The Biden administration’s proposal to require stablecoin issuers to become federally insured banks would force state regulators to change their bank-chartering options or get left behind.
A recent report from the President’s Working Group on Financial Markets found “key gaps” in the oversight of stablecoins—cryptocurrencies pegged to the dollar and other national currencies—that would leave federal regulators powerless to intervene if instability in the $130 billion market triggers a broader financial crisis.
The working group proposed that stablecoin issuers, such as those that issue Tether, US Dollar Coin and Dai, become federally insured depository institutions, subject to the same oversight as banks. But the report makes little mention of chartering structures in states like New York that already set capital, liquidity and anti-money laundering requirements for stablecoin issuers.
The group’s proposed changes, which would require Congress to pass legislation, could create their own risks by removing state expertise from the supervisory mix, said Todd Baker, a senior business, law and public policy fellow at Columbia University’s Richman Center.
“The concern is always that the state regulatory hand will be lighter and less capable of regulating a fast-moving business such as this one. And I think there’s some validity to that,” Baker said.
“On the other hand, right now the most experienced regulators are in the states, such as New York,” he said.
Stablecoins are largely used in digital asset trading. Traders can convert more volatile assets into stablecoins that are perceived to have greater stability.
More than 72 billion Tethers have been issued to date, according to CoinMarketCap.com, a digital asset price tracking site. Each Tether is redeemable for US$1, according to its issuer’s site, but state and federal regulators have recently cracked down on the company for allegedly falling short of that pledge.
The Nov. 1 report noted that such assets are untested during times of financial stress or during cybersecurity breach. Confidence in stablecoins could be undermined if a coin issuer’s reserve assets become depleted or illiquid, or if there’s a lack of clarity about coin holders’ redemption rights.
Federal regulators fear that a stablecoin “run”—resulting in a deluge of stablecoin redemptions into other digital assets or traditional “fiat” currencies, like the dollar or yen—would spill over and harm the broader financial system.
State regulators that already oversee stablecoin transactions were notably absent from the list of industry players, academics and activist groups the working group spoke to for the report.
“At the most practical level, states could’ve shared with their federal counterparts how they approach stablecoins,” said Matt Homer, a former New York Department of Financial Services official who was in charge of innovation efforts.
New York has led the states in regulating cryptocurrency companies through its BitLicense regime since 2015. The state has authorized crypto exchanges Paxos, GMO-Z.com and Gemini to support stablecoin transactions on their exchanges via bank-like trust charters.
Those trust charters require one-to-one crypto-to-dollar reserves. The concept originated from state banking law. “It has a lot of the same DNA, and it’s subject to the same kind of oversight that a bank would be,” Homer said.
Wyoming carved its own crypto regulatory niche in 2019 when it established a type of bank-like charter to let companies custody cryptocurrencies. The state’s requirements allow digital asset companies to take deposits, but don’t require them to obtain FDIC deposit insurance.
Four “special purpose deposit institution” charters have been approved in the state so far.
The report—authored by the Treasury Department, the Federal Reserve, the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.—proposed that only federally-insured banks be allowed to issue stablecoins.
Homer and others see room for a hybrid system that preserves state crypto licensing authority, while adding on the extra layer of oversight federal regulators are seeking.
Small banks that are only chartered in the state where they operate—but still receive federal deposit insurance—could serve as a model. The FDIC cooperates with state banking departments to supervise and examine those banks.
Payments companies like PayPal Inc. and Venmo are also licensed and overseen by states. But they must comply with federal anti-money laundering regulations set by Treasury’s Financial Crimes Enforcement Network.
But the supervision of Venmo and other payments apps works because nearly every state has licensing requirements. States that don’t have stablecoin licensing or chartering requirements would have to quickly get up to speed for a state-federal hybrid model to work, experts say.
Some fear that stablecoin issuers would able to play “regulatory arbitrage” by getting licensed in states that have the least-restrictive oversight regimes.
Stablecoins are “an area where there should be appropriate oversight and supervision” if a company is transacting in a substitute for fiat currency, said Kari Larsen, a partner at Perkins Coie LLP who specializes in digital assets and custody.
Stablecoins are used for crypto investing and trading activities, but some issuers predict that they will eventually be widely adopted for payments and remittances.
The report called for the Financial Stability Oversight Council to designate certain stablecoin activities as “systemically important payment, clearing, and settlement activities.”
That designation would put the activities of some stablecoin issuers—including Circle, Kraken, Paxos and others—under direct federal oversight of the Fed, the SEC, or other agencies.
State regulators have a non-voting seat on the FSOC, and hope to shape discussions on how to regulate stablecoins moving forward.
“I know we will add to this process and maybe now is the time that Treasury and others will begin to engage with us,” said John Ryan, the president and CEO of the Conference of State Bank Supervisors.
If federal regulators want to move quickly, they could use some of the best functioning state structures and find ways to incorporate them under their regulatory umbrella, Homer said.
That could force states to rejigger existing state charters while federal regulators create new charters that could be more attractive to issuers.
But even if state regulators reshape their charters, they’ll face a fight to keep their models alive if federal stablecoin charters come online.
“We are about to enter a zone of jurisdictional jockeying,” Larsen said.