Regulation of Stablecoins
Stable coins are cryptocurrencies designed to mirror the value of a real currency, often fiat, such as the US dollar or British pound sterling, euro, ruble, etc. They differ in the way they achieve this goal, but according to Coinmarketrate.com , the largest of them – USDC from Coinbase, USDT from Tether and BUSD from Binance, achieve trading parity by (so far) reliable promises of assets held in reserve to back up the issued obligations.
Stable coins are used because the price volatility of other cryptocurrencies makes them more than ideal for trading or storing digital assets. Thanks to digital currencies with a stable value provided by companies such as Tether, Binance and Coinbase, users have access to a settlement asset that easily switches from cryptocurrency to fiat, which allows them to avoid friction when transferring money between crypto exchanges and banks, along the old money rails.
The report’s proposal is a mirror image of the STABLE Act, which was announced in December last year, and provides for the establishment of the same rules for issuers of stable cryptocurrencies as for banks. It is important to note that issuers of stablecoins are equated with banks offering savings accounts to customers. This privilege is accompanied by similar regulatory requirements, such as obtaining a banking license, insurance by the Federal Deposit Insurance Corporation (FDIC), and possibly even opening a primary account with the Fed.
The fact that financial regulators will come for cryptocurrencies should not be a surprise. As of December 2021, the decentralized financial industry (DeFi) of cryptocurrencies is $80 billion. According to one estimate, by the end of 2022, it will grow tenfold.
Stable coins are what connects this fast-growing space with the world of fiat money. Consumers and users in the world of cryptocurrencies rely on stable coins to make transactions inside and outside their spheres. Due to the globally decentralized (and often anonymous) nature of DeFi, it makes great logical sense for regulators to attack organizations that represent a centralized organizational goal. If you can’t restrain transactions or regulate users successfully, at least you can target the main nodes.
In theory, these centralized stable coins are backed by fiat funds and backed by reserve assets. In practice, however, it is not always clear how reliable these guarantees are, which raises regulators’ concerns about the potential defeat of banks.
Unforeseen consequences of the regulation of stable coins
Should the cryptocurrency world be worried about what seems to be the impending regulation of stable coins?
First of all, it should be noted that the proposals to regulate issuers of stable coins, as banks, are completely proactive and are not based on any plausible damage to consumers that already takes place.
The US Treasury report repeatedly emphasizes the “urgency” of protecting consumers from abuse and bank flight, although these problems are purely hypothetical (at least for now). Thus, this step of the regulator has all the signs of seizing political power.
This cautious approach may be well-intentioned, but it will also have consequences in the form of limiting capital inflows into DeFi and distorting price signals and profit incentives that are necessary to stimulate innovation in the nascent industry.
Secondly, the regulation of established stable coins will consolidate their positions in the market. Burdensome capital reservation or anti-money laundering requirements will be easily met by these leaders, while for smaller competitors and future participants in the stablecoin market, the entry barrier will be much higher.
This is not surprising, and the major players are well aware of the competitive advantages that such regulation will give them. Both Tether and Circle themselves spoke approvingly of the report’s proposal, and the founder of the latter stated that he “fully supports the call for Congress to act and establish federal banking supervision over the issuance of stablecoins”. When the key regulatory entities themselves willingly go to the lion’s den, one does not need to be a cynic to notice that the wheels of corporate capitalism are well oiled and have already started moving.
Regulating stable coins as banks will automatically increase their competitive advantages as the “best” stable coins in a wide range of niche crypto markets, such as centralized crypto exchanges or wealth management companies such as BlockFi and Celsius, which offer consumers attractive interest rates of 8% or more for deposited stable coins.
For regulatory compliance reasons, these companies (which themselves face regulatory scrutiny) will have a greater incentive to give preference to regulated stable coins as part of their offerings, again at the expense of smaller competitors or innovators. If this is not a seizure of political power, then strengthening today’s market structure, not tomorrow’s.
Today, the stablecoin market consists of at least 53 active stable coins with various bindings to the US dollar, pound sterling, commodities or currency baskets. The very novelty of DeFi is a good reason to maintain a competitive state in the stable coin market as more and more consumers come to cryptocurrencies.
Third, a strong cryptocurrency ethic aimed at maintaining decentralization is likely to respond to these rules by accelerating innovation and market demand for decentralized stable coins that are inaccessible to regulators. Perhaps this is a good thing, although it is an unintended consequence.
There are many similar forms of decentralized stable coins, from TerraUSD (UST) and Liquidity USD (LUSD) to Olympus (OHM), but the most popular example is MakerDAO’s DAI, which relies on price incentives to equalize the value of its coin to $1.
When the market value of DAI rises above $ 1, users have the opportunity to make a profit by issuing DAI more expensive than the average value, increasing the supply and thereby exerting downward pressure on the asset price. Similarly, when the DAI falls below $ 1, the owners of the coin can do the opposite: repay their DAI debt for ETH at a more favorable rate, and put pressure on its price upward.
These mechanisms provide users with stable coins, which enable them to navigate the world of DeFi, without being subject to the control of regulators, because unlike USDT or USDC, they provided no active management of reserves in Fiat or corporate bonds (thereby placing these organizations in the field of view of the regulators), and crypto-assets and smart contracts. As distrust of centralized stable coins grows due to looming regulatory pressure, cryptocurrency users are likely to find these options more and more desirable.
Conclusion
At first glance, stable coins behave roughly like banks, so it seems reasonable to extend the regulation regime of traditional banks to them. But this simple train of thought makes a serious mistake. Stable coins emerged as part of an alternative financial ecosystem after the financial crisis by entrepreneurs who sought to avoid excessive regulation of the traditional banking system. They can be parallel to savings deposits as a store of value, but unlike savings accounts, their key purpose is not the final parking place of capital, but a “bridge” for capital in DeFi.
Supporters of the regulation of stable coins would do well to remember this important detail. All the risks that accompany the danger of excessive regulation, such as rent seeking and the seizure of the regulator, are amplified in the event of a regulatory failure.