Regulators Are Hurrying to Enact the First Major Cryptocurrency Regulations.
Concerned about the possibility of a digital-era bank run, the Treasury Department is developing a regulatory framework for the sector's rapid growth.
Federal authorities are scrambling to address possible threats to consumers and financial markets after years of mainly remaining silent as Bitcoin evolved from a digital curiosity to a volatile but broadly appreciated invention.
Their fears have only intensified as both new and existing organizations scramble to capitalize on the vast wealth held in Bitcoin by offering quasi-banking services such as interest-bearing accounts and lending.
Now, the Treasury Department and other regulatory agencies are focusing their efforts on a single target for tightening regulation: a rapidly developing product known as a stablecoin.
Stablecoins, which are issued by a range of organizations that are now very loosely regulated by a patchwork of state regulations, act as a link between cryptocurrency markets and the regular economy.
A stablecoin's value is ostensibly fixed 1:1 to the US dollar, gold, or some other stable asset. The goal is to make it easier for those who own bitcoin — which is infamous for its wild price swings — to conduct activities like as purchasing goods and services or earning income on their cryptocurrency holdings.
Stablecoin use is accelerating, and regulators are growing increasingly concerned that they are not truly stable and may result in a digital-era bank run. Just this year, dollar-denominated stablecoins such as Tether, USD Coin, and Pax Dollar have grown in circulation from $30 billion in January to around $125 billion as of mid-September.
“It is critical for the agencies to act swiftly to ensure the establishment of an acceptable US regulatory framework,” Nellie Liang, an undersecretary of the Treasury who is assisting in the endeavor, said in a statement.
The Biden administration's push to establish some control over stablecoins is the tip of a much larger argument about the government's role in regulating cryptocurrencies - a subject that has sparked considerable alarm in Washington.
“I witnessed one fool's gold rush up close in the run-up to the 2008 financial crisis,” acting comptroller of the currency Michael Hsu said in remarks Tuesday. “It appears as though we are on the verge of another with cryptocurrencies.”
While bitcoin is primarily used for speculation, it is gradually transforming banking and finance, sparking debate about whether governments should issue their own digital currencies to supplement or eventually replace their traditional currencies.
Stablecoins now account for an increasing share of cryptocurrency transactions globally, at a time when the entire value of issued crypto tokens such as Bitcoin is over $2 trillion — roughly equal to the total value of all US dollars in circulation.
The regulatory drive has sparked a lobbying frenzy among cryptocurrency executives. They have convened a series of virtual and in-person talks with banking and financial authorities in recent weeks, attempting to influence the new rules while basically accepting that some type of government control is now unavoidable.
Regulators are concerned about stablecoin enterprises' ability to maintain sufficient liquid assets to back up the money they issue.
Along with cash and short-term Treasury bonds — which are considered safe and easy to redeem — issuers of stablecoins such as USDT and USDC, for example, previously held reserve assets such as unsecured debt in corporations, which is significantly riskier and more difficult to convert into cash quickly, particularly during times of financial turmoil. This "commercial paper" is inextricably linked to other critical components of the financial system.
Additionally, Treasury Department officials seek reassurance that stablecoin firms have the technical capacity to handle high spikes in transaction volume, so that they do not trigger a chain reaction of problems if a large number of clients attempt to cash out their holdings.
Already, complications have arisen. On Sept. 14, the Solana blockchain, a relatively young network that has reported a "exploding" volume of stablecoin transactions, experienced a 17-hour downtime. The corporation cited "network resource exhaustion" as the reason clients were unable to buy or sell during the meltdown.
Federal officials have indicated in interviews that they are considering using expansive powers granted by the Dodd-Frank financial reform law, which was enacted in the aftermath of the 2008 financial crisis, to initiate a review and potentially declare stablecoins "systemically important," a designation that would likely subject them to strict federal regulation.
“When the hazards to society become bigger, regulators become more concerned,” said Jeremy D. Allaire, CEO of Circle, a payments and digital currency startup that assisted in the creation of USD Coin. “It's logical for regulators to seek measures to mitigate those risks.”
USD Coin has increased in value by almost 750 percent this year, reaching approximately $30 billion in circulation. It is expected to surpass $200 billion by late 2023 at its present rate of expansion, Mr. Allaire stated.
