What Stablecoins Might Become

Identifying the ideal path to regulatory compliance for a stablecoin has been difficult. U.S. regulators have taken a much more active interest in the industry, though it is still not entirely clear what they will want stablecoins to be.

U.S. Treasury Secretary Janet Yellen has warned about the risks stablecoins pose to the financial system and national security.

”Depending on its design and other factors, a stablecoin may constitute a security, commodity or derivative subject to the U.S. federal securities, commodity and/or derivatives laws,” she said in a statement that certainly leaves some ambiguity. But regulators, however, should make their intentions clear in the next couple of months.

Bennett Tomlin, in his personal time, is a blogger and podcaster with an interest in stablecoins. This op-ed is part of CoinDesk’s Policy Week, a forum for discussing how regulators are reckoning with crypto (and vice versa).

Opinions on the appropriate regulatory response to stablecoins vary from fitting these fiat-pegged digital assets into a money transmitter framework to treating issuers as banks. Some regulation enthusiasts believe there should be no space for stablecoins. Despite the disagreement and uncertainty around stablecoins, it’s clear that the $130 billion market has drawn the attention of powerful people.

U.S. Securities and Exchange Commission Chairman Gary Gensler has suggested that “stable-value coins” may be securities. It seems clear that he is trying to tie them to stable-value funds, a fund design that the SEC already claims jurisdiction over. If stablecoins, or at least stablecoins backed by noncash assets, are securities, then they will no longer be useful for the things that they are now. It seems unlikely that they would be able to continue to move and trade unimpeded across censorship-resistant global networks.

Some cryptocurrency companies have taken a proactive approach to finding existing regulations they believe more adequately cover what their stablecoin would do. Avanti – a special purpose depository institution, which is a bank with only a state charter, a classification that was created under new legislation in Wyoming – seems to believe that the Uniform Commercial Code, which (in part) dictates standards for banknotes, would allow for the issuance of a “digital banknote.” If its token is considered a banknote, then it will be exempted from regulation as a security. That also may in part explain why digital asset company Paxos has a bank charter and payments company Circle wants one.

The Office of the Comptroller of Currency has issued guidance that makes it clear that banks are allowed to use stablecoins as part of their normal business, including payments, and that they can hold reserves for stablecoins. That suggests that stablecoin issuers may look like banks.

However, it may be difficult for depository institutions like Avanti to gain access to Federal Reserve master accounts. The Narrow Bank, an earlier proposed bank that would have parked its funds at the Federal Reserve and then passed on higher interest rates to depositors, hasn’t been able to get such access so far. Both Avanti and crypto exchange Kraken have applied for Federal Reserve access and so far neither has been accepted. Lack of access to the Federal Reserve payment rails would make running a stablecoin more difficult, or require Avanti and Kraken to rely on other service providers that do have access to the Fed through federally chartered banks.

A new piece of legislation known as the the STABLE Act would create a framework for stablecoins and other money transmitters where they would be obligated to keep all of their reserves at the Federal Reserve. Under a framework like the STABLE Act, there is a much better path toward a more narrow stablecoin issued by a bank.

There may still be significant legislative, regulatory and political hurdles related to effectively creating a new type of bank. Furthermore, the STABLE Act is not just limited to what those in cryptocurrency circles consider stablecoins, but would likely involve a wide array of money transmitters and may even change things for companies such as PayPal.

But it’s not just issuers that are eyeing the banking system as a model. Federal Reserve officials, such as Fed attorney Jeffery Zhang in his article ”Taming Wildcat Stablecoins,” have proposed bringing stablecoin issuers into the broader bank regulatory framework. While the Federal Deposit Insurance Corp. (FDIC) is reportedly studying how to extend deposit insurance to stablecoins to help protect users. Meanwhile, the Biden administration has stated it thinks stablecoin issuer are at least “bank-like.”

The Digital Asset Market Structure and Investor Protection Act outlines a process where every stablecoin issuer must apply to the Treasury, at which point the Treasury checks with the Federal Reserve, the SEC, the Commodity Futures Trading Commission and banks and decides whether to approve the stablecoin.

If that legislation passes (it’s now in committee in Congress), any unapproved stablecoin – including any digital asset pegged or collateralized significantly by a fiat currency – would then be unlawful. The bill, however, provides a path for approved stablecoins to avoid being considered a security.

It is difficult to say exactly how all of this will play out. My intuition is that a new type of banking charter will be created that will allow stablecoin issuers to access Fed master accounts and there will be an expectation that stablecoins will hold their reserves there. It also seems reasonably likely that the Treasury gets its way and stablecoin issuers will need to register with the Treasury. I expect that securities regulations may be part of the cudgel that will be used to help ensure that the only stablecoins are the “approved” stablecoins.

The end result of this will likely be that any stablecoin issuer that wants to continue operating would need to become a bank and is going to have significantly less flexibility with what they can do with their reserves. Those that choose not to register or are not approved are likely to have difficulty accessing the U.S. banking system. They may have trouble servicing redemptions, and may perhaps even find themselves aggressively pursued by regulators.

The effect on the average crypto user is likely a degradation of their experience using stablecoins. However, there will be significantly greater certitude surrounding the backing and safety of the token, and regulators will no longer have to worry about them being an existential financial risk. In effect the government may take the private money that is stablecoins, and integrate it into the banking regulation framework so that it can become publicly guaranteed.