On November 1, 2021, the President’s Working Group on Financial Markets (PWG) released its much-anticipated Report on Stablecoins (Report).1 The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) joined the PWG in issuing the Report.2
The Report provides an overview of how stablecoins are created and operate, discusses the risks they present (including regulatory gaps), and makes a series of recommendations for addressing these risks. The Report also discusses the role played, and risks presented, by digital wallets, transfer agents, digital asset exchanges, and DeFi generally in facilitating the use of stablecoins.
The Report signals the Biden administration’s concerns about the rapidly developing digital asset markets and their lack of appropriate federal regulation. The PWG has indicated that the Report is part of a broader effort by the Biden administration to examine and identify the risks posed by digital assets and other blockchain-based technologies products, “promote consistent regulatory approaches,” and “foster responsible financial innovation.”3 At the same time, the Report leaves a number of significant questions unanswered and defers to Congress and federal financial regulators to make key decisions on how stablecoins should be regulated. In this Legal Update, we summarize key aspects of the Report and look ahead to key questions and next steps for the regulation of stablecoins.
The Report identifies three primary risks presented by stablecoins: (1) “loss of value,” whereby a decline in the value of the assets backing a stablecoin or an operational failure triggers a “run” on the stablecoin and/or fire sales of assets by the issuer or other market participants, resulting in losses to stablecoin users and threatening financial stability; (2) “payment system risks,” whereby credit, liquidity, operational, governance, or settlement risks undermine the functioning of stablecoin payments systems; and (3) “risks of scale,” whereby a stablecoin issuer or supporting entity acquires either a central position in the market such that its failure would have adverse consequences for the financial system, or economic or market power that would grant it unfair advantages over its competitors or in other markets (similar to traditional concerns with the mixing of banking and commerce).
Despite the existence of these risks associated with stablecoins, the Report notes that there are not consistent and comprehensive regulatory standards for stablecoin arrangements or DeFi generally. Indeed, the Report demonstrates the regulatory uncertainty surrounding stablecoins by failing to specify if, and the extent to which, stablecoins should be classified as a security, commodity, and/or derivative under the US federal securities laws or the Commodity Exchange Act (CEA). Securities and Exchange Commission Chair Gary Gensler has taken a strong public position that many, if not most, stablecoins fall under the SEC’s jurisdiction.4 In contrast, the Report merely states that the “federal securities laws and/or the CEA may apply to the stablecoin, the stablecoin arrangement, and transactions in, and/or participants involved in, the stablecoin or stablecoin arrangements” and derivatives of such instruments.5 (Emphasis added.)
To address these regulatory uncertainties and the risks associated with stablecoins, the Report proposes a series of legislative and regulatory reforms to enhance federal oversight and regulation of stablecoin issuers and other entities involved in the functioning of stablecoins.
1. Federal Legislation. The Report recommends that Congress “promptly” enact legislation to subject stablecoins and stablecoin arrangements to federal prudential oversight.6 The Report recommends that such legislation include:
- Limiting core stablecoin activities (i.e., issuance, redemption, maintenance of reserve assets) to insured depository institutions with consolidated supervision at the holding company level by the Federal Reserve;7
- Imposing prudential standards for stablecoin issuers, including capital and liquidity requirements;
- Providing federal oversight of custodial wallet providers that would prevent lending of customer stablecoins and subject them to prudential regulation;
- Extending federal supervisory, examination, and enforcement authority to entities that perform critical activities for the functioning of stablecoin arrangements; and
- Granting federal banking agencies authority to adopt regulations to promote interoperability among stablecoins or between stablecoins and other payment instruments.
Due to the speed of innovation in digital asset markets, the Report also emphasized the need for any federal legislation for stablecoins to be flexible enough to respond to future developments and risks across a variety of organizational structures.
2. Interim Regulatory Measures. Recognizing that congressional action is not likely to happen in the near term, the Report states that, in the interim, federal financial regulatory agencies intend to use their existing authorities to “address risks falling within each agency’s jurisdiction.”8 These actions include:
- The federal banking agencies will evaluate charter applications for the risks identified by the Report, while the SEC and the CFTC will utilize their investor protection and market protection authorities to the extent a stablecoin falls under their respective jurisdictions.
- The Department of Justice (DOJ) and other government authorities “may consider whether or how section 21(a)(2) of the Glass-Steagall Act may apply to certain stablecoin arrangements.”9 Section 21(a)(2) prohibits any company other than regulated banks from receiving demand deposits and is enforceable with criminal penalties.10
- The Consumer Financial Protection Bureau (CFPB) may utilize the Electronic Fund Transfer Act, the Gramm-Leach-Bliley Act, and the Consumer Financial Protection Act (contained within the Dodd-Frank Act) to protect consumers. The Report does not discuss the particular authorities the CFPB would utilize under these statutes.
