The News: Stablecoin regulation is coming. In fact, just last week, the Biden administration, through its Working Group on Financial Markets, released a report urging lawmakers to subject stablecoin issuers to the same strict federal oversight as banks. Read the full report from the Treasury Department here.
Stablecoin Regulation Is Coming — Here is Why That Matters
Analyst Take: Stablecoin regulation is coming. The digital assets, designed to maintain a stable value relative to national currency or other reference assets, are squarely in the sights of lawmakers. The Treasury Department’s Report on Stablecoins also recommends that custodial wallet providers should be regulated by a federal agency and that stablecoin issuers’ interactions with non-financial companies (such as technology platforms and telecom providers) be limited.
The President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) includes Treasury Secretary Janet Yellen, Federal Reserve Chair Jerome Powell, Securities and Exchange Commission Chair Gary Gensler, Acting Commodity Futures Trading Commission Chair Rostin Behnam, and representatives of the OCC and the FDIC, so the recommendations it brings to Congress and regulatory agencies come with a good deal of political and executive weight.
Starting at the Beginning: What are Stablecoins?
As mentioned earlier, stablecoins are digital assets designed to maintain a stable value relative to a national currency or other reference assets. While they broadly fall under the cryptocurrency , stablecoins, as the nomenclature suggests, tend to adjust their value to match a specific national currency, like the US Dollar. Stablecoins are used to facilitate the trading, lending, or borrowing of other digital assets, typically either on or through digital asset trading platforms.
Why Does the Working Group Feel that Stablecoins Should be Regulated?
So, why does the Working Group feel that stablecoins should be regulated? In a word, risk.
From the Report on Stablecoins:
- Investor and Market Protection: “Speculative digital asset trading, which may involve the use of stablecoins to move easily between digital asset platforms or in decentralized finance (DeFi) arrangements, presents risks related to market integrity and investor protection. These market integrity and investor protection risks encompass possible fraud and misconduct in digital asset trading, including market manipulation, insider trading, and front running, as well as a lack of trading or price transparency. Where these activities involve complex relationships or significant amounts of leverage, there may also be risks to the broader financial system.”
- Logical Oversight Theory: “Digital asset trading platforms and other market participants play a key role in providing access to stablecoins and liquidity in the market or stablecoins. To the extent activity related to digital assets falls under the jurisdiction of the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), the SEC and CFTC have broad enforcement, rulemaking, and oversight authorities that may address certain of these concerns.”
- AML/CFT Concerns: “Stablecoins also pose illicit finance concerns and risks to financial integrity, including concerns related to compliance with rules governing anti-money laundering (AML) and countering the financing of terrorism (CFT) and proliferation. To prevent misuse of stablecoins and other digital assets by illicit actors, Treasury will continue leading eﬀorts at the Financial Action Task Force (FATF) to encourage countries to implement international AML/CFT standards and pursue additional resources to support supervision of domestic AML/CFT regulations.”
- Prudential Concerns: “In addition to market integrity, investor protection, and illicit finance concerns, the potential or the increased use of stablecoins as a means of payment raises a range of prudential concerns. If stablecoin issuers do not honor a request to redeem a stablecoin, or if users lose confidence in a stablecoin issuer’s ability to honor such a request, runs on the arrangement could occur that may result in harm to users and the broader financial system.”
Indeed, it appears increasingly likely that stablecoins could become more broadly used by households and businesses as a means of digital payments over the next decade, as technology and media platforms incorporate them at scale across their business and UX ecosystems.
Is the Move for Stablecoin Regulation Another Jab At Big Tech? Yes and No, but Mostly No.
The move for stablecoin regulation makes perfect sense. This rapidly growing $138 billion segment of the broader crypto market was bound to land in the sights of financial regulators, and for valid reasons. I believe that what may have regulators especially agitated is how stablecoins could fuel some of Big Tech’s broader financial ambitions at a time when governments and regulators are trying to wrap their heads around how to regain some control over the power that technology giants now have over national security matters, politics, and financial markets. Indeed, it probably isn’t a stretch to assume that Diem (formerly Libra), the stablecoin project created by Meta (formerly Facebook), was probably very much on the minds of the Working Group during the drafting of its report, but Meta is just the tip of the proverbial iceberg. Things are far more complicated than that.
Despite the argument I just made, I don’t believe that the push for stablecoin regulation is driven primarily by the broader effort to break up Big Tech or regulate it more aggressively. Is it part of the equation? Sure. It probably even pushed the working group to push the pace. The focus, however, seems to be far more about the legitimate need for stablecoin regulation than about finding ways of boxing in tech companies with new regulations.
The report also explicitly states that it is not looking to target decentralized finance (DeFi) altogether. In other words, I don’t see this as the kind of overreach that we sometimes see when regulatory agencies see an opportunity to expand their authority, budgets, and power. This seems genuine. The objective for stablecoin regulation is not to ban or impose arbitrary limitations on stablecoins, but simply to bring them in line with other broadly available, consumer-facing financial products.
