What’s All the Fuss About? U.S. Treasury vs. Stablecoins

The Biden administration has called upon Congress to pass legislation to strengthen government regulation of stablecoins. Before we say, “Sure, why not?” we have to ask ourselves: “Do we know what stablecoins even are?” Sounds like something I would pay my farrier with. Stablecoins are a form of cryptocurrency that has gained mass popularity in the last year. It is a technology like traditional cryptocurrencies, but is backed by real-world assets, which essentially makes them less prone to significant drops in value compared to their highly volatile cousins (think Bitcoin). So, by keeping, for example, each coin valued at $1 USD, stablecoins do not fluctuate wildly in price, and are potentially better suited for commercial transactions. 

In a 22-page report issued by the U.S. Treasury in November, it was determined that legislation should require that stablecoin issuers become banks, potentially making them subject to a wide range of rules, including those requiring that banks hold sufficient cash reserves and implement measures to prevent money laundering and other illicit activities. The hard-line response from regulators was that stablecoins can be used for money-laundering and tax avoidance, all done with the aim of circumventing U.S. financial sanctions. 

Currently, there are over 200 stablecoins worth nearly $130 billion, most of which are used in cryptocurrency exchanges in order to purchase other digital assets like Bitcoin. Most of those exchanges lack relationships with banks. As stablecoins increase in use, the risk of an It’s a Wonderful Life run to take George Bailey’s last two dollars moves closer to a reality—should a large number of holders of one stablecoin decide to redeem them for dollars, a lack of reserves to facilitate redemptions could pose financial risk. Currently, this is not a system with uniformity. Some issuers keep reserves in cash and short-term Treasuries to be quickly converted to cash, while others hold their cash reserves in riskier assets, like short-term business loans (commercial paper), corporate and municipal bonds, or even other cryptocurrencies. 

So, what do these gaps in prudential authority over stablecoin mean for financial institutions at this time? Not much—the Working Group on Financial Markets, along with the FDIC and OCC in the “Report on Stablecoins” are, at this time, merely urging Congress to act promptly to enact legislation to ensure that payment stablecoins and payment stablecoin arrangements are going to be subject to a federal prudential framework on a consistent and comprehensive basis. But with that being said, it does raise the risks banks need to be mitigating for as with any cryptocurrency: 

Consumer Risk: Consumers are falling victim to fraudster and cryptocurrency investment scams. Those who participate are at a risk of suffering losses, whether by the rise and fall of crypto’s value or assets being stolen by hackers or malicious developers. 

Regulatory Scrutiny: When the OCC issued its January 4, 2021 Letter stating national banks could use stablecoin to conduct payment activities and other bank-permissible functions, that meant banks could use related stablecoins to carry out permissible payment activities, all under applicable law, and safe and sound and fair banking practices. With the uncertainties of a strictler regulatory environment for stablecoin issuers, what pandora’s box has been opened for banks who participated?

What this will create, however, is a new pool of competitors for community banks. The topic of cryptocurrency continues to remain on the tickertape. For additional information, please refer to C/A’s Cryptocurrency toolkit found here: https://compliancealliance.com/find-a-tool/by-toolkit/cryptocurrency-cvc-and-digital-assets