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Op-Ed | The American Prospect | August 4, 2022

Proposed Stablecoin Legislation Is Worse Than Nothing

Congressional OversightCryptocurrencyFinancial Regulation
Proposed Stablecoin Legislation Is Worse Than Nothing

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In light of enduring turmoil in crypto markets, leaders of the House Financial Services Committee recently sought to advance a bipartisan bill focused on “stablecoins.” These are crypto assets purportedly pegged to the U.S. dollar or other fiat (i.e., real) currencies. Tether, for example, supposedly possesses $66 billion for each of the 66 billion tethers in circulation, while Bitcoin or Ethereum have no such backing.

The proposed legislation being drawn up by Chair Maxine Waters (D-CA) and ranking member Patrick McHenry (R-NC) aims to regulate these comically sketchy assets by placing light restrictions on issuance and the composition of reserve assets. The bill is so compromised it is worse than nothing.

Access to draft text has been limited, but reports indicate that the bill would grant banks the authority to issue their own stablecoins and place non-bank issuers under the purview of the Federal Reserve. Issuers would be required to maintain 100 percent reserves. Additionally, the bill would prohibit non-financial companies from issuing stablecoins, in a bid to limit the ongoing movement of commercial companies into financial activity. The last key part of the proposal directs the Federal Reserve to research and develop a central bank digital currency.

Initial plans to mark up the bill before Congress’s August recess hit a roadblock after Treasury Secretary Janet Yellen expressed concern over how the bill would address customers’ assets. For instance, even 100 percent backing might prove insufficient if a panic develops and a stablecoin company is forced to sell illiquid assets at fire-sale prices. Treasury thus sought to include language that would protect customers from potential events of insolvency by segregating their assets from providers’ assets. While there were attempts to incorporate Treasury’s demands, the committee had little appetite for modifications. One source working closely with the committee who spoke to the Prospect on the condition of anonymity shared that legitimate concerns raised by consumer advocates have been dismissed and ignored, even as it seems unlikely that there are enough votes to pass the committee.

On the face of it, the bill may look like a positive step, bringing at least some regulation to an area that has been allowed to develop with minimal oversight. However, significant issues abound. By defining the product as “payment stablecoins,” the committee turns a blind eye to the fact that in their current form, stablecoins are largely used for speculative purposes. Moreover, this techno-optimist framing provides the foundation for haphazardly bringing stablecoins into the banking system.

Each provision in the proposal carries unique risks. Non-bank issuers would be folded into the banking system without first obtaining bank licenses and with no requirement to purchase and hold deposit insurance. This would likely give these institutions access to Federal Reserve perks such as the discount window and master accounts. But with no banking license requirement, non-bank issuers would be subject to weaker liquidity rules and capital adequacy ratios as well as virtually no Community Reinvestment Act obligations.

Permitting non-bank issuers to forgo deposit insurance is dangerous and surprising especially considering recent runs on some stablecoins and the recent shakiness of the peg of Tether, the largest stablecoin (not to mention its highly suspicious asset claims and criminal investigations). Deposit insurance remains the most reliable way to protect customers’ assets when entities go belly-up. As the recent bankruptcies of crypto lenders Celsius and Voyager show, customers are usually at the back of the queue when a crypto company implodes. And since a significant amount of stablecoin activity occurs on loosely regulated crypto exchanges, there is still a high chance of companies overleveraging their assets—and according to reports, the proposed legislation does not address stablecoin activity on exchanges in any meaningful way.

Concerns with the text also extend to bank issuers. Newfound authority to issue uninsured stablecoins would bring about unnecessary confusion. One could easily imagine a situation where customers who are unaware of the distinction between traditional bank deposits and the novel uninsured stablecoins place their money in the less-safe latter option. The presence of a more lightly regulated stablecoin regime would also incentivize banks to shift some of their regulated activity into these more dangerous vehicles, creating serious risk of broader financial instability.

In short, the Waters-McHenry bill follows the trend recently set by Sens. Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) in attempting to defang the Securities and Exchange Commission’s authority in the crypto space. The Senate bill—which followed prodigious lobbying by the crypto industry, including courting of the junior New York senator—sought to enshrine the Commodity Futures Trading Commission (CFTC) as the primary regulator of digital assets. This House bill seeks to empower the Federal Reserve over the SEC, pushing vice chair for supervision Michael Barr into a leading oversight role.

Sure enough, Michael Barr’s ties to the crypto and fintech industries are well documented. He served as an adviser to scandal-ridden firms Ripple and Lending Club. Ripple is currently facing a lawsuit from the SEC for issuing an unregistered security, XRP. Barr also sat on crypto-funded think tank Alliance for Innovative Regulation’s advisory council and served as an adviser to fintech-focused venture capital firm Nyca Partners. Barr’s relationship with Nyca Partners yielded over 80 investments in fintech and crypto-related startups. This included positions in one company that helps financial institutions’ customers buy and sell crypto and in another that claims to have developed technology to scale Coinbase’s offerings. If granted the authority to monitor stablecoins, the onus would be on Michael Barr to prove to the public that he is not constrained by his extensive corporate ties and embrace of the vision of crypto enthusiasts, especially as the SEC continues to develop its capacity to effectively police the space.

The SEC boasts of a 50-person team in its Enforcement Division’s Crypto Assets and Cyber Unit. Recent enforcement moves by chair Gary Gensler showcase the agency’s readiness to step up to the plate even as he manages a turf war with the CFTC. The CFTC just rebranded its in-house fintech arm as the Office of Technology Innovation as it continues its push for a greater role in regulating crypto markets. There is obviously a role for the CFTC in this space, since Bitcoin is a commodity, but as Gensler has long maintained, many digital tokens are securities, and as such, exchanges listing these securities must register with the agency.

Evidently, the SEC cannot regulate crypto or stablecoins all on its own. While it has a key role to play in overseeing exchanges, the Federal Reserve and Federal Deposit Insurance Corporation can step in if appropriately directed to apply the full suite of banking regulations to stablecoin issuers. Additionally, existing law provides vigilant government officials with tools to regulate the space. Take, for example, the current law that makes it illegal for non-bank entities to receive deposits repayable on demand. Since stablecoins are essentially deposits (holders exchange $1 for 1stablecoin with the explicit or implicit understanding that their $1 will be available for withdrawal whenever), the Justice Department could easily bring enforcement actions against distributors unlawfully issuing these crypto assets. Rather than write shoddy new laws, Congress should provide regulators with more resources to implement current ones, including cash for enforcement capacity and visible support of currently vigilant regulators.

Better still, the government could consider more aggressive action. Application of existing law would bring some stability to the stablecoin space, but there is one more simple and effective option: banning them outright. Stablecoins are an essential component of a deeply fraudulent industry that is financially and environmentally destructive. Guaranteeing their existence is an unnecessary risk.

IMAGE CREDIT: Stefani Reynolds, © 2021 Bloomberg Finance LP

Congressional OversightCryptocurrencyFinancial Regulation

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