the similarity of stablecoins to money market funds. That’s a market that has needed two interventions in recent years and was the topic of a PWG discussion earlier this year. Fitch ratings echoed these concerns.
Last year, the PWG published a document outlining initial regulatory issues regarding stablecoins. That paper had in its sights the likes of Diem (formerly Libra), the stablecoin initiative founded by Facebook. And Diem is getting significantly closer to launch. But even without Diem the top three stablecoins Tether, USDC and Binance USD have a total market capitalization of $100 billion.
One of the challenges for the regulators is the fact that they’re playing catchup. The initial focus was on how to address BigTech stablecoins. Now there’s a realization that blockchain enables accelerated network effects. Hence the focus is on the combination of anti money laundering, consumer protection and how assets are managed both to ensure consumer protection and prevent financial stability risks.
However, the question is whether the emphasis is still on stablecoins as a payment instrument because that’s not the main driver of the current growth. Stablecoins are widely used as deposits, both in DeFi and at centralized cryptocurrency lenders, and it is this that has been a key factor in recent growth.
So while the current focus may be the quality of the backing assets, the other issue is “same business, same risk, same rules” as mentioned in the 2020 President’s Working Group paper.
That document also stated, “a stablecoin may constitute a security, commodity, or derivative subject to the U.S. federal securities, commodity, and/or derivatives laws.”
This contrasts with laws elsewhere, such as Europe, where draft legislation plans to govern fiat-backed stablecoins as e-money which has quite specific rules and puts the issuer firmly under the oversight of central banks. However, as we recently noted, even within the EU, there are still some inconsistencies with e-money legislation between jurisdictions.
In the U.S. during 2019, the CFTC issued a document that stated stablecoin issuers would need to register with FinCEN as a money service business and seek licenses from the various state money transmitter regulators as a payment instrument issuer.
Additionally, it stated that “A stablecoin backed 100% by fiat currency or a tangible commodity is likely a “commodity” under the Commodity Exchange Act, but the CFTC should have no day-to-day oversight over such a stablecoin; it retains anti-fraud and anti-manipulation authority, however.”
Stablecoins have a lot to offer in terms of openness, efficiencies and convenience, but also introduce fragility in multiple ways. How to regulate them in such a fast-moving market and still support innovation is no easy task.