Jerome Powell’s remarks on Sept. 30 following his testimony about the financial hardships of the pandemic caught the attention of crypto enthusiasts. Taking questions from the House Committee on Financial Services, Chairman Powell said the Federal Reserve would not seek a ban on crypto but reiterated that stablecoins should be regulated.
Bitcoin jumped by over 17%, outperforming Ethereum, which rallied by just 4% (see graph). (Many stablecoins are built on the Ethereum blockchain.) The crypto market reaction is notable because previously any suggestion of regulation by the Securities and Exchange Commission or the U.S. Department of the Treasury sent Bitcoin prices in a tailspin.
So why didn’t investors balk at increased oversight of the crypto industry? It may have something to do with the market cap of the global crypto market reaching $2 trillion, and the number of institutions and companies getting involved becoming larger.
A captive institutional audience favors more rather than less regulation on an asset class like crypto. For one, to be able to trade effectively and safely as Citadel’s Ken Griffin argued at a recent investment forum. Second, institutional and retail clients require a compliance mandate on crypto. Lastly, regulated assets can be invested in exchange-traded and mutual funds.
That may explain why Bitcoin didn’t plunge, but not why Bitcoin caught a strong lift.
The uncertainty around the U.S. debt ceiling made investors desire an alternative safe asset in the event of a technical default of U.S. Treasuries. The Fed’s reverse repurchase facility has seen a record demand as investors substituted T-Bills they consider at risk of default for “risk-free” money, or crypto.
What especially greenlighted a new rally of Bitcoin for crypto investors was that Powell specifically mentioned that stablecoins function like unregulated money-market funds or bank deposits. By regulating stablecoins — cryptocurrencies pegged to the U.S. dollar — an anchor for the liquidity of Bitcoin and the entire crypto market could be established.
A pegged cryptocurrency under Federal oversight could function as an “implicit digital currency” that is backed by crypto deposits. These are already under the supervision of the U.S. currency comptroller, the agency that overlooks the commercial banks.
A stablecoin could operate as a money-market fund of digital assets, such as bonds and stocks issued by companies with a direct investment in crypto and Bitcoin. It can act as a liquidity pool provider to a decentralized financing system that would fall under federal supervision. Stablecoins are riskier without regulation, and that is why the President’s Working Group on Financial Markets (PWG) has taken steps to address stablecoins to the U.S. Congress.
If a regulatory framework for stablecoins is created, it does not establish stablecoins as a perfect substitute for U.S. currency. Financial markets assign an extremely high credibility to the dollar’s reserve currency status. Likewise, investors maintain high confidence in the dollar, while the Federal Reserve is working on a soon-to-be-published paper about U.S. digital currency.
The rally of Bitcoin since last week was followed by strengthening of the dollar, as uncertainty about the energy crisis in Europe and the U.S. debt ceiling engulfed markets. This suggests that future regulated stablecoins and a possible central bank-backed digital currency, or CBDC, are unlikely to topple the existing currency system with the U.S. dollar as the center.
On the contrary, a situation where there is no ban on crypto but regulations on stablecoins could drive several important trends. Issuance of blockchain in fixed-income and equity markets could pick up as institutions are more comfortable with legality of crypto.
Increased blockchain issuance could result in speedier settlements of bonds and stocks at lower transaction costs. This may spur the launch of exchange-traded funds that hold digitally settled securities in their portfolio. Companies could also broaden their exposure to crypto payment services as future regulation brings greater stability to crypto markets.
Comments by central banks about crypto and Bitcoin are carefully parsed. The advent of blockchain technology and better regulated stablecoins is likely to transform the future of the international payment system.