On November 1, 2021, the President’s Working Group on Financial Markets (PWG), along with the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) (collectively, the Agencies) issued a Report on Stablecoins (the Report).[1] Stablecoins “are digital assets that are designed to maintain a stable value relative to a national currency or other reference assets.”[2] The Report recommends that Congress act promptly to enact legislation addressing stablecoins[3] and signals the Biden Administration’s focus on this issue and looming enforcement from governing agencies such as the Department of Justice (DOJ), Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC).
The Report provides an overview of stablecoins and decentralized finance (DeFi) platforms more generally; risks and regulatory gaps; and the group’s recommendation. In drafting the Report, the Agencies held discussions with key industry stakeholders, including Coinbase, Kraken, and Stripe. While the Report signals that one day we may see clarity on relevant guidelines related to stablecoins, the Report itself offers little clarity or specific guidance to stakeholders today.
Legislation
The Report recommends that Congress pass legislation to address three primary areas of concern:
- Stablecoin Runs: Create a framework to negate the risk of stablecoin runs, including requiring stablecoin issuers to be “insured depository institutions” that are subject to supervision and regulations.[4] Notably, if Congress were to pass such legislation, any truly decentralized stablecoins would be prohibited.[5] Decentralized networks may face challenges qualifying as an “insured depository institution” given that DeFi platforms attempt to organize themselves so that there is no single organization responsible or accountable for risk management and operations.
- Payment System Risk: Require custodial wallet providers to be “subject to appropriate federal oversight,” which would include a “federal supervisor, in order to limit credit, liquidity, operational or settlement risks.”[6] The Report notes that stablecoins and traditional financial institutions face many of the same risks, including “credit risk, liquidity risk, operational risk, risks arising from improper or ineffective system governance, and settlement risk.”[7] Interestingly, this recommendation appears to target centralized custodial wallets, such as wallets on traditional exchanges like Coinbase, and excludes non-custodial decentralized wallets, which allow pure peer-to-peer digital transactions.[8]
- Systematic Risk and Concentration of Economic Power: Require stablecoin issuers to limit their affiliations with specific commercial entities and potentially limit use of users’ transactional data.[9] This recommendation addresses three primary concerns with rapid growth of an individual stablecoin. First, “a stablecoin issuer or a key participant in a stablecoin arrangement (e.g., a custodial wallet provider) could pose systemic risk – meaning that the failure or distress of that entity could adversely affect financial stability” and, as the Report calls it, the “real economy”.[10] Second, there may be excessive concentration of economic power in a single entity.[11] Third, there may be anti-competitive effects that require a user to use a specific stablecoin. The Report also notes the potential that a systematic run on stablecoin, among other conceivable problems, could have systemwide consequences on the macroeconomy.
Interim Measures
While the Report repeatedly says “that legislation is urgently needed,” it also calls upon regulatory agencies to address agency risks within their jurisdiction while legislative action is pending. This includes suggesting:
- Banking agencies, when evaluating charter applications, should seek to ensure that applicants address the risks outlined within the Report, “including risks associated with stablecoin issuance and other related services conducted by the banking organization or third-party service providers.”[12]
- The Department of Justice should “consider whether or how section 21(a)(2) of the Glass-Steagall Act may apply to certain stablecoin arrangements.”[13]
- The Consumer Financial Protection Bureau (CFPB) should protect consumers by enforcing the Electronic Fund Transfer Act, the Gramm-Leach-Bliley Act, and the Consumer Financial Protection Act (contained within the Dodd-Frank Act).
- The Financial Crimes Enforcement Network (FinCEN) should enforce any anti-money laundering or terrorism financing obligations under the Bank Secrecy Act.
- The Financial Stability Oversight Council should consider designating certain activities as “systematically important payment, clearing, and settlement (PCS) activities”[14] to permit appropriate agencies to set standards for PCS activities.
Key Takeaways
First, the tone of the Report as a whole foreshadows a tough road ahead for DeFi, including decentralized exchanges and the stablecoins that help facilitate their activities, as regulators grapple with perceived risks to market integrity and investor protection. Indeed, the Report appears to be skeptical that many of these exchanges are in fact decentralized at all noting that “[i]n some cases, despite claims of decentralization, operations and activities within DeFi are highly concentrated in and governed or administered by a small group of developers and/or investors.”[15]
Second, the Biden Administration clearly views stablecoins as a top priority and is encouraging federal regulators to act swiftly—with or without legislative action.
Finally, although the Report states that it does not want to stifle innovation and wants to support competition in the space, the call to quick regulation could have a chilling effect on further development of stablecoins.
[1] PWG, FDIC, and OCC, Report on Stablecoins (November 1, 2021), available at https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf (“The Report”).
[2] Id. at 1.
[3] Id. at 2.
[4] Id. at 2.
[5] Etherum, Digital Money for Everyday Use, https://ethereum.org/en/stablecoins/ (last visited November 15, 2021)
[6] The Report at 2.
[7] Id. at 12.
[8] A non-custodial wallet is a digital assets wallet where the user owns and controls the “private keys,” which function like a password to keep funds safe. Tiago Serodio, Custodial vs Non-Custodial Wallets: Why are they important? https://medium.com/cardwallet/custodial-vs-non-custodial-wallets-why-are-they-important-a3bc5856a57b (June 29, 2021).[ do we need this?]
[9] The Report at 3.
[10] Id. at 14.
[11] Id.
[12] Id. at 18.
[13] Id.
[14] Id.
[15] Id. at 9.