Last week, the Federal Reserve (Fed) and the US Treasury Department (Treasury) noted potential risks associated with certain aspects of stablecoins. While the Fed claimed that “the overall value of stablecoins[…]has grown rapidly over the past year to reach more than $180 billion in March 2022,” and the Treasury acknowledged that the stablecoin and other digital assets “present opportunities to foster innovation and increase the efficiency,” both warned of potential systemic risks, including liquidity and valuation issues during times of market stress and a vulnerability to panics. The two agencies addressed regulatory gaps in the area of digital assets, with Treasury Secretary Yellen calling for the development of a “coherent federal framework” to address the “problems and opportunities posed by digital assets,” including stable coins.
On May 9, the Fed released its Financial Stability Report (report). The purpose of the report, which the Fed releases in May and November each year, is to provide the Fed with “the current assessment of the resilience of the U.S. financial system[,]” and to “[…] promote public understanding and increase the transparency and accountability of the Federal Reserve’s views on this subject. In the report, the Fed assessed the “vulnerability of the financial system” in four key areas: asset valuations, corporate and household borrowing, leverage in the financial sector, and funding risks. A funding risk noted by the report was that “structural vulnerabilities persist in some money market funds, bond funds and stablecoins”, and it specifically noted that “the stablecoin sector has continued to grow rapidly and remains exposed to liquidity risk”.
A stablecoin is a digital asset “designed to maintain a stable value against a national currency or other benchmark assets”. In common parlance, stablecoins are often referred to as “tied” to these other assets or groups of assets. As the Fed explained in its report, “Stablecoins generally aim to be convertible, at par, into dollars, but they are backed by assets that can lose value or become illiquid in times of crisis; therefore, they face reimbursement risks similar to premiums and tax-exempt. [Money Market Funds (MMFs)].” The Fed warned that “[t]These vulnerabilities can be exacerbated by a lack of transparency regarding the risk and liquidity of assets backing stablecoins. Additionally, the increasing use of stablecoins to meet margin requirements for leveraged trading in other cryptocurrencies may amplify the volatility of demand for stablecoins and increase redemption risks. The Fed went on to note that “[t]The President’s Task Force on Financial Markets, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency have made recommendations to address the prudential risks posed by stablecoins[,]and that the Presidential Executive Order on Ensuring Responsible Development of Digital Assets also instructed various bodies to consider the development of digital asset regulation.
A day later, on May 10, during the Financial Stability Supervisory Board’s annual report to Congress, Secretary Yellen also addressed the stablecoin and the need for increased regulatory oversight in the area of digital assets. Secretary Yellen noted that “[w]When it comes to digital assets, new products and technologies can present opportunities to promote innovation and increase efficiency. However, digital assets can pose risks to the financial system, and increased and coordinated regulatory attention is needed. Regarding stablecoins, Secretary Yellen said Treasury looks forward to working with Congress to “ensure that payment stablecoins and their arrangements are subject to a federal prudential framework on a consistent and comprehensive basis.”
While there is agreement among some federal entities and legislators on the need to establish a stablecoin regulatory framework, there is no consensus yet on what form it should take. For example, in November 2021, the President’s Financial Markets Task Force (PWG), joined by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), released a report on stablecoins. The report called on “Congress [to] act quickly to ensure that payout stablecoins are subject to appropriate federal prudential oversight on a consistent and comprehensive basis[,]” and said that “[t]To achieve these objectives, legislation should limit the issuance of stablecoins and related activities of redemption and maintenance of reserve assets to entities that are insured depository institutions. Alternatively, Senator Toomey, a member of the Senate Banking Committee, who released a bill in April that would establish a new regulatory framework for stablecoins, expressed the view that while increased regulation is needed, the issuance of stablecoins should be authorized by “(1) a money transfer business or other person authorized by a state bank or similar authority to issue stablecoins; (2) a domestic issuer of payout stablecoins limited; or (3) an insured deposit-taking institution.
Regulation will play a key role in shaping the stablecoin sphere. As the use and uses of the stablecoin continue to develop and grow, it will be important to watch how the various federal agencies and legislators determine how best to develop stablecoin regulations.