The President’s Working Group for Regulating Stablecoins: An Alternative Approach

Stablecoins are a relatively new means of exchange within the payments system. They have many of the characteristics of money, serving as a store of value and a medium of exchange, although they do not serve as a unit of account. Stablecoin issuers tie their currency, unit-for-unit, to the national currency, and to assure confidence in its value, the issuers hold acceptable assets as reserves denominated in the national currency. Such reserves are invested in relatively safe assets that provide a return sufficient to pay interest to the holders of stablecoins while also earning the issuer a profit.

Individuals using stablecoins do so because it yields better returns or benefits than bank deposits while also providing an efficient means of exchange, domestically and across borders. So long as stablecoin issuers must purchase and maintain a unit-for-unit match between itself and the sovereign currency, the central bank remains in control the nation’s money supply. However, stablecoins do facilitate market participants’ ability to engage in digital asset trading and to move easily between digital asset platforms and applications, reducing the need for fiat currencies and traditional financial institutions as the only means of exchange. A useful way to think of stablecoins is as a money market mutual fund (MMMF) with the added feature of being a means of exchange.

Stablecoins and their issuers currently are more lightly regulated and subject to less bank-like supervisory oversight. While the SEC and CFTC have some oversight responsibilities for issuers because they engage in asset offerings or commodity futures or options activities, this oversight is limited.

The President’s Working Group Recommendations for Regulating Stablecoins

As stablecoins have become more prominent, regulatory authorities have increased their interest in them and are beginning to advocate for their greater regulation and oversight. While stablecoins are backed by “high quality” asset reserves, they are not insured and are generally thought to be risker than bank deposits. For example, should the economy come under stress or encounter significant operational disruptions, confidence in stablecoins could be undermined with destabilizing consequences.

Given these concerns and the industry’s recent growth, the President’s Working Group on Financial Markets, with input from the FDIC and Comptroller of the Currency, recently made several legislative recommendations that would make issuers of stablecoin, in essence, regulated banks.¹ Recommendations include:

• Issuers of stablecoin must be insured institutions and subject to appropriate supervision and regulation.
• Custodial wallet providers² should be subject to Federal oversight and meet bank risk management standards.
• The issuance, redemption, and maintenance of stablecoin reserve assets should be confined to insured banks.
• Regulators should be empowered to require standards to promote interoperability among the different stablecoin issuers.
• The principle of the separation of banking and commerce should be retained by implementing legislation to assure that stabile coin issuers cannot be affiliated with commercial businesses.

Alternative Options for Regulatory Oversight of Stablecoins

These recommendations essentially would require that stablecoin issuers become banks. Such recommendations might mitigate certain risks that come with stablecoins operating outside the banking system, but they also interrupt the potential innovations and benefits that might otherwise flow to the consumer. If individuals choose to hold stablecoins and bear the risk of loss for potentially greater returns rather than place their funds with an insured bank, they should be free to make that choice. The regulatory authorities should work to assure that investors are informed of the risks and remain accountable for their choice should an issuer fail.

Rather than preclude stablecoins from operating outside the banking system, an alternative to the Working Group’s proposal for regulating stablecoin activities would be to focus on disclosure and accountability. Provisions might include:

• A focus on investor protection. Laws covering the MMMF industry should be amended to specifically include stablecoins.
• Provisions that subject stablecoins to the same payments rules as apply to banks. This would serve to protect the investor against fraud and misrepresentation by the issuing party and provide a standard of conduct for stablecoin payments activities.
• Provisions that subject stablecoin issuers and wallet providers to bank secrecy act and anti-money laundering rules, confirmed during the audit process and subject to Treasury enforcement.
• Provisions that require stablecoin reserves to be assets that can be marked to market daily and available to the investor at their Net Asset Value.³ The reported value would be the amount available to conduct payments transactions. Acceptable reserve assets might include treasury bills and notes and AAA rated short term assets.
• Provisions that specifically exclude stablecoins from being a government insured liability. Stablecoins are backed by high quality, liquid reserve assets that protect the holder from catastrophic loss.
• Provisions that require stablecoin issuers and wallet providers to have annual audits fully disclosable to the public.

The PWG also recommends that stablecoin issuers and commercial businesses remain separate, not under common ownership. There is a long history in the U.S. in which such separation has been maintained. However, concentration within the banking industry has increased significantly over the past 20 years to where the largest 10 banks today control over 55 percent of banking assets, and their competitive dominance and increased standing as too big to fail institutions have become more prominent issues. Thus, the question of whether commercial businesses if allowed to issue stablecoin would be pro or anti-competitive or would promote or harm financial stability deserves consideration. Issues to consider might include, for example:

• Given that stablecoin issuers are not currently provided deposit insurances, unlike banks, do the arguments nominally justifying the separation of banking and commerce, that center around that insurance, apply to stablecoin issuers?
• Would such combinations of business and financial firms increase systemic risk within the economy and add to the number of firms considered too big to fail?
• If so, would this result in extending the safety net and its subsidy to a new set of participants within the financial industry?
• Would permitting commercial businesses to issue stablecoins dilute or accelerate a concentration of financial resources and help or hinder competition?
• Would such combinations introduce potential abusive conflicts of interest in which commercial firms gain access to low-cost funding relying on the government’s implicit safety net and subsidy?

The advent of stablecoin introduces the opportunity to enhance competition in finance, banking, and payments. The industry may very well require enhanced regulation to assure a reasonably safe, fair, and open market, but confining the industry to operating within a strict banking model may not be the bests long run outcome for a competitive, dynamic market. While making stable coin issuers banks might reduce some level of financial risk, it may come at the cost of a less innovative market and, perhaps, a less competitive marketplace.

[1] See President’s Working Group on Financial Markets, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency (2021), Report on Stablecoins (Washington: PWG, FDIC, and OCC, November) https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.

[2] Digital “wallets” provide a variety of services to users, including facilitating the transfer of stablecoins between users. A “custodial wallet provider” is a wallet provider that users may rely on to hold stablecoins on their behalf.

[3] Net asset value (NAV) is the value of an entity’s assets minus the value of its liabilities.

Thomas M. Hoenig is a Distinguished Senior Fellow at the Mercatus Center at George Mason University. He has served as the Vice Chairman of the Federal Deposit Insurance Corporation and President of the Federal Reserve Bank of Kansas City.