The Treasury Department's first action is anticipated to be to produce a report with recommendations this fall. Industry executives, lobbyists, and regulators provided an outline of the topics they anticipate being covered in these suggestions, which will serve as a template for prospective regulations to be prepared over the next year.
According to them, the rules will almost certainly require that reserves remain liquid enough to fulfill redemption demands and that the software systems processing these transactions are robust enough to avoid crashes and severe slowdowns when dealing with large numbers of concurrent transactions.
Additionally, they anticipated, there would be laws governing the process of establishing new stablecoins, as well as security mechanisms to safeguard users' privacy and data, as well as consumer protection measures. Separately, the Treasury Department is prepared to enact rules aimed at preventing bitcoin from being used for illegal purposes such as money laundering and tax evasion.
Already, there have been some measures to rein in the sector.
The most widely used stablecoin in the world is USDT, which is issued by Hong Kong-based Tether; it presently accounts for more than half of the global stablecoin supply. In 2019, New York State officials initiated a fraud investigation into Tether, which was resolved this year with an agreement barring the company from conducting business with New York consumers and requiring it to frequently reveal the types of reserve assets that back up its stablecoin.
Circle has already announced plans to voluntarily move its reserves this month to more liquid assets.
The new standards will create winners and losers, with some industry participants better positioned to embrace them than others, who may be forced to alter their business models to comply.
Paxos, for example, assists the effort to regulate stablecoins. However, it opposes the use of the authority granted by the 2010 Dodd-Frank Act, which empowers an entity called the Financial Stability Oversight Council — comprised of the Treasury secretary, the Federal Reserve chairman, and 13 other senior federal and state financial regulators and financial experts — to effectively extend its reach to stablecoins by declaring stablecoin activity or companies "systemically important."
However, Circle's CEO stated that he does not disagree to the designation.
“Large-scale full reserve, asset-backed dollar stablecoins that can be utilized throughout the entire internet will be at that time, they will have achieved systemic status,” Circle's Mr. Allaire explained.
Another possibility is to develop a new form of banking charter just for stablecoin issuers that overcomes many of the regulatory concerns.
Additionally, the Securities and Exchange Commission may exercise its authority to require that certain stablecoin issuers with reserves backed by securities — such as commercial paper, bonds, or money market funds — register as securities, requiring companies to provide additional disclosures to investors.
As S.E.C. Chairman Gary Gensler has noted, the agency did just that with the mutual fund sector in 2016, following the collapse of a big fund that relied on hazardous debt and was forced to restrict investor withdrawals. He told the Senate Banking Committee that cryptocurrency requires a comparable response.
“To be honest, it feels more like the Wild West or the old world of 'buyer beware' that existed prior to the enactment of the securities laws,” Mr. Gensler stated.
To avoid suffocating the industry's expansion, industry executives have been spreading their wings to lobby cabinet secretaries, Federal Reserve governors, top White House staffers, members of Congress on the Senate Banking and House Financial Services Committees, as well as financial regulators.
Additionally, crypto firms and trade associations have been progressively employing lobbyists and former regulators to work in Washington on their behalf.
Companies and industry groups that met with Treasury Department officials recently included leading stablecoin issuers such as Tether, Circle, and Paxos; cryptocurrency exchanges that are also stablecoin creators, such as Coinbase and Gemini; and traditional and new financial services companies such as BlockFi, Mastercard, and the Blockchain Association.
Industry leaders stated during these sessions that cryptocurrency, which is based in part on stablecoins, could enable the global expansion of banking and payment services to billions of individuals who currently lack access to the financial system.
Stablecoins, they assert, are necessary components of this concept. That is the picture created by American executives for El Salvadoran officials and cryptocurrency enthusiasts worldwide in the run-up to the Central American country's recent adoption of Bitcoin as legal coinage.
If officials severely restrict the expansion of cryptocurrency through stringent new restrictions, industry executives argue, the United States will drive innovation abroad, jeopardize the dollar's primacy, and suffocate the promise of digital banking.
“If we look back at the twentieth century, big technologies such as aircraft and automobiles came first,” said Tomicah Tillemann, a former Senate staffer to President Biden who now works for Andreessen Horowitz, a venture capital firm that is a significant cryptocurrency investor. “Then there are investments in regulatory frameworks that have aided in spreading the benefits of those technologies to a broader population.”