About the author: Timothy G. Massad is a research fellow and the director of the Digital Assets Policy Project at the Harvard Kennedy School, and former chairman of the Commodity Futures Trading Commission. He is on PayPal’s advisory council on Blockchain Crypto and Digital Currencies.
Two years ago on a summer Friday, Treasury Secretary Janet Yellen announced that the President’s Working Group on Financial Markets would meet the next Monday to discuss stablecoins. The urgency reflected concerns about the growth and risks posed by these crypto tokens, whose value is tied to the dollar.
But despite three subsequent reports from the Treasury calling for legislation and a White House executive order on crypto, we still don’t have a regulatory framework that can put the “stable” into stablecoins. If we don’t create one soon, we may find that dollar-based stablecoins grow anyway, under legal frameworks that are not to our liking. That’s essentially what happened with the Eurodollar market.
Competition from stablecoins might improve our payment system, where the otherwise innovative U.S. financial system lags much of the world. Few of us notice that—our credit cards, mobile banking and phone apps seem to work just fine. But although our system is safe and reliable, it is slow and expensive compared to what’s possible. The burden falls most heavily on the poor, who pay a lot just to use their money. Improving the technology of payments can also help preserve the dollar as the dominant global currency.
The Federal Reserve will launch FedNow, a real-time payments service, this month. But its benefits may be limited without regulatory changes that increase access and competition, and its pricing may also discourage usage.
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Stablecoins have potential advantages in speed, cost and programmability. Tokenization could provide benefits that FedNow never can. Payments today involve separate movements of the payment information—name and account of payor and payee and amount—and the value. Each involves multiple steps and parties. Stablecoins can combine messaging, reconciliation, and transfer of value all at once, instantly.
Stablecoins have risks: If demand for redemptions suddenly spiked, there could be a run, as with a bank. Rapid liquidation of reserves could lead to fire sales that depress asset prices. There is no resolution scheme to prioritize holders’ claims in case of a failure. And because tokenized money is a bearer instrument, it may create more risk of illicit activity than account-based payments, although stablecoins are much easier to track than cash in suitcases.
Regulation can mitigate these risks. Issuers can be required to invest reserves only in demand deposits at banks or even central bank reserves. They can be prohibited from creating credit or engaging in other activities. A resolution scheme can be created. And issuers can assume some responsibility for the quality and safety of the decentralized blockchains on which their stablecoins move, just as we require banks to take responsibility for storing data on the cloud. Issuers can also monitor blockchain transfers and freeze tokens if so requested by law enforcement.
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There have been thoughtful proposals introduced in Congress by members on both sides of the aisle, and it would seem that a compromise, at least in the House, could be reached. But the White House has not prioritized the issue.
Administration officials have been riding off in multiple directions. The Treasury has called for legislation while U.S. bank regulators have said stablecoins pose too much risk. The Securities and Exchange Commission sued a crypto exchange for promoting a stablecoin while the Commodity Futures Trading Commission chairman said Tether, the largest stablecoin, is a commodity. (That latter statement is true because there are futures contracts traded on Tether, just as interest rates are a commodity because of interest rate futures contracts. But the CFTC doesn’t regulate Tether just as it doesn’t set interest rates.)
Rather than fighting over which regulator’s existing jurisdiction might cover stablecoins, let’s create the proper framework from a functional perspective, which is that stablecoins should be regulated as a payment instrument. That approach would also mean last week’s court decision on whether the crypto token XRP is a security—which is rocking the regulatory debate—would not be directly relevant.
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This could be done administratively even if Congress doesn’t act, as I have written with Professors Howell Jackson of Harvard Law School and Dan Awrey of Cornell Law School. The Office of the Comptroller of the Currency, with the assistance of other regulators, could implement a framework under existing law. The White House has leverage because the OCC is an office of the Treasury, headed by an acting director.
The main reason for legislation is that the risks could grow even if federal regulators try to keep them outside of the regulatory perimeter. That’s because states are licensing them, and other countries—including Europe, the U.K. and Singapore—are implementing legislation, which could lead to more dollar-based stablecoins being issued offshore. The Eurodollar market history is instructive.
That was also a market that grew quickly, outside the control of U.S. bank regulators, as Josh Younger of the New York Fed recounts in a recent podcast. Foreign banks that took in dollar deposits and created dollar liabilities were not constrained by U.S. reserve requirements or interest rate limits. U.S. policy makers started to worry about the risk of runs, the absence of a central bank liquidity backstop in dollars, and possible interference with monetary policy. Ultimately they realized they not only needed to engage with the market, including by providing swap lines, but that the market could help cement the dollar as the main currency for international commerce.
Stablecoins are likely to grow, and we are better off acting now to address the risks and maximize potential advantages. Otherwise the U.S. could become a standards taker rather than a standards maker.
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