Regulators shouldn’t ‘front-run’ Congress on stablecoins
Regarding one aspect of cryptocurrency regulatory policy—payment stablecoins—a discreet consensus is gradually forming among important players. Stablecoins will be the focus of another hearing on Thursday by the House Financial Services Committee’s Subcommittee on Digital Assets, Financial Technology, and Inclusion, the second one on the topic in the previous four weeks. Prior to the hearing, two more bill draughts from the committee’s chair, rep. Patrick McHenry, and ranking member, rep. Maxine Waters was put on the committee’s website. Both of these draughts were modifications of the joint draught that the committee had previously considered. The House’s commitment to introducing and passing a bill in this area is indicated by the most recent hearing and newly distributed draughts.
Members of the Subcommittee on Cryptocurrency have differing viewpoints, but many agree on a few fundamental points regarding how payment stablecoins should be regulated. It may have been simple to overlook during the crosstalk at the hearing last month, but several Subcommittee members and the testifying witnesses all agreed that:
Payment stablecoins require immediate congressional action;
Other sorts of non-payment stablecoins (which may employ various strategies to maintain a “soft peg” to the U.S. dollar or another currency) are unique and distinct from payment stablecoins backed 1:1 by cash or cash equivalents;
Payment stablecoin issuers ought to be subject to a prudential framework with safeguards like reserve and redemption requirements, asset segregation, rehypothecation prohibitions, asset commingling restrictions, and AML/KYC obligations, similar to payments or banking regulation;
Important public policy goals can be promoted by properly regulating and monitoring payment stablecoins, such as maintaining the U.S. dollar’s hegemony and promoting financial inclusion.
The proposal to regulate payment stablecoins, say through a securities framework, has yet to be made by Congress. However, one financial regulator, the SEC, seems prepared to take that action. Financial regulators shouldn’t “front-run” Congress with regulation-by-enforcement, given the current legislative activity on stablecoins.
What is a stablecoin for payments?
A unit of fiat money is represented as a “payment stablecoin” on a blockchain. Stablecoins designed for payments—which can be quickly redeemed or exchanged for fiat currency—are typically backed 1:1 by cash or cash equivalents. Payment stablecoins are not as unique or exotic as their cryptocurrency roots may imply, despite the fact that the name “stablecoin” is frequently used as a general phrase. These “look like pretty basic cash instruments,” as one witness said during the hearing last month.
Stablecoins with fiat backing are distinct from those that are algorithmically stabilized with a non-stable companion asset or from those that are collateralised with cryptocurrencies, such as DAI. Due to the possibility of price fluctuations and the possibility that they may not be redeemed or exchanged for fiat on a 1:1 basis, these non-payment stablecoins are said to be only “soft-pegged” to a unit of currency.
Recent hearings and draught legislation have mostly focused on regulating payment stablecoins like USDC or Tether, which are expected to make up about 90% of the global stablecoin market and are significant players in the cryptocurrency ecosystem.
What purpose do stablecoins serve as means of payment?
For many cryptocurrency transactions, U.S. dollars are the favored form of settlement. But without stablecoins, a third party, such as a payments processor or a bank, is needed to make payments in U.S. dollars or any other currency in return for cryptocurrencies. Stablecoins are a useful innovation because they act as a unit of fiat money within an open standard on a blockchain, enabling transactions to take place and settle in dollars without the use of a third-party intermediary by using “smart contracts” — self-executing code stored on a blockchain.
Imagine having a balance in Apple Pay that could be accessed from any other cash balances you may have on your phone, such as those in your Venmo, Zelle, or Amazon accounts. Stablecoins used for payments are essential, having the additional advantage of real-time, round-the-clock settlement. Payment stablecoins act as a link between the crypto world and conventional finance in this way.
Naturally, the worth and usefulness of payment stablecoins depend entirely on the currency and financial equivalents that support them. The good news is that humans are adept at properly controlling cash-like instruments since we have had them for a while.
Regulation of stablecoins proposed legislation
The anticipated McHenry-Waters stablecoin bill is the most recent in a long line of legislation that has been submitted in recent years to regulate stablecoins, including the Stablecoin Transparency Act, the Stablecoin TRUST Act, and the Responsible Financial Innovation Act, among others. There is a broad bipartisan consensus to regulate payment stablecoins as cash instruments rather than securities, despite the fact that the scope and approaches of these laws vary.
The most recent draughts of the legislation would provide a prudential framework for policing payment stablecoins that would include crucial protections and restrictions like:
- 1:1 backing of capital and reserves
- Conditions for the redemption timeline
- Asset separation
- Restrictions on or prohibitions against rehypothecation (such as lending or investing the proceeds) and mixing
- Considering payment stablecoin issuers as financial institutions liable for the Bank Secrecy Act’s AML/KYC regulations.
