Hilary Allen, a law professor at American University, has expressed concerns that stablecoins pose a significant threat to the stability of the banking system and ultimately harm the public at large. Her views come as the US Congress considers regulating stablecoins at the federal level. While Allen suggests that stablecoins serve no practical purpose and should be banned, this perspective is unwarranted for individuals who oppose competition and lack clarity in regulation.
In reality, stablecoins are the next iteration of electronic money (e-money), which allows technological startups to issue payment instruments in a secure and controlled manner. Unlike traditional banks, which provide various services and are subject to greater risks and tighter regulation, obtaining a bank account for digital payments can be challenging and expensive. To simplify matters, regulators created a distinct regulatory framework for e-money providers that focuses solely on converting cash into digital currency, which can then be utilized via a prepaid card or electronic device.
Stablecoins, which are denominated in fiat currencies such as the US dollar, are essentially electronic money that can be used globally due to their blockchain-based nature. As they offer similar benefits to e-money, such as increased competition, lower costs for consumers, and improved financial inclusion, these digital assets have the potential to deliver on the initial e-money promises.
However, for stablecoins to realize their full potential, federal-level regulation is necessary. Currently, stablecoin issuers in the US are subject to state money transmitter laws, which lack consistency in terms of client fund segregation and asset preservation protocols. To address this, an effective regulatory structure for stablecoins should consist of three key components: authorization for non-bank licenses, direct access to central bank accounts, and bankruptcy protection for backing assets.
Firstly, while banks can hold deposits from the public that aren’t necessarily 100% secured, stablecoin issuers aim to maintain a one-to-one ratio between each stablecoin and the underlying asset. Unlike banks, where lending is part of their core business, stablecoin issuers’ primary function is to receive cash, offer a stablecoin in exchange, and preserve the cash securely until redemption. Therefore, it would be illogical to impose banking licenses upon stablecoin issuers since they do not engage in fractional reserve banking practices. Instead, a simpler non-bank license with appropriate capital requirements applicable to their minimal risk profile is recommended.
Secondly, stablecoin issuers should have direct access to central bank accounts for depositing their backing assets. While keeping funds in a bank account or short-term securities may be safe options, these alternatives can become hazardous in times of crisis. Circle, a US stablecoin issuer, experienced difficulties when Silicon Valley Bank collapsed, and $3.3 billion of its cash reserves (approximately 10% of the total reserves) held by the bank became momentarily unavailable. Additionally, many banks, including SVB, experienced losses following rising interest rates, causing market prices for US Treasuries to decline, resulting in liquidity difficulties for the banks.
To prevent systemic issues in the banking industry or the US Treasury market from spilling over into stablecoins, direct access to central bank accounts for stablecoin issuers is essential. This step would eradicate credit risks in the US stablecoin industry, permit real-time monitoring of stablecoins’ backing resources, and eliminate the likelihood of bailouts, just like e-money.
Thirdly, stablecoin users’ funds must be regarded as segregated from the issuer’s funds in accordance with the law, and they shouldn’t be affected by the issuer’s insolvency, whether it results from operational hazards such as fraud. By adopting this approach, stablecoin users would be able to promptly restore access to their funds throughout the liquidation process, and the issuer’s bankruptcy creditors would not be able to confiscate stablecoin users’ funds. This measure mirrors best practices followed by e-money issuers.
In the ongoing discourse regarding stablecoin regulation, exaggerated perspectives might captivate an unsophisticated audience, but balanced arguments based on global success stories and precedents should predominate.
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