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Will Stablecoins Be Tethered to the Fed? Lawmakers Have Circled That Option

Jesse Hamilton - CoinDesk
2022-07-27 12:30

Companies issuing stablecoins would have to deal with the Federal Reserve as the chief oversight agency, according to the current version of a bill being developed in the U.S. House of Representatives, say people familiar with the talks.

While the industry is desperate for rules and supervision to settle the uncertainties that keep most investors on the sidelines, stablecoin firms would be policed by an agency that devotes much of its time trying to keep Wall Street banks on a short leash. This change would be novel for the Fed and for the nonbank crypto businesses that have never had a federal supervisor.

Lawmakers in the House Financial Services Committee have found common ground on a bipartisan effort to establish stablecoin oversight in the U.S. It could mark a first step toward crypto regulation, though a few points remain to be hashed out. As it stands, naming the Fed as the government’s watchdog for stablecoin issuers is in the bill, said two people who asked not to be named because the legislation hasn’t yet been released. The details are still fluid, though, so the Fed’s role could shift.

“The Fed is the big fish in the pond of bank regulators and stablecoins are a big deal, so this isn't surprising,” said Ian Katz, a managing director at Capital Alpha Partners, a Washington, D.C.-based research firm. “There was always going to be a big role for the Fed in stablecoin oversight because of stablecoins' potential ramifications for the dollar.”

Committee leaders initially thought they’d be set to put out the bill this week, but a last-minute intervention from Treasury Secretary Janet Yellen may have delayed it until after the August congressional recess, said another person familiar with that matter.

The Treasury Department is insisting that the bill address risks to customers’ money when crypto exchanges don’t take steps to wall off that money from the firms’ own assets. Meanwhile, Republicans objected to expanding the legislation, the person said. Lawmakers and their staffs will have the rest of the summer to work on the language, though the Fed’s role isn’t as controversial as other elements of the bill.

Stablecoins such as Tether’s USDT and Circle Internet Financial’s USDC, which are tied to the value of the dollar, represent a relatively small share of the $1 trillion in crypto’s overall market capitalization but are traded at very high volumes because they’re often used by investors to move in and out of bitcoin (BTC), ether (ETH) and other cryptocurrencies.

If the House bill opens such nonbank issuers to Fed master accounts, “it makes sense that the Fed would play the role of primary federal supervisor,” said Alexandra Steinberg Barrage, a former senior official at the Federal Deposit Insurance Corp. who is now a regulatory lawyer at Davis Wright Tremaine. And if the Fed is in charge of licensing nonbank stablecoin issuers, it puts “the payment, licensing and supervisory functions in one regulator.”

Dueling roles

Licensing financial institutions is a job more commonly associated with the Office of the Comptroller of the Currency, which controls bank charters at the federal level.

When that agency was run by Trump administration appointee Brian Brooks, who is now the chief executive of Bitfury, the crypto industry enjoyed a brief period in which a government ally tried to open the door for digital assets in U.S. banking. But that halted with the arrival of Acting Comptroller of the Currency Michael Hsu, a self-described “crypto skeptic” who says the industry has an unhealthy “dependency on hype.”

As of last week, the Fed officially has a new vice chairman for supervision, Michael Barr. While the crypto world knows him as a former adviser to Ripple Labs, he’s also known to champion aggressive oversight of finance, so his view on regulating digital assets remains an open question. That question would certainly be answered if his agency is suddenly granted direct authority over who issues stablecoins, because he’d be taking a leading role.

The central bank has long regulated and supervised Wall Street banks, and it routinely weighs applications for new bank holding companies or changes in their businesses. But the Fed’s experience with nonbanks is tied to powers granted in the 2010 Dodd-Frank Act, which said the agency is the watchdog for financial firms that another group – the Financial Stability Oversight Council – declares are threats to the country’s financial system.

In practical terms, though, there aren’t any firms on that list at the moment. The council has leaned away from using that power, so the Fed’s background is limited.

The chairwoman of the House committee, Maxine Waters (D-Calif.), negotiates with the panel’s ranking Republican, Patrick McHenry (R-N.C.), and each seeks support from the members of their parties. So a proposal to empower the Fed would have to thread a political needle.

Republicans have spent years railing against the Fed's powers. Progressive groups would rather not see nonbank stablecoin issuers given legal legitimacy at all, so Democratic lawmakers aligned with them are likely to resist the legislation. Meanwhile, financial lobbyists on both sides have weighed in – crypto representatives eager to get something done and banking lobbyists defending their industry’s turf.

If it manages to survive the House, the bill's next hurdle could be Sen. Sherrod Brown (D-Ohio), the chairman of the Senate Banking Committee. He’s highly distrustful of the crypto industry, but his views on this legislative effort aren’t yet clear. The top Republican on that panel, Sen. Pat Toomey (R-Pa.), has proposed his own version of stablecoin legislation and has said he thinks a bipartisan bill can be negotiated this year. He is retiring from public office at the end of the current session.

Putting the Fed in the driver’s seat for stablecoins could also raise questions about whether the Securities and Exchange Commission would have a lesser role with those tokens. The Fed's involvement could be welcome news for cryptocurrency businesses that have an adversarial relationship with the SEC. Its chairman, Gary Gensler, has often declared that most crypto tokens meet his agency’s definition of securities that should be registered.

The Fed can be one of the world’s toughest financial regulators when it comes to expectations for capital reserves and liquidity minimums, which are expected in this bill. Keith Noreika, who once ran the OCC, cautioned against crypto advocates being in such a hurry to get regulated that they disregard the potential difficulties of being overseen by the Fed.

“Perhaps at this early stage it is better to evolve regulation of this new technology organically rather than create a monopoly federal gatekeeper that may inhibit innovation,” said Noreika, who recently took a senior role at Patomak Global Partners and expects to be working with crypto clients. The longtime regulatory lawyer said the central bank often takes a one-size-fits-all approach to regulation, which may have a “dramatically adverse impact” on stablecoin technology.

The Fed had a track record thanks to one of recent history’s most prominent stablecoin efforts: libra, which became diem. That would-be stablecoin – backed by Facebook (now Meta) and other tech heavyweights – negotiated with the Fed, among others, for months before U.S. authorities stepped in and the diem effort eventually collapsed.

“Unfortunately, the timing just wasn't right, and the messenger wasn't right, either,” said Kurt Hemecker, who was chief of staff and head of internal business operations for the diem effort.

Hemecker, who is now chief operating officer for the Mina Foundation, has no ill will over that episode, suggesting that – considering the central bank’s role in supervising the U.S. financial system – it “makes sense for the Fed to be the kind of overall regulator” for stablecoins.

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