- The Financial Crimes Enforcement Network (FinCEN) may utilize the Bank Secrecy Act to enforce anti-money laundering and counter-terrorist financing compliance obligations against stablecoin arrangements that offer money transmission services.
- The Financial Stability Oversight Council (FSOC) could designate certain stablecoin arrangement activities as (or likely to become) systemically important payment, clearing, and settlement activities, which would authorize federal agencies to establish prudential standards for financial institutions engaged in such activities.
3. Observations. The Report’s recommendations are based on an approach to the regulation of stablecoins that, if enacted by law or adopted by regulation, would impact both how stablecoins are regulated and which regulators have regulatory authority.
- Banks Not MMFs. The Report’s recommendation that stablecoins should be issued only by insured depository institutions reveals that the Biden administration is viewing stablecoins as equivalent or comparable to demand deposits rather than as similar to money market funds (MMFs), which are subject to oversight by the SEC that is less comprehensive than that by federal banking regulators for insured depository institutions. This is not entirely surprising as the FSOC has repeatedly supported stronger regulation of MMFs to address its concerns about the run risks MMFs posed during both the 2008 financial crisis and the 2020 COVID-19 crisis. Accordingly, although stablecoins are often considered analogous to MMFs, the PWG likely believes that it needs to preemptively address the run risks of stablecoins by adopting a bank regulatory approach.
- Favorable to Federal Reserve. The Report embodies a Fed-centric approach to the regulation of stablecoins by recommending not only that stablecoins be issued only by insured depository institutions but that such issuers have consolidated supervision by the Federal Reserve. In addition, FSOC designation of stablecoin arrangements as systemically important payment, clearing, and settlement activities would provide the Federal Reserve with additional authority over stablecoin issuers and participants in stablecoin arrangements.11
Over the past several years, the OCC has sought to lead the development of digital finance at the federal level by issuing trust and bank charters to cryptocurrency firms and by authorizing banks to provide trust services to such firms. Nevertheless, the Report indicates that the Biden administration will support a shift to greater Federal Reserve involvement in future stablecoin regulatory initiatives.
- Pro-Federal Regulation. The Report’s recommendation that stablecoin issuers be insured depository institutions implicitly seeks to move regulation of stablecoins to the federal level, potentially preempting ongoing state chartering and regulatory activities, including by the states of New York and Wyoming.
- Banking and Commerce. The application of the traditional restriction on mixing banking and commerce to stablecoin arrangements could impose a significant impediment to the development of the stablecoin markets given that commercial companies are among some of the most likely issuers of stablecoins.
- FSOC. The Report potentially sets the stage for the FSOC to effectively establish a federal regulatory regime for stablecoins in the absence of federal legislation by using its designation authority to impose prudential regulatory requirements on stablecoin arrangements.
4. Key Open Questions. The Report does not provide specific details about the content of potential prudential regulations for stablecoin issuers, including whether such regulation would be the same as that for other insured depository institutions or tailored to the unique risks presented by stablecoin issuers. The Report also contains surprisingly little on what would be the appropriate consumer protections for stablecoins or where the regulatory perimeter is between the banking and securities/derivatives regulatory regimes. Yet these technical details are likely to be decisive factors in how such regulations would affect the future use and development of stablecoins. In refining the recommendations set forth in the Report, Congress and federal financial regulators will need to carefully craft regulations that properly addresses identified risks without stifling the use and development of stablecoins with inappropriately tailored and costly regulatory requirements. Although the Report is certainly an important step toward establishing a federal regulatory regime for stablecoins, Congress and federal financial regulators still have substantial work ahead of them.
1 Press Release, President’s Working Group on Financial Markets Releases Report and Recommendations on Stablecoins (Nov. 1, 2021), https://home.treasury.gov/news/press-releases/jy0454.
2 The President’s Working Group on Financial Markets consists of the secretary of the Treasury, the chair of the Board of Governors of the Federal Reserve System, the chair of the Securities and Exchange Commission, and the chair of the Commodity Futures Trading Commission (CFTC).
3 The Report at 3.
5 Report at 11.
6 Report at 15.
7 The Report notes that insured depository institutions have deposit insurance provided by the FDIC and have access to emergency liquidity and Federal Reserve services but does not take a firm position on whether stablecoin issuers also should have deposit insurance or access to emergency facilities and Federal Reserve services. The Report only states that legislation “should provide . . . potentially, access to appropriate components of the federal safety net.” (Emphasis added.) Report at 16.
8 Report at 18.
10 “Whoever shall willfully violate any of the provisions of this section shall upon conviction be fined not more than $5,000 or imprisoned not more than five years, or both, and any officer, director, employee, or agent of any person, firm, corporation, association, business trust, or other similar organization who knowingly participates in any such violation shall be punished by a like fine or imprisonment or both.” 12 U.S.C. § 378(a)(2).
11 See 12 U.S.C. 5464.