Federal agencies took their first step toward regulating stablecoins, raising concerns that the tokens could threaten the U.S. economy while making a big bet on the bitterly divided Congress to put guardrails on the fast-growing market.
In a highly anticipated report, the Treasury Department, Federal Reserve and other regulators urged lawmakers to let them police stablecoin issuers like banks with robust capital requirements and constant supervision. But as a Plan B, the watchdogs made clear they would activate a rarely used power to examine whether the coins pose a systemic threat to financial stability — a review that could trigger a raft of new rules.
The 26-page document, released Monday by the President’s Working Group on Financial Markets, represents a watershed moment for the $130 billion stablecoin market and cryptocurrencies worth trillions that it underpins. The industry has so far operated with little government oversight, and the President’s Working Group is sending a clear message: That era is coming to an end.
“The rapid growth of stablecoins increases the urgency of this work,” the regulators said. “Failure to act risks growth of payment stablecoins without adequate protection for users, the financial system, and the broader economy.”
The coins are called “stable” because they have a value tied to that of another asset, such as the U.S. dollar. Stablecoin issuers say they achieve that peg by keeping an amount in reserves that’s equivalent to their tokens in circulation, and they typically guarantee that investors can exchange their tokens for actual currency at any time. But regulators have long been concerned that that pledge could ring hollow, particularly during a crisis.
Though some stablecoin issuers predict they will be widely used for payments and remittances, most investors for now rely on the coins as a parking place for money they want to invest in Bitcoin and other cryptocurrencies or as a means to easily transfer money across crypto trading venues. Tether is the biggest stablecoin with a value exceeding $70 billion, according to CoinMarketCap.
While the recommendations envision stablecoins as a regulated banking product, the report emphasizes that the Securities and Exchange Commission, Commodity Futures Trading Commission and other agencies can police transactions in the meantime that involve trading, lending and borrowing.
The regulators also lay out that they oppose a major technology firm or other corporate giant backing stablecoins. The report calls for a wall between tokens and non-financial businesses, emulating the longstanding division between banking and commerce. Such an idea could strangle efforts by Meta — the company formerly known as Facebook Inc. — and its partners to launch a stablecoin under the name Diem or to provide customers with crypto wallet services.
Here are some of the report’s highlights:
Though stablecoins are currently an insignificant part of the global financial system, the report shows that U.S. regulators are keenly aware of how fast that can change.
The report expresses concern that stablecoin issuers could fail to protect their reserves or that the reserves could fall in value, making it difficult or impossible for users to exchange tokens for actual currency. A loss in confidence in a stablecoin could also cause a run on the issuer, leading the company to unload assets in a fire sale and to risk not being able to meet redemptions, the report said.
That could lead to runs on other stablecoins and to a shock to the broader financial system. Similar issues could arise if payments using the stablecoin don’t process or settle as expected, the regulators said, and if certain stablecoin issuers continue to grow rapidly, they could eventually pose a systemic risk and wield too much market power.
The report urges Congress to pass legislation that requires stablecoin issuers to become banks with insured deposits, capital and liquidity requirements and Fed supervision. In fact, companies should be prohibited from offering payment stablecoins unless they are insured depository institutions.
The regulators added that any action Congress takes should give federal agencies flexibility to respond to how stablecoins evolve because the market is “an emerging and rapidly developing type of financial asset.” Treasury officials said they have already held preliminary discussions with Capitol Hill aides on crypto oversight.
It’s far from certain that Congress will do anything considering that Democrats and Republicans have failed to agree on much in recent years. Further, lawmakers don’t have a great track record of passing legislation until a calamity forces their hand, as was the case when they finally brought oversight to derivatives after the 2008 financial crisis.
The government is relying heavily on the SEC and CFTC to police stablecoins, noting that depending on their structures, tokens might be securities, commodities or derivatives. If stablecoins are securities, the SEC has power over sales and promotions and situations in which firms are investing in the assets, according to the document.
For certain stablecoins, the CFTC could have broad authority to regulate transactions. And it can crack down on manipulation and fraud when tokens are commodities. The President’s Working Group also said the Consumer Financial Protection Bureau could have a role in regulating customer payments involving stablecoins.
What’s not spelled out in the report is what guidelines the government will use for assessing whether stablecoins are securities or commodities. Further, it raises a notable red flag by acknowledging in one section that some activities fall “outside of the regulatory perimeter altogether.”
SEC Chair Gary Gensler has been outspoken in asserting that he believes many cryptocurrencies should be registered with his agency. While that view indicates he’s poised to be aggressive in asserting authority, the industry has largely bristled in response. That signals that courts could ultimately decide how such fights play out.
The report could spell trouble for Facebook’s long-stalled ambition to gain a foothold in the crypto market. The social-media company, along with dozens of other firms, in 2019 announced it would help create a stablecoin, then called Libra.
The plan was met with a swift backlash from lawmakers, who said they didn’t trust the firm, and from regulators who feared that the proposed coin, since renamed Diem, could instantly become a payments juggernaut if Facebook were to roll it out to its billions of users. Though Diem, which lost many of its original partners, hasn’t yet launched, Facebook last month rolled out a pilot of its own cryptocurrency wallet using a stablecoin issued by another company.
The regulators’ recommendations could spell trouble for both Diem and Facebook’s wallet. The report urges Congress to pass legislation limiting stablecoin issuers’ affiliations with commercial entities. Notably, the report says lawmakers should also consider restricting firms’ ties with stablecoin wallet providers and how stablecoin transaction data is used.
The report says that “in the absence of congressional action,” the next move will be made by the Financial Stability Oversight Council, which includes all the members of the President’s Working Group. The council was created after the 2008 market crash to head off future meltdowns, but it’s been criticized for moving at a glacial pace.
The council can declare certain activities as a threat to the financial system and direct member agencies to respond. But council action may be a long road and could result in fragmented oversight. The group already started mulling the possible dangers of stablecoins at its most recent meeting last month. But even if the council flags the pitfalls of the tokens, it can’t bestow new authorities on the regulators. That’s Congress’ job.
— By Jesse Hamilton and Joe Light (Bloomberg Mercury)