House hearing on stablecoins
Who gets to regulate?
What a week this has been for crypto policy talk.
On Tuesday, the House Committee on Financial Services held a hearing on stablecoins. On Wednesday, the Senate Committee on Agriculture, Nutrition, and Forestry followed suit and held a hearing on digital assets more broadly.
In this newsletter, I focus on the House hearing, because (not to pick favorites but) I found that one to be a lot more interesting and insightful than the Senate hearing.
One piece of background before jumping into the newsletter: The House hearing had only one witness, the Honorable Nellie Liang (Under Secretary for Domestic Finance, U.S. Department of the Treasury), who is also a part of the President’s Working Group (PWG).
Please enjoy, and see you next Friday!
-Katja
Digital Assets and the Future of Finance: The President’s Working Group on Financial Markets’ Report on Stablecoins
We’ve seen time and time again, the private and public sector push for a more comprehensive regulatory framework for digital assets. Although many states have adopted their own specific regulations, the federal government has yet to issue any single comprehensive framework.
This hearing focused specifically on stablecoins. Stablecoins are a type of cryptocurrency that has its market value tied to some external asset (like a fiat currency or a commodity like gold). Stablecoins can be classified as the “middle ground” between traditional currency and crypto. They bring the advantages of the blockchain (discussed later) without the volatility.
PWG recently released a report on stablecoins, outlining risks, regulatory gaps, and recommendations. This report ended up leaving out two critical elements: 1) the benefits of stablecoins and 2) the existing state regulatory frameworks. Multiple representatives like McHenry (R-NC), Wagner (R-MO), Posey (R-FL), and Steil (R-WI) brought attention to those missing pieces of the report.
Benefits of stablecoins and existing state regulations
During the last several hearings, it became evident that Congress is trying to understand digital assets and the whole blockchain ecosystem. However, some members of Congress continue to overlook the benefits that can come from this new technology. Rep. Green (D-TX) said during the hearing: investing in stablecoins is like investing in nothing and, eventually, “you get what you pay for.”
Rep. Himes (D-CT) drew the important distinction that there is a difference between stablecoins that are fully backed dollar-to-dollar and other assets (like meme coins) that have nothing backing them. Besides being collateralized, stablecoins offer other benefits associated with the blockchain.
As discussed in a previous newsletter, the blockchain facilitates instantaneous 24/7 transactions with lower fees and without intermediaries, so the system allows for real-world applications like sending remittances and letting the bankless population participate. I wouldn’t call these advantages “nothing.”
However, no new technology comes without its risks, which the PWG report discussed thoroughly.
“Failure of stablecoins to maintain a stable value could expose stablecoin users to unexpected losses and lead to stablecoin runs that damage financial stability. Disruptions to the payment chain that allow stablecoins to be transferred among users could lead to a loss of payments efficiency and, depending on the extent to which stablecoins are used, undermine functioning in the broader economy. The potential for stablecoin arrangements to rapidly scale raises additional issues related to systemic risk and concentration of economic power. Stablecoins also pose illicit finance concerns and risks to financial integrity, including concerns related to compliance with rules governing anti-money laundering (AML) and countering the financing of terrorism (CFT) and proliferation. Further, digital asset trading activities present risks related to market integrity and investor protection.”
In developing an approach for evaluating and mitigating those risks, PWG wants to develop a comprehensive governance framework that will let the government have access to more information, employ effective risk management, and provide legal clarity for users. Rep. Wagner (R-MO) noted the states are already addressing these principles at a high-level, with Rep. McHenry (R-NC) citing New York as an example.
This gets to the core of the debate around regulation (and really is the quintessential issue around American politics). Some members of Congress are pushing for a federal regulatory framework that complements what already exists at the state-level, while others want the federal government to take full regulatory power.
IDIs and their risks
The main concern surrounding stablecoins is whether the issuers truly back the digital currency. Therefore, in order to promote market integrity and protect consumers, some level of regulation is needed. One of the central proposals from PWG was to have insured depository institutions (IDIs - which basically just includes banks) issue stablecoins. As you may expect, this recommendation received much pushback.
For one, IDIs go against the core principles of blockchain and diminish the benefits of stablecoins by making the financial system centralized, reducing the privacy associated with blockchain transactions.
Such centralization would create equity concerns. Gonzalez (R-OH), Meeks (D-NY), and Garcia (D-TX) noted that crypto has seen wide adoption by minority communities, especially the bankless. These individuals have been left out by traditional financial systems because they couldn’t meet minimum balance requirements or have an inherent distrust of banks. IDIs would push them back into these structures or leave them out once again.
In addition to this, several representatives including McHenry (R-NC), Luetkemeyer (R-MI), Gottheimer (D-NJ), and Williams (R-TX) brought up how federal oversight could limit innovation and push jobs out of this country. IDIs would become a massive advantage to the most skeptical institutions (like banks) while leaving behind the crypto entrepreneurs, who may, therefore, consider leaving the country.
Over-regulation of stablecoins could also undermine the US's position in the global economy. As Reps. Torres (D-NY) and Rose (R-KS) pointed out, stablecoins have an opportunity to reinvigorate the US dollar by allowing the US to lead the way in digital currency as well as the regulations that come with it.
It does seem like the IDI idea may offer some flexibility. As Reps. Gonzalez (R-OH) and Himes (D-CT) brought up, the definition of stablecoins and stablecoin issuers will ultimately determine the need for IDIs. Institutions that only issue stablecoins without engaging in other payment system operations (like making loans) may not need to be an IDI. Barr (R-KY) also brought up an alternative solution like requiring an audit or some type of oversight to ensure stablecoins are fully collateralized while avoiding the use of IDIs.
Some concluding thoughts
PWG’s recommendations are built on the idea that stablecoins (and their associated risks) are quickly growing. PWG has proposed building on existing securities and consumer protection laws by pushing for IDIs and supervisory oversight.
Rep. Wagner (R-MO) noted that the government should not be overlaying traditional financial regulations over a new and emerging technology like stablecoins. Rep. Timmons (R-SC) doubled down on this point by saying that Congress needs to consider crafting new policies for the new industry.
PWG wants to stay with existing, tested frameworks that are available and could be applied easily. I find that approach lazy and in opposition to the principles of innovation, as disruption is a necessary and vital part of progress.
After this hearing, it will be interesting to see how PWG rethinks and reworks its recommendations.
Crypto news of the week
New Hampshire governor establishes new commission to study crypto & Tennessee lawmaker proposes allowing the state to invest in cryptocurrencies and NFTs
McDonald's files trademark for metaverse-based 'virtual restaurant'
Bud Light partners with Nouns DAO for Super Bowl ad
Gucci buys virtual land on The Sandbox as part of metaverse experience bid
Top Japanese bank MUFG introduces new stablecoin platform
Sotheby’s to present landmark live evening auction for single lot of 104 CryptoPunk NFTs
KPMG Canada adds Bitcoin and Ethereum to its balance sheet
FarmVille developer Zynga set to release first NFT game this year
BlackRock planning to offer Bitcoin trading
El Salvador plans raft of legislation to cover bitcoin bond issue