Regulatory Note — Cryptocurrency - Report on Stablecoins
On Monday, November 1, the President’s Working Group on Financial Markets, joined by the FDIC and the OCC, published a Report on Stablecoins (the “Report”). The Report could have far-reaching consequences for the banking industry: the Report’s threshold recommendation is that Congress permit only insured depository institutions to issue stablecoins. A bank that enters the issuing business would face several tasks, including decisions about reserve assets, management of new or expanded prudential risks, and compliance with laws against illicit finance.
Stablecoins are digital assets that can be exchanged for fiat currency. The Report identifies three elements of “stablecoin arrangements,” which (together with other aspects of the stablecoin business) present prudential risks and in turn lead to three sets of legislative recommendations.
The three elements of stablecoin arrangements described in the Report are the creation and redemption of stablecoins, transfers between parties, and storage. Stablecoins are backed by “reserve assets,” which may range from insured deposits and U.S. Treasury bills to more volatile commercial paper, bonds, and other assets. Redemption rights vary and can include waiting periods and the right to suspend redemptions. Transfers of stablecoins usually involve either a stablecoin wallet or a distributed ledger, the latter bearing similarities to traditional payment systems. Stablecoins are generally held by third-party custodians or custodial wallet providers although in some cases users may hold and transfer stablecoins directly.
These arrangements generate three sets of prudential risks: (i) user protection and run risk, (ii) payment system risk, and (iii) systemic risk and concentration of economic power. Run risk is presented by a loss in value of reserve assets, limits on (or lack of clarity about) redemption rights, and risks related to cybersecurity and the storage of stablecoins. Payment system risk exists because, while the transfer of stablecoins involves many of the same risks associated with traditional payment systems, these risks are heightened in stablecoin arrangements. Inconsistent risk management standards, the number of parties involved in an arrangement, and operational complexity all contribute to the heightened risk. Systemic risk arises from the potential for a stablecoin to scale rapidly, which could result in issuers whose failure would reverberate throughout the financial services industry. Additionally, a few large participants could lead to an excessive concentration of economic power and could have anti- competitive effects if users face difficulty in switching from one stablecoin to another.
To address these risks, the Report recommends enactment of a statute that would establish a federal regulatory framework for stablecoin arrangements. This framework would include three provisions tied to the three sets of prudential risks.
User protection and run risk. Banks and other depository institutions, which are subject to broad safety-and-soundness regulation, would be the only issuers of stablecoins.
Payment system risk. The Report urges two types of reforms. First, custodial wallet providers would be subject to “appropriate” federal oversight. Second, the bank regulatory agencies would have authority to impose risk management standards on any participant that performs activities critical to the functioning of a stablecoin arrangement.
Systemic risk and concentrations of economic power. Banks as stablecoin issuers would be subject to limits on affiliations with commercial entities. The bank regulatory agencies would promote interoperability standards. The Report also refers to possible limits on custodial wallet providers’ relationships with commercial entities and on their use of transaction data, but these do not appear to be firm recommendations.
Note that the Report mentions regulation of stablecoins as securities or commodities and illicit finance concerns, but it makes no recommendations on these matters.
If Congress does not act, the Report recommends that the Financial Stability Oversight Council use its existing statutory authority to designate certain stablecoin activities as systemically important payment, clearing, and settlement activities. Such a designation would pave the way for the imposition of risk management standards, as well as examination and supervision by the appropriate federal agency.