A top official at the Treasury Department responsible for financial oversight charged Congress with taking quick action to regulate stablecoins due to their perceived risk to the U.S. economy and individual investors.
“If Congress does not enact legislation, the regulators [SEC, Fed, Treasury, etc.] will try to use what authority they have,” but they will be left without sufficient oversight powers, said Nellie Liang, Treasury undersecretary for domestic finance in an interview with Bloomberg. “They can do a little here and a little there, but if these are foundational to crypto assets and they aren’t stable, that could potentially be a big risk.”
Stablecoins are a form of cryptocurrency that are issued and traded on blockchains, which are pegged to a “stable” off-chain asset such as gold, fiat currencies, or government bonds. By being staked to a tangible asset, the digital currency is supposed to be less volatile and more secure than other crypto assets.
Typically crypto users will park profits from the sale of various crypto assets by converting those proceeds into stablecoins. The stablecoins provide a reliable store of value and rapid liquidity to invest funds elsewhere.
In its latest Financial Stability Report published last month, the U.S. Federal Reserve ranked stablecoins among its top threats to U.S. financial stability over the next 12 to 18 months. The Fed report is printed twice a year, once in the spring and again in the fall, and its current edition includes a chart on page 67 that ranks crypto/stablecoins as the fifth most serious risk to financial stability — tucked between U.S.-China tensions and climate issues.
The report section regarding the risk also noted that the value of stablecoins has exponentially grown fivefold during the past 12 months to $130 billion as of October 2021.
Here are the main reasons for concern cited in the Fed’s publication:
- The largest stablecoins by market cap promise to be redeemable at any time at a stable value in U.S. dollars, but each token is not necessarily backed 1:1 with a fiat equivalent. Instead, some stablecoins are backed by commercial bonds, which may lose value or become illiquid. If those assets lose value, issuers may not be able to meet redemption demands.
- Stablecoins have structural weaknesses similar to certain money market funds that make them susceptible to liquidation runs by investors who could drain their accounts all at once.
- The report states that these shortcomings could be magnified by a lack of transparency and governance standards regarding some of the assets backing stablecoins.
- Lastly, the potential use of stablecoins in payments and their capacity to grow can also pose risks to payment and financial systems.
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