Depending on who you ask, private stablecoins are either a new technology that will change the way we do business or a crypto-crazed fad. The dichotomy is on display in the federal government.
Some in Congress want to ban stablecoins, while others embrace them. The new embrace of Congress, the Stablecoin TRUST Lawgoes to the administration concerns regarding the growth of private stablecoins by standardizing the legal and regulatory treatment of stablecoins, but not in the bank-centric way the administration envisioned. The law provides regulatory certainty that will boost the public’s willingness to accept private stablecoins as payment, but proposes a legal framework that has yet to be publicly adopted by the crypto administration or industry.
Private stablecoins are digital instruments that can be bought and traded over the internet and used as a means of payment. They are designed to trade at stable values relative to a benchmark currency such as the dollar or a commodity such as gold. However, unlike bank deposits which are also digital money, private dollar-pegged stablecoins are not federally insured or universally accepted as payment. Also, there is no guarantee that stablecoins will hold their value relative to the dollar, and there is no guarantee that they can be easily exchanged for dollars. Much of this uncertainty would be resolved with the passage of the Stablecoin TRUST Act.
There are two types of private stablecoins: reserve asset stablecoins and algorithmic stablecoins. In a dollar-pegged reserve asset stablecoin, the dollar proceeds of a newly issued stablecoin are converted into an equivalent value of high-quality, short-term, dollar-denominated liquid assets held by the stablecoin’s sponsor . If the stablecoin trades below $1, the sponsor can liquidate the reserve assets and buy outstanding stablecoins from cryptocurrency exchanges to push the market price towards $1. If the stablecoin is trading above $1, the stablecoin backer can issue additional coins to lower the price of the stablecoin.
There are also dollar-pegged stablecoins that hold cryptocurrencies as reserve assets. These stablecoins must hold cryptocurrency reserves with a market value greater than the dollar value of the stablecoins sold. Excess collateral is necessary because the dollar value of cryptocurrencies like Bitcoin fluctuates daily, sometimes by large amounts. Currently, there is no regulation or authority to ensure that private reserve asset stablecoins maintain adequate reserves.
Algorithmic stablecoins hold parity with the dollar using arbitrage trading strategies involving other cryptocurrencies. Algorithmic stablecoins are typically organized as decentralized autonomous organizations (DAOs) that are made up of open source computer code that executes arbitrage operations designed to maintain dollar parity using actively traded cryptocurrencies.
Private stablecoins resemble several existing financial instruments, and this similarity creates ambiguity regarding their regulatory treatment. Currently, cryptocurrencies like Bitcoin are treated as commodities subject to the regulations of the Commodity Futures Trading Commission. Depending on their characteristics, private stablecoins may be securities subject to Securities and Exchange Commission regulations or fall under state regulations that apply to money transfer agents. Algorithmic private stablecoins do not fit neatly into any regulatory framework because they are virtual organizations without management, physical assets, financial statements, or even a business address.
The Stablecoin TRUST Act standardizes the definition of “paying stablecoin”. A payment stablecoin must: maintain a stable value relative to a fiat currency or currencies; convert directly into fiat currency by the issuer; be issued by a central entity; do not pay interest; be widely used as a medium of exchange and be recorded in a distributed public ledger. The law also clarifies that payment stablecoins are not securities or investment funds and are not subject to SEC regulations.
This definition excludes many private stablecoin transactions today. Algorithmic stablecoins, DAO (no central issuer) stablecoins, commodity-linked stablecoins, stablecoins designed for specialized transactions and not for general use, and coins that cannot be easily redeemed by the issuer are not covered by the law.
Under the law, a payment stablecoin can be issued by different legal entities, each of which is overseen by a state or federal regulator. The law does not require a single regulator or regulatory framework other than the common requirements that a payment stablecoin must meet. Potential issuers include entities that have a National Limited Payment Stablecoin Issuer license, a license or authorization to engage in a state-regulated money transmission business, or a federally insured depository institution. Regardless of the licensing authority, all issuers of payment stablecoins are required to publicly disclose their reserve assets on a monthly basis and have these disclosures certified by a registered public accounting firm on a quarterly basis.
The National Limited Stablecoin Issuer license is a new limited purpose national banking charter administered by the Office of the Comptroller of the Currency (OCC). Licensees will be subject to capital, liquidity, and other requirements established by the OCC and will have access to the Federal Reserve bank payment system. Issuers must fully guarantee their stablecoins with high quality liquid assets and may not make loans or offer extensions of credit other than those necessary to manage reserve assets, issue, redeem or create a market in its stablecoin.
Unlike the President’s Task Force recommendations, payment stablecoin issuers may, but need not, be regulated like banks. In addition, there is no requirement that payment stablecoins have federal deposit insurance or face uniform capital, liquidity, risk management, or other operational requirements. Interest-paying private stablecoins could still be regulated as securities by the SEC and the law does not clarify the legal and regulatory framework that applies to DAO, commodity-linked or algorithmic stablecoins.
The Stablecoin TRUST Act is a positive step towards legitimizing private stablecoins pegged to fiat currency. To its credit, the law recognizes the value of regulatory competition in creating alternative paths to becoming a licensed payment stablecoin issuer. However, the plurality of options may be anathema given the administration’s preference for a strict regulatory framework focused on banks. Furthermore, the fact that the legislation does not provide a framework for many popular forms of stablecoins currently being traded may lessen their attractiveness to the crypto industry.
Paul H. Kupiec is a senior fellow specializing in banking and finance industry issues at the American Enterprise Institute.