In as much an attack on centralized crypto asset trading ("CeFI") platforms and decentralized finance ("DeFi") protocols as stablecoins, the President's Working Group on Financial Markets, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Current (collectively "Regulators") issued a much anticipated report on November 1, 2021, making recommendations that Congress should implement through new laws to better regulate stablecoins.
Indeed, first and foremost among the risks of stablecoins spotlighted by the Regulators were stablecoins potential use to facilitate "speculative digital asset trading" on CeFi platforms or through DeFi protocols which "presen[t] risks related to market integrity and investor protection."
Additionally, claimed the Regulators, stablecoins implicate risks of investor protection and illicit finance, as wells as prudential concerns. According to the Regulators, "[i]f stablecoin issuers do not honor a request to redeem a stablecoin, or if users lose confidence in a stablecoin issuer's ability to honor such a request, runs on the arrangement could occur that may result in harm to users and the broader financial system."
As result, the Regulators recommended that Congress quickly enact new legislation to require:
- stablecoin issuers to be limited to insured depository institutions that are subject to "appropriate supervision and regulation" at the depository institution and holding company level;
- custodial wallet providers to be subject to "appropriate" federal oversight. Also. a supervisor of a stablecoin issuer should have the authority to require any entity "that performs activities critical to the functioning of the stablecoin arrangement to meet appropriate risk-management standards;" and
- stablecoin issuers to comply with "activities restrictions that limit affiliation with commercial entities." Supervisors of stablecoin issuers should also encourage interoperability among stablecoins.
In their report, the Regulators extensively discussed the interrelationship between DeFi protocols, and stablecoins. The report observed that "[s]tablecoins are central to the functioning of DeFi, as they are often used in DeFi arrangements to facilitate trading or as collateral for lending and borrowing." In a not-so-subtle warning to CeFi platforms and DeFi protocols, the Regulators cautioned that these organizations "also raise broader questions about digital asset market regulation, supervision and enforcement. These questions are under active consideration by the CFTC and SEC but are not the subject of the recommendations in this report."
The report noted that, prior to Congressional action, to the extent stablecoins are securities or futures, options or swaps (or incorporate elements of such Commodity Futures Trading Commission-overseen products), federal securities or commodities laws, respectively, would likely apply to transactions involving such stablecoins. Other regulators, including the Department of Justice, the Consumer Financial Protection Bureau and the Financial Crimes Enforcement Network of the U.S. Department of Treasury likely also have regulatory tools they can apply today said the Regulators.
In response to the report, one U.S. senator, Senator Patrick Tomey of Pennsylvania, cautioned that "[w]hile Congress works on thoughtful legislation, I hope the administration will resist the urge to stretch existing laws in an effort to expand its regulatory authority."
The Regulators' proposed recommendations appear to track traditional approaches to the regulation of brick and mortar financial institutions and products, and suggest little flexibility to tailor an approach tailored specifically to the characteristics of decentralized digital assets.
The PWG, was created in 1988 to help "...enhance the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence..." It consists of the Secretary of the Treasury, and the Chairs of the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission and the CFTC.
"[Operational, settlement and liquidity] risks may remain inadequately addressed for stablecoin arrangements due to the lack of consistent risk-management standards among arrangements, the number of different key parties that may be involved in an arrangement, and the operational complexity of an arrangement." PWG, FDIC and OCC Report on Stablecoins, November 1, 2021