The US Treasury Department in the last week shared its views on stablecoins, indicating that they are growing and regulators need to establish guard rails to prevent significant systemic risks from emerging.

A stablecoin is described as any cryptocurrency designed to have a relatively stable price, typically through being pegged to a commodity or currency or having its supply regulated by an algorithm.

In a review shared on March 22 by United States Undersecretary for Domestic Finance Nellie Liang, she noted that the currencies — designed to maintain a stable value relative to a reference asset which is often the US dollar — have grown rapidly, from a market capitalisation of roughly US$5 billion at the start of 2020 to approximately US$175 billion today.

A November 2021 report by the US President’s Working Group (PWG) on Financial Markets recommended that legislation be created to ensure a consistent and comprehensive framework that is proportional to the prudential risks posed by ballooning usage. It also recommended that the legislation complement existing authorities with respect to market integrity, investor and consumer protection, and illicit finance.

Benefits and drawbacks

Liang outlined that stablecoins play a significant role in the emerging set of digital assets, activities, and services. The PWG November 2021 report said that by offering a stable value, they have the potential to be widely used by households and businesses to make payments and purchases. Many companies are exploring ways to increase their use for these purposes.

However, the PWG report highlighted some significant “prudential risks” associated with stablecoins for payments.

Liang raised the spectre of run risk indicated by PWG — a scenario in which loss of confidence in stablecoin could trigger a wave of redemptions, which could have spillover effects for the broader financial system.

Second, she said, there are payment risks, including operational issues that could interfere with the ability of users to actually store and transfer them to make payments.

Third, there are concerns related to concentration of economic power; for example, if a stablecoin provider gained market power and harmed competition and consumers.

Laing said that the PWG report found significant gaps in authorities that would address these prudential risks.

The Treasury official stated, “Some of the largest stablecoin issuers operate with limited regulatory oversight and there are significant questions about whether they are adequately backed.”

She added, “Even where a stablecoin issuer is subject to oversight, supervisors may not have sufficient visibility into the broader operations, such as custodial wallet providers, that support the use of the stablecoin, which may be distributed across multiple entities.”

Liang said that current requirements under state money transmitter or securities laws were not designed to address the risks of runs, payment system, or concentration of economic power for a payment instrument based on new distributed ledger technology.

To fill this regulatory gap, the PWG report recommended specifically: to limit issuance of stablecoins to insured depository institutions; to give supervisors of stablecoin issuers visibility into the broader stablecoin arrangement, and authority to set risk management standards for critical activities related to use of stablecoins for payment; and to consider other protections — such as data privacy or interoperability — to reduce concerns related to concentration of economic power.

Insurance

Liang noted that, in developing the recommendation for stablecoin issuers to be insured depository institutions, the PWG report “relied upon the flexibility that the banking agencies would have to adjust for differences between stablecoin issuers and traditional commercial banks, and to new products and structures that may emerge over time.”

She concluded, “Digital assets and the associated technology have introduced new channels for the delivery of financial services. These may be part of creating a more efficient inclusive financial system alongside other efforts. There are, however, some known risks that should be addressed.”