Regulators are worried about hidden risks to investors and even the financial system stemming from a fast-growing corner of the crypto market meant to be immune from volatility.
Their focus is on so-called stablecoins, a form of cryptocurrency that has a fixed price, typically one dollar, and is backed by real-money reserves.
At the end of May, the total market capitalization of stablecoins, which include ones offered by crypto firms Tether and Centre, broke $100 billion.
But in recent weeks, lawmakers and officials from the Federal Reserve and the administration have expressed alarm both in public and private that some consumers won’t actually be protected should one of the firms not have the backing they purport to have. They also say the growing size of stablecoins has created a situation where huge amounts of U.S. dollar-equivalent coins are being exchanged without touching the U.S. banking system, potentially blinding regulators to illicit finance.
“They’re dangerous to both their users and, as they grow, to the broader financial system,” said Lev Menand, an academic fellow at Columbia Law School, in testimony to a Senate Banking subcommittee last week.
Administration officials have expressed concern to representatives of stablecoin issuers in recent weeks that consumers don’t understand that money held in a stablecoin isn’t protected by the Federal Deposit Insurance Corp. and that, in some cases, they could potentially lose money on a stablecoin, according to a person familiar with the matter who requested anonymity to describe confidential discussions. The person said officials are also worried that criminals could use stablecoins to transfer money without having to touch a bank, meaning that they could avoid protections meant to catch money laundering and other illicit activity.
Massachusetts Democratic Senator Elizabeth Warren compared stablecoins to “wildcat notes” issued by poorly capitalized banks in the 19th century that later stuck many of their holders with large losses, speaking at a Senate Banking subcommittee hearing last week. Warren said that if the Federal Reserve were to issue its own digital currency, consumers could get the benefits of a stablecoin without that kind of risk.
The U.S. and other nations are already considering launching their own digital currencies. Those coins, known as central bank digital currencies, would be direct competitors to stablecoins. Later this year, the Federal Reserve Bank of Boston plans to publish research and open-source code showing technology that could underpin a digital dollar. Fed Chair Jerome Powell has said lawmakers will likely need to weigh in for the project to advance and that the process could take years.
Last month, in a statement on the Fed’s progress in researching a CBDC, Powell said that stablecoins could pose risks to the financial system. “As stablecoins’ use increases, so must our attention to the appropriate regulatory and oversight framework,” Powell said.
Days after Powell’s statement, Fed Governor Lael Brainard in a speech gave her own warning, saying that widening use of stablecoins could fragment the financial system, potentially raising costs for U.S. households and businesses.
Brainard and other Fed officials have warned that if privately-issued stablecoins become widely used, but consumers then lose confidence in them, it could result in the kind of “run on the bank” panic that threatens financial stability.
As cryptocurrency trading has exploded, so has the use of stablecoins. Right now, investors primarily use stablecoins as a place to park money on cryptocurrency exchanges without having to transfer cash back to their bank accounts. The largest by far, with a market capitalization of $62.6 billion, is Tether, which is incorporated in Hong Kong. U.S. Dollar Coin, or USDC, has a market value of $23.8 billion and was created by the Centre Consortium, a partnership between crypto payments firm Circle Internet Financial Inc. and U.S. crypto exchange Coinbase Global Inc.
Early stablecoin controversies circled around Tether International Ltd., which originally said its coins were completely backed by cash. In February, New York’s attorney general said the company for years didn’t actually have the cash it said it did and banned Tether from trading with New York residents. Now the company says Tether’s coin is backed not just by cash, but by assets including commercial paper, corporate bonds and precious metals. The Centre Consortium says each U.S. Dollar Coin is backed by a dollar held in a bank account.
“Tether embraces transparency and regulation,” said Tether General Counsel Stuart Hoegner, in a statement, noting that the company is registered as a money-services business with the Treasury Department. Hoegner said Tether doesn’t currently accept U.S. customers and is pursuing audits for past years of Tether’s reserves. “We continue to look for avenues of regulation globally and are pursuing regimes in several countries,” he said.
Centre didn’t respond to a request for comment.
Other than continuing work on a potential central bank digital currency and increasing what stablecoin firms have to disclose to consumers, it’s unclear what regulators can do to slow stablecoins’ rapid growth. Timothy Massad, former chairman of the Commodity Futures Trading Commission, in a May op-ed said the Securities and Exchange Commission could regulate stablecoins in a similar way to money-market funds, which aren’t FDIC-insured and faced stress during the 2008 financial crisis.
One bill introduced in Congress last year would require stablecoin issuers to have a banking charter and get approval from the Fed, among other agencies, though the bill is unlikely to become law.
The most immediate way that some stablecoins might come under attack is from enforcers, such as what happened with the New York attorney general, who could pursue issuers for lying to consumers, said Josh Lipsky, director of the Atlantic Council’s GeoEconomics Center. Lipsky said stablecoin issuers could eventually work in tandem with international governments’ projects to issue their own digital currencies but that the U.S. and others will have to develop regulations to ensure consumers aren’t hurt.
“The way it’s marketed is that you’re getting a dollar, but stablecoins are not always that stable,” Lipsky said.