Published: October 28th, 2021
The US Department of the Treasury has decided to give the US Securities and Exchange Commission (SEC) regulatory authority to oversee stablecoins such as Tether and USDC. The SEC’s sister agency, the Commodity Futures Trading Commission (CFTC), will also play a role.
According to Bloomberg, the new powers will be outlined in a Treasury report expected to be published the week commencing 25 October, or early the following week.
Acting on the growing influence of stablecoins like Tether inside the crypto industry, US Treasury Secretary Janet Yellen called a flash meeting of financial regulators in September and asked them for recommendations on how to ensure transparency and risk mitigation for the USD 130 billion (and growing) asset class.
If reports are accurate, SEC Chair Gary Gensler, who has lobbied Yellen for the power to set policies for stablecoins and enforce them, looks to have achieved his objective.
In an early draft of the report, the US government is urged to create a dedicated bank charter for stablecoin issuers. The report also says that the SEC ‘already has existing powers’ to regulate tokens when they're used in investment transactions.
While that assertion hasn’t been tested in the courts, both Gensler and Fed Chairman Jerome Powell have both said publicly they believe stablecoins operate much the way money market funds do, and that it makes sense to regulate them the same way.
Yellen appears to agree, and now plans to place stablecoins under the SEC's purview.
Tether is now the world's biggest stablecoin by market capitalisation and the fourth-biggest crypto asset. With a market cap of USD 70 billion, it accounts for more than half of the entire stablecoin market.
The company found itself mired in controversy, however, after it was forced to walk back claims that every tether coin was backed 1-to-1 by a US dollar. A recent transparency report revealed that much of Tether's backing rests in commercial paper, technically a form of debt that can become risky in times of financial crisis.
Its top competitor is Circle’s USD Coin, issued in partnership with Coinbase, America’s largest cryptocurrency exchange. USDC’s market cap is now more than USD 32 billion. A report last summer revealed that only 60 per cent of its backing is in cash, with treasury notes, certificates of deposit, corporate bonds, and commercial paper making up the rest.
The SEC’s Gensler has suggested that he wants reign-in stablecoins and the decentralised finance (DeFI) markets that depend on them. The rapidly expanding asset class could help bad actors ‘sidestep a host of public policy goals,’ he’s said, potentially even threatening US national security.
In September, the International Monetary Fund (IMF) added its voice to a growing chorus of concern over stablecoins and their rising profile in crypto markets and beyond.
In its 2021 Financial Stability Report, the global financial body said stablecoins don’t present a systemic threat to the world economic order, but the risks are real and severe. Since many jurisdictions have inadequate regulatory frameworks for crypto transactions, stablecoins need to be monitored closely.’
The web of connections that link modern financial systems means a failure of oversight in one country can overspill rapidly into others.
To address those risks, the IMF wants to see global crypto regulatory standards agreed to stop the risk of contagion between markets.
This IMF’s annual stability report lists digital assets amongst a basket of systemic threats, which include the ongoing COVID-19 pandemic and the impacts of climate change. The report strikes a more measured tone, however, elsewhere in the text, where cryptocurrencies are described as an emerging set of assets ‘bearing opportunities as well as challenges.
‘The rapid growth of a blockchain-based investments and payments ecosystem has driven and accelerating pace of innovation and an influx of new market operators, some of whom have operational and governance frameworks that fall well short of the ideal,’ the report says. It lists service disruptions on major exchanges, the threat of cyberattacks and data breaches, and the ‘pervasive issue of transparency around how some tokens are issued and distributed,’ an apparent reference to stablecoins.
While those worries raise the risk of sharp losses for individual investors, especially in high leverage situations, they haven't changed how the current financial system manages risk.
The IMF says that could lead to sudden shocks thanks to imbalances in the crypto marketplace. Once exchange, Binance, controls the majority of cryptocurrency trading, while Tether has quickly emerged as the top vehicle for executing bitcoin trades. The dominance and relative vulnerability of two crypto entities is inherently risky, the IMF asserts.
Should either one be hit by a cyber-attack or see its operations hemmed in by regulatory action, the entire crypto ecosystem could collapse. That could see traditional financial institutions go into a tailspin, as an increasing number of investment banks, corporates, and hedge funds have invested heavily in bitcoin and crypto-backed assets the year.
Add to those concerns the uncertainty about stablecoins’ true backing spurred by Tether’s ambiguous claims around how it can be redeemed. In addition, the IMF says stablecoins are highly vulnerable to runs, with a likely impact on the broader financial system. One notable example in the report is the case of the IRON stablecoin, which collapsed this past summer when it experienced a sudden spike in redemptions. The backing wasn’t there to honour them all, and many investors lost their money as a result
Runs on an asset are typically set off by concerns that it won’t be redeemable for its full value. For stabelcoins backed by commercial paper, there is a risk that the commercial paper could be sold off at extreme discounts to minimise losses during a crisis, shredding the value of investor holdings.