Stablecoin Risk Spurs U.S. Agencies to Seek Power to Crack Down

A loss in confidence in a stablecoin could also cause a run on the issuer, leading the company to unload assets in a fire sale and to risk not being able to meet redemptions, the report said.

That could lead to runs on other stablecoins and to a shock to the broader financial system. Similar issues could arise if payments using the stablecoin don't process or settle as expected, the regulators said, and if certain stablecoin issuers continue to grow rapidly, they could eventually pose a systemic risk and wield too much market power.

Legislative Recommendations

The report urges Congress to pass legislation that requires stablecoin issuers to become banks with insured deposits, capital and liquidity requirements and Fed supervision. In fact, companies should be prohibited from offering payment stablecoins unless they are insured depository institutions.

The regulators added that any action Congress takes should give federal agencies flexibility to respond to how stablecoins evolve because the market is "an emerging and rapidly developing type of financial asset." Treasury officials said they have already held preliminary discussions with Capitol Hill aides on crypto oversight.

It's far from certain that Congress will do anything considering that Democrats and Republicans have failed to agree on much in recent years. Further, lawmakers don't have a great track record of passing legislation until a calamity forces their hand, as was the case when they finally brought oversight to derivatives after the 2008 financial crisis.

Existing Powers

The government is relying heavily on the SEC and CFTC to police stablecoins, noting that depending on their structures, tokens might be securities, commodities or derivatives. If stablecoins are securities, the SEC has power over sales and promotions and situations in which firms are investing in the assets, according to the document.

For certain stablecoins, the CFTC could have broad authority to regulate transactions. And it can crack down on manipulation and fraud when tokens are commodities. The President's Working Group also said the Consumer Financial Protection Bureau could have a role in regulating customer payments involving stablecoins.

What's not spelled out in the report is what guidelines the government will use for assessing whether stablecoins are securities or commodities. Further, it raises a notable red flag by acknowledging in one section that some activities fall "outside of the regulatory perimeter altogether."

SEC Chair Gary Gensler has been outspoken in asserting that he believes many cryptocurrencies should be registered with his agency. While that view indicates he's poised to be aggressive in asserting authority, the industry has largely bristled in response. That signals that courts could ultimately decide how such fights play out.

Facebook Threat

The report could spell trouble for Facebook's long-stalled ambition to gain a foothold in the crypto market. The social-media company, along with dozens of other firms, in 2019 announced it would help create a stablecoin, then called Libra.

The plan was met with a swift backlash from lawmakers, who said they didn't trust the firm, and from regulators who feared that the proposed coin, since renamed Diem, could instantly become a payments juggernaut if Facebook were to roll it out to its billions of users.

Though Diem, which lost many of its original partners, hasn't yet launched, Facebook last month rolled out a pilot of its own cryptocurrency wallet using a stablecoin issued by another company.

The regulators' recommendations could spell trouble for both Diem and Facebook's wallet. The report urges Congress to pass legislation limiting stablecoin issuers' affiliations with commercial entities. Notably, the report says lawmakers should also consider restricting firms' ties with stablecoin wallet providers and how stablecoin transaction data is used.

FSOC Review

The report says that "in the absence of congressional action," the next move will be made by the Financial Stability Oversight Council, which includes all the members of the President's Working Group. The council was created after the 2008 market crash to head off future meltdowns, but it's been criticized for moving at a glacial pace.

The council can declare certain activities as a threat to the financial system and direct member agencies to respond. But council action may be a long road and could result in fragmented oversight.

The group already started mulling the possible dangers of stablecoins at its most recent meeting last month. But even if the council flags the pitfalls of the tokens, it can't bestow new authorities on the regulators. That's Congress' job.

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