The stablecoin market has been growing exponentially — from only $21.5 billion in mid-October of last year to $130 billion at the start of November; a six-fold increase — so it was only reasonable to expect that the United States government would have to come to grips with these digital assets that are designed to maintain a stable value relative to a fiat currency like the U.S. dollar (USD) or a commodity like gold.
The Treasury Department revealed its latest thinking on the subject this week with the much-anticipated President’s Working Group on Financial Markets’ (PWG’s) report on Stablecoins. That report recommended that Congress act promptly to enact legislation to ensure that payment stablecoin issuers be regulated more like U.S. banks. That is, stablecoins might be issued only through “entities that are insured depository institutions.”
Surprisingly, the report didn’t provoke much industry pushback. Perhaps the crypto community was just relieved that the government wasn’t looking to ban stablecoins outright? The report did raise some questions, though.
If enacted, what impact will such legislation have on the global stablecoin market? Could it stifle innovation as some in the crypto community have warned? Or, rather, could it bring regulatory certainty to a sector whose lack of supervision may have turned off institutional investors, corporations and even retail investors from exploring crypto alternatives?
An edge for legacy banks?
With regard to the first question, Salman Banaei, head of policy at cryptocurrency intelligence firm Chainalysis, told Cointelegraph that assuming the recommended legislation were passed and signed into law — a big “if,” given the current legislative stalemate in Washington — its provisions “would put current bank-backed stablecoins like JPM Coin in a prime competitive position versus non-bank stablecoin issuers.”
Non-bank stablecoin issuers would need, at minimum, to renegotiate arrangements with their current banking service providers, with the latter obtaining more leverage in these partnership arrangements, continued Banaei. The PWG Report contemplates that many of these relationships would be subject to the Bank Service Company Act. “Alternatively, these non-bank stablecoin issuers could apply to become depository institutions or acquire depository institutions, although these options can be expensive and slow.”
But, would it discourage financial start-ups and hinder innovation — as some in the crypto community fear? In the short term, it would likely hinder innovation, answered Banaei, as it would limit the pool of potential stablecoin issuers to depository institutions. “In the longer term, however, the legislation would encourage innovation” because clear regulatory “rules of the road” would eliminate the regulatory risk that has been the primary hindrance to broad adoption of stablecoins.
This, in turn, could “encourage the adoption of stablecoins in a variety of contexts across the financial markets,” continued Banaei. The fixed costs associated with a depository institution issuing a stablecoin are relatively low, and this could “encourage depository institutions to compete to offer stablecoins and to adopt or facilitate their use” in a variety of circumstances.
A gateway to the crypto world?
In an August blog, Chainalysis’ chief economist Philipp Gradwell wrote that “Stablecoins are vital for many institutional investors because they’re the fundamental gateway into the world of digital currency.” If that is the case, wouldn’t institutional investors and corporations prefer more market and regulatory certainty vis-a-vis stablecoins? That is, wouldn’t they arguably be supportive of the PWG’s recommendations?
In Europe, regulatory uncertainty is “without doubt discouraging them [i.e., institutional investors] from holding stablecoins, investing in cryptocurrencies through stablecoins and using stablecoins for yield in DeFi or issuing stablecoins themselves,” Patrick Hansen, head of strategy and growth at Unstoppable Finance, told Cointelegraph, adding further:
“But, contrary to many retail investors, most institutions don’t buy cryptocurrencies through stablecoins anyway — but either with fiat money or through some form of crypto trust, certificate or derivative — and, in the future, probably more and more through ETFs.”
Sidharth Sogani, CEO of crypto research firm CREBACO Global, admittedly no fan of stablecoins, tended to agree. “Nobody wants to own a stablecoin until and unless required to book profit. Also, with more ways to invest now, including ETFs, etc., I think people are reducing exposure to stablecoins,” he told Cointelegraph.
“The chief benefit of the legislation recommended by the PWG Report is it would provide a path to enter the ‘gateway’ into new financial services and technology,” commented Banaei, adding: “The PWG Report presents one model of how to open this ‘gateway’ to new, more efficient and competitive ways of delivering financial services.”
Unlocking an opportunity
The report might have directed regulatory agencies like the Securities and Exchange Commission (SEC) or the Commodity Futures Trading Commission (CFTC) to open that “gateway” using their existing regulatory authority, added Banaei, but it didn’t. Instead, it recommended a longer but arguably more enduring path: congressional legislation. Banaei’s fear is that if legislation fails, then “the PWG Report will fail to spur regulators to implement the rules necessary to comprehensively address the risks detailed in the report” like illiquidity or failure to redeem or illicit finance problems and never realize “the opportunities unlocked by the widespread use of stablecoins.”
The report met with approval from a fairly wide spectrum of players that are involved. Rohan Grey, assistant professor at Willamette University College of Law, who helped craft the STABLE Act — i.e., stablecoin legislation earlier introduced in Congress — said that the proposals were generally positive, further explaining to Cointelegraph:
“This was the underlying vision behind the STABLE Act that we introduced at the end of 2020. Bringing stablecoins squarely within the purview of banking regulation and under the umbrella of deposit insurance would be unequivocally positive for financial stability.”