The report clearly shines a light on this point: “Several existing stablecoin issuers and entities with stablecoin projects under development have the stated ambition or the stablecoins they create to be used widely by retail users to pay or goods and services, by corporations in the context of supply chain payments, and in the context of international remittances.” I believe that the working group sees a need to get ahead of this while it still can, as it should. As such, I don’t interpret this move for stablecoin regulation as being motivated by broader efforts to regulate or weaken Big Tech.
“Because payment stablecoins are an emerging and rapidly developing type of financial asset,” the report also states, “legislation should provide regulators flexibility to respond to future developments and adequately address risks across a variety of organizational structures.” Translation: Across a variety of industries and use cases.
Why Are U.S. Regulators Handing This Off to Congress?
So why are U.S. regulators handing off stablecoin regulation to Congress? In the United States, and specifically under the Biden administration, the preferred path of action is to make the case to Congress to enact legislation that will address the problem in a more codified, bipartisan, and long-term manner, and in a way that will not hinder or harm decentralized finance wholesale.
In my view, one of the more eye-opening aspects of this report on stablecoin regulation is the number of regulatory agencies that cosigned it, and what it suggests about the complexity of the U.S. regulatory ecosystem: The Department of Treasury, the Federal Reserve, the SEC, the CFTC, the OCC, and the FDIC. In fact, I was surprised that the Department of Justice didn’t add itself to the list. On the one hand, seeing all of these different federal agencies come together to make these recommendations speaks to the importance of the matter, and to consensus across all concerned agencies, and that is a good thing. It will make lawmakers notice, and it will also help cut through some of the politically partisan interference that one might expect on Capitol Hill.
On the other hand, it also reveals the extent to which having too many regulatory agencies with overlapping jurisdictions may be overcomplicating what could otherwise be a simpler matter to address and resolve. Looking at that list, I can’t help but think that while enacting laws provides a more stable, consistent, and reliable framework for regulatory oversight than solving a regulatory problem by way of executive branch remedies, that’s not the only thing at play here. A secondary reason for the working group’s request to Congress on stablecoin regulation may be that getting that many separate bureaucracies on the same page when it comes to stablecoins and cryptocurrencies in general is a project that no one across the breadth of those agencies wants to take on unless it becomes absolutely necessary. It’s better to pass that particular hot potato on to Congress.
Consider, for example, that the SEC’s jurisdiction covers digital assets and securities, which can include stablecoins, in matters that involve digital asset oﬀers, sales, and promotions, as well as instances where stablecoin issuers and/or holders (which includes platforms) engage in the business of investing in securities, and therefore qualify as investment companies. Meanwhile, the CFTC’s regulatory authority over stablecoins covers “intermediaries and exchanges oﬀering or engaged in commodity futures, options, and swaps, as well as certain leveraged retail transactions,” in addition to anti-fraud and anti-manipulation jurisdiction over commodity transactions in interstate commerce. It is clear that an overarching framework for stablecoin regulation to harmonize rules, authority, enforcement, and remedies is needed, and the working group is asking Congress to provide it.
A third motivation for stablecoin regulation is also likely that a bill signed into law will be a lot more difficult to challenge in court than an executive order, let alone agency directives, which the working group rightly qualifies as temporary measures. The market demands certainty when it comes to financial products, and due to the unique uses of stablecoins, along with the potential risks, it makes sense for the U.S. government to not fumble or create an unstable regulatory regime around the category. The working group appears to be conscious of the need for permanence, albeit flexible enough to adapt to yet unseen regulatory challenges brought on by future stablecoin innovation.
A Note About Harmonization and International Standards
The working group’s report also appears to be in line with existing recommendations, standards, principles, and guidance regarding stablecoins. It cites the Financial Stability Board, which created a set of recommendations aimed at facilitating “the coordinated regulation, supervision, and oversight” of Global Stablecoin (GSC) arrangements without causing interference with innovation or stepping over domestic regulatory regimes.
International standard-setting organizations (SSOs) are also working on developing international standards for stablecoin arrangements, which the working group saw fit to mention. Two principal SSOs of note are the Committee on Payments and Market Infrastructures (CPMI), and the International Organization of Securities Commissions (IOSCO). I expect that the United States will play a key role in developing these standards.
At another level, the Financial Action Task Force (FATF), the SSO created by the G-7 in 1989 to combat money laundering and terrorist financing, updated its standards two years ago to cover digital assets, including stablecoin arrangements, and is reportedly working on new implementation recommendations for these standards.
Per the report: “the agencies are committed to continuing engagement at the FSB and the standard-setting bodies to ensure comprehensive oversight of stablecoin arrangements, further common regulatory outcomes across jurisdictions, and reduce opportunities for regulatory arbitrage.” I believe this signals that the working group’s intention is for the United States’ financial regulatory agencies to help create a global set of standards with regard to the regulation, supervision, and oversight of stablecoins, which would go a long way toward bringing welcome stability and security to that important corner of the cryptocurrency ecosystem.
This is a space we’ll be watching with interest.
Disclosure: Futurum Research is a research and advisory firm that engages or has engaged in research, analysis, and advisory services with many technology companies, including those mentioned in this article. The author does not hold any equity positions with any company mentioned in this article.
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