Stablecoins are digital currencies tied to assets that don’t fluctuate much in value, such as the U.S. dollar, and thus are more consistent in pricing than cryptocurrencies. Stablecoins may also be pegged to a commodity’s price, such as gold, and achieve price stability via collateralization or through algorithmic mechanisms of buying and selling a reference asset or its derivatives.
The popularity of stablecoins has dramatically increased because they are a cheap and easy way to transact in cryptocurrency. But worries among lawmakers and Fed officials are mounting because without standard disclosure or reporting requirements, it is hard to know exactly what asset is behind a stablecoin and difficult to track how they are used.
Concerns about stablecoins were voiced in the July Federal Open Market Committee Minutes, where participants concluded they are “new financial arrangements” that appear to have “the same structural maturity and liquidity transformation vulnerabilities” as prime money funds but with less transparency. They highlighted the fragility and the general lack of transparency associated with stablecoins, the importance of monitoring them closely, and the need to develop an appropriate regulatory framework.
Stablecoin issuers, however, aren’t regulated under a sweeping framework and they provide varying levels of transparency into the composition of reserves that back their stablecoins. Bank of America estimated stablecoins have a market value of around US$141 billion with a quarterly transaction volume of over US$1 trillion in 2021. Tether, the largest stablecoin, has a market value of US$76 billion according to research platform Delphi Digital.
On Nov. 1, the President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency together issued a highly anticipated report on stablecoins. The agencies recommended cryptocurrency companies that issue stablecoins be regulated as banks, and that Congress take action to regulate stablecoin issuers, tailored according to the amount of risk they pose to users and the financial system.
The report outlines how stablecoins could be regulated. The FDIC could insure stablecoins so that if the issuers deposit fiat currency reserves at an FDIC-insured bank to meet the requirements for deposit insurance coverage, the deposit would be insured to each stablecoin holder individually for up to $250,000. Issuers would be required to meet capital and liquidity requirements, and would be required to come up with a resolution plan — like a living will — so that in the event of failure, the firm would know how to wind down its operations without injuring the financial system.
In a paper published this summer, “Taming Wildcat Stablecoins,” Yale School of Management finance professor, Gary Gorton, and Federal Reserve Board attorney and economist Jeffrey Zhang (now senior economist to the White House Council of Economic Advisers) outline the no-questions-asked (NQA) principle of money. In an NQA both parties agree to a transaction that the money must be accepted at a price of 100 (par). Stablecoin issuers seem to implicitly understand their NQA vulnerabilities and the related run-risk. It’s for this reason the biggest names in the crypto sector have opted for full transparency, publishing regular updates of the composition of their reserves.
George Selgin, senior fellow and director emeritus of the Cato Institute’s Center for Monetary and Financial Alternatives, argues the opposite. Stablecoins are used as a niche currency and not as an investment, and for that reason they may be less prone to runs in which investors try to withdraw their funds all at once. Another reason is that stablecoins are roughly half invested in U.S. Treasury bills, Treasury short term notes and commercial paper.
However, this is not enough to prevent stablecoins from becoming new sources of systemic risk. In a letter to Senator Warren, Securities and Exchange Commission Chairman Gary Gensler wrote that “stablecoins may facilitate those seeking to sidestep a host of public-policy goals connected to our traditional banking and financial system: anti-money-laundering, tax compliance, and sanctions.”
A range of Federal regulators are laying the political groundwork to preside over stablecoins and their issuance even in the absence of statute, including the SEC, the Federal Reserve and the Treasury Department. The Financial Stability Oversight Council is pressing to get emergency authority over stablecoins if Congressional action is not forthcoming.
The stability of stablecoins is a phantom. Tether Holdings loaning money from its reserves to bolster an affiliated cryptocurrency exchange is an example of how money backing stablecoins may not be real. The risk, and the challenge for the regulators, is that belatedly policing stablecoins now that so many are in circulation could prompt the type of run on their issuers that the government wants to guard against.