Elsewhere, Michael Saylor, an ardent Bitcoinist, stated that the PWG report should be "required reading for anyone interested in bitcoin or crypto,” while Quantum Economics founder and crypto crusader Mati Greenspan wrote in his newsletter that the Treasury report is “insanely bullish for the entire crypto space, and we can already see prices reacting.”
Olya Veramchuk, director of Tax Solutions at Lukka, a crypto data and software provider, flagged the report’s view that stablecoin issuers should be restricted to be “insured depository institutions, which are subject to appropriate supervision and regulation,” a restriction that would essentially equalize “stablecoin issuers to traditional banks,” clarifying further for Cointelegraph:
“This would most certainly increase compliance costs and would likely make it more difficult for stablecoin issuers to be profitable. On the flip side, however, more regulation could increase institutional investor comfort.”
What about the rest of the world?
Of course, the White House paper applies to a single jurisdiction: the United States. This is a world that continues to struggle to find the optimum balance between regulation and innovation for the cryptocurrency and blockchain sector.
“The crypto regulatory space is getting increasingly heated, and not only in the U.S. but also in the rest of the world,” Firat Cengiz, senior lecturer in law at the University of Liverpool, told Cointelegraph previously, adding: “DeFi and stablecoins — rather than exchange or store-of-value coins such as BTC or ETH — will be the key target of emerging regulations.” For instance, drafts of European Union regulations “will ban interest on stablecoins.”
Eloisa Cadenas, CEO at CryptoFintech and co-founder of PXO Token, the first Mexican stablecoin, applauded the attempt to impose some regularity on the stablecoin market, telling Cointelegraph:
“The regulations being developed around stablecoins, specifically collateralized fiat, contrary to what one might think, are very necessary and fundamental since they will guarantee that there is a healthy monetary policy — without it, there is the possibility of systemic risk and liquidity risk.”
Others suggested, however, that the regulatory “cure” could be worse than the “disease” of regulatory uncertainty. In Europe, Hansen, formerly head of blockchain at Bitkom, an association of German companies operating in the digital economy, said that the stablecoin rules being discussed in the context of the EU’s Markets in Crypto-Assets Regulation (MiCA) “will stifle European innovation in that sector.”
Issuers of so-called e-money tokens, for example, will have to get authorized as credit or e-money institutions and face very high compliance requirements. “I don’t expect many projects and startups in the EU to be willing to go through that expensive and lengthy authorization process in order to issue a euro-denominated stablecoin,” he told Cointelegraph.
Asked about the PWG’s proposals, Sogani, whose firm is based in Mumbai, India, agreed that legislation to regulate the stablecoin market is necessary. At present, many stablecoin issuers “may not be able to handle certain things like fiat liquidity,” so some capital requirements could be useful. Also, many issuer’s reserves “are not being audited systematically by recognized auditors.” For example, “USDT is now available on five-plus chains for transactions,” including ERC-20, BEP-20, Solana, Tron and BEP-2. “To audit on multiple chains” where funds are changing hands 24/7 is well nigh “impossible,” he suggested.
Holding stablecoins over fiat dollars?
Meanwhile, stablecoins continue to proliferate. Chainalysis’ data shows that in mid-March 2021, large investors began buying an increasing number of stablecoins and holding them for longer time periods than was previously the case. Gradwell wrote that since many are willing to significant wealth in stablecoins over fiat, “there’s an untapped market for any company that would start offering that. This is one reason why Facebook’s Diem coin caused so much excitement.”
But, stablecoins have also been dogged by controversy. It was suggested earlier this year that not every stablecoin is backed 1:1 by USD or U.S. Treasury bills, “with some holding a high percentage of riskier assets in their reserves,” i.e., other digital assets, commercial papers, corporate bonds, etc., Veramchuk told Cointelegraph, adding:
“There are no standards governing the reserve composition. That, combined with the regulatory uncertainty and the relative novelty of the asset class, results in the institutional investors behaving cautiously.”
Regulations will also have to account for differences among different types of stablecoins. “There needs to be a clear distinction between centrally issued stablecoins with a central reserve and, on the other side, decentralized and algorithmically generated stablecoins on top of open permissionless public blockchains,” said Hansen.
Grey, too, mentioned algorithmic, or hybrid, stablecoins that aren’t backed by fiat currencies or commodities — but rather rely on complex algorithms to keep their prices stable. “An outstanding question from the [PWG] report's findings is what would happen to so-called ‘algorithmic’ stablecoins, which the report distinguishes from ‘fiat-backed’ stablecoins in ways I'm not sure are justifiable or helpful.”
“Regulation for stablecoins is very necessary”
All in all, the arrival of the PWG report appeared to be greeted with some relief within the crypto community — at least the U.S. Treasury Department wasn’t proposing to outlaw stablecoins. The deposit insurance requirement didn’t appear to be insurmountable — at least no hue and cry has yet emerged — and innovation in the industry wouldn’t be throttled in any meaningful way because stablecoins really aren’t about innovation, others noted.
Many viewed that regulatory uncertainty is the real scourge here, and while the devil is in the details, as Grey observed, the government proposals weren’t seen as an unwelcome development on balance. People generally like to have someone overseeing the sausage-making process — even if they don’t want to watch sausage being made themselves. Cadenas added:
“Stablecoin projects like the one we are creating in Mexico are faced with various barriers including not knowing where or if they will be able to operate. In short, regulation for stablecoins is very necessary."