In fact, only one of the stablecoin legislations that has been put up in Congress thus far — the one from 2019 — may grant the SEC the authority to regulate the payment of stablecoins. Another measure from 2020 would designate the Treasury Department (FinCEN) as the primary regulator for reserve-backed (i.e., fiat-backed) stablecoins while excluding “synthetic” stablecoins (i.e., uncollateralized, algorithmically stabilized) stablecoins. Since then, almost every stablecoin legislation has regulated the payment of stablecoins using a banking or prudential approach.
Stablecoins for payments are not securities
SEC Chair Gary Gensler has stated repeatedly that he believes that these “so-called stablecoins” may be securities, comparing them to “poker chips at the casino” or, when used within cryptocurrency exchange platforms, possibly security-based swaps, despite the SEC not having proposed a rule, provided guidance, or brought an enforcement action with regard to payment stablecoins.
Some payment stablecoins according to him, are similar to money market mutual funds, which he added. The SEC also revealed in February that it was considering taking enforcement action against Paxos. This blockchain infrastructure platform creates BUSD, a stablecoin governed by the financial authority of New York State. This was because BUSD is unregistered security, according to the SEC.
It is obvious that the SEC considers at least some payment stablecoins to be securities and that it may soon impose sanctions on them. Payment stablecoins do not, despite some stablecoin arrangements possibly fitting the definition of a security within an enumerated category, such as an “investment contract” under the Howey test or a “note” under the Reves test. Simply put, holders of payment stablecoins are not driven by the hope of making money, which is an essential condition under Howey and a crucial element of a complex balancing test under Reves. Stablecoins used for payments often don’t pay interest and function like cash. The assumption that payment stablecoins are notes under the Reves test is also refuted by the fact that they are fully backed and utilized for non-investment reasons.
Regarding how they differ from money market mutual funds, the majority of payment stablecoins are sold and utilized as digital currency rather than dividend or income-producing alternatives to bank deposits. The majority of payment stablecoin issuers don’t pool and reinvest funds; instead, they produce digital copies of fiat currency that are backed by cash or short-term treasury bills.
Payment stablecoins are dependent on an administrator or issuer to arrange for custody of the underlying cash or cash equivalents that support the stablecoin’s value, but this kind of financial activity and relationship is typically governed by a prudential framework that emphasizes safety, soundness, and supervision. Such a strategy is in line with the suggestions made by the Presidential Working Group on Financial Markets in their joint “Report on Stablecoins” released in late 2021 in partnership with the FDIC and the OCC, as well as the majority of stablecoin laws put up by Congress thus far.
While this is going on, the CFTC has claimed in a number of enforcement actions that some stablecoins, such as USDT, USDC, BUSD, and DAI, are commodities. According to Congress Chair Benham, USDC and other stablecoins identical will be considered commodities until CFTC declares otherwise. Different financial authorities have varied and occasionally opposing stances, which only emphasizes the necessity of Congressional action to bring everyone on the same page.
Financial authorities like the SEC and CFTC should let that process take its course since Congress is actively pursuing a bipartisan, prudential regulatory policy to govern payment stablecoins. Although the timing of any stablecoin legislation is uncertain, it is apparent that both parties in Congress place high importance on the issue because they have spent more time on stablecoin legislation than on any other crypto-related policy topic.
It is a good idea to have comprehensive stablecoin legislation
In the hearing held last month, almost all of the witnesses concurred that the U.S. has a strong public policy interest in encouraging financial access, ensuring regulatory clarity, and preserving the dominance of the U.S. dollar. All three of these objectives will be helped by sensible, all-encompassing payment stablecoin law.
Some have suggested that stablecoins may be dangerous for the overall financial system, pointing out that Circle, which controls and issues USDC, had sizable accounts at the recently shut down Silicon Valley Bank. Chair Gensler made an effort to link the actions of Silvergate and Signature Bank in the cryptocurrency space to their eventual downfall. Adrienne Harris, Superintendent of New York State’s Financial Regulator, which oversaw Signature Bank, indicated unequivocally during the hearing held last month that the failure of the bank was not caused by cryptocurrencies and referred to the notion as a “misnomer.”
Others have objected to regulatory plans for stablecoins that call for a dual federal-state strategy akin to that used for banks. But with this structure, regulation can be better and more specialized.
According to Austin Campbell, one of the witnesses at the hearing last month, “It does not make rational sense for the OCC or the Federal Reserve to be spending a lot of time on a $2 million market cap stablecoin run out of Alabama, but it also does not make sense for Alabama to be the sole overseer for a $500 billion market cap stablecoin.” This strategy was approved by Superintendent Harris as well, who noted that FTX, Voyager, Celsius, and Terra/Luna had been prohibited from conducting business in the state and said that “states can act more nimbly.”
The need for comprehensive payment stablecoin legislation is becoming increasingly widely acknowledged, giving Congress a chance to enact sensible regulation over a significant portion of the cryptocurrency market. However, finding common ground between crypto advocates and U.S. regulators has grown increasingly challenging in the wake of recent events.