Stablecoins, Stability, and Financial Inclusion

The hope of extending financial services to communities that have long been left behind across the world is a central reason for our work, and we have been worried by an odd trend that has taken hold in Western economies over the last several decades. An increasing share of GDP is moving into the finance industry, yet millions still lack access to basic financial services. At the same time, in much of the rest of the world, Chinese fintech has become a leading candidate for serving the unbanked. A widening range of voices, from Senators Cynthia Lummis and Pat Toomey on the right to Senators Elizabeth Warren and Kyrsten Sinema on the left, are recognizing that digital currency may be a powerful way to help bring “more people into the system.”

Stablecoins — privately issued cryptocurrencies tied to a stable asset such as the U.S. dollar — can play an important part in the next wave of democratized financial services. Total stablecoin supply has risen from $20B to over $125B in the past year. Unsurprisingly, this dramatic expansion has drawn the attention of lawmakers and regulators. America’s technological and financial advantage has always rested on business leaders and policymakers working together so the private sector can test ideas and build, while suitable regulatory systems help limit the real downside risks that could otherwise hurt consumers.

Together with stablecoin technology, smart and effective stablecoin rules will be essential to protecting consumers, stopping financial crime, and maintaining the safety and stability of the financial system. When thinking about such regulation, policymakers should concentrate on three main principles: (1) expanding fair access; (2) making sure issuers and reserves are sound; and (3) improving the technological and operational resilience of stablecoin networks.

There are already many different kinds of stablecoins — and the market keeps innovating — so a one-size-fits-all approach is a bad option if we want to capture the technology’s benefits and limit its risks. We are still at an early stage. The total market value of stablecoins is roughly equal to Starbucks — a company that, by coincidence, runs one of the nation’s biggest mobile payments platforms. Now is the moment to put the right framework in place for how we want this technology to serve society.

Today’s stablecoin landscape

Before we go deeper into these principles, we want to establish the context. The value of the three largest stablecoins is up by about 10x from a year ago.

Established companies such as Visa, Mastercard, JPMorgan Chase, and Wells Fargo are testing stablecoin integrations to make their current infrastructure more efficient. More importantly, stablecoins are also broadening access to financial services by supporting new consumer finance products that bypass the traditional financial sector — the clearest example is their use in decentralized finance, or DeFi. Stablecoins have been a key enabling technology behind DeFi’s growth, since it depends on low-volatility on-chain assets for daily transactions. In fact, the idea of “banking the unbanked” could become outdated if stablecoins make it possible to access core financial services with no bank involved at all.

Stablecoin issuers generally rely on one of two methods to keep a stablecoin’s value linked to that of a reference asset:

• Asset-backed stablecoins hold reserves of fiat or crypto as collateral and use demand-side price arbitrage to keep prices steady Algorithmic stablecoins rely on the automated operation of smart contracts to preserve price stability

One worry with asset-backed stablecoins is whether the underlying assets are secure, and whether they create links to the traditional financial system that could produce systemic risk. For algorithmic stablecoins, the main risks today are technological and operational — whether the smart contracts work as intended, whether they can be disrupted by malicious actors, and whether the protocol’s economics and incentives create unintended effects that can be readily identified and properly reduced.

This matters to note as we enter the policy discussion, because a one-size-fits-all solution does not solve these very different concerns.

Principles for stablecoin regulation

We believe policymakers should welcome responsibly regulated stablecoins. Making use of the vibrant private stablecoin ecosystem can help the U.S. move quickly to prevail in the emerging geopolitical arms race in financial innovation. This is a vital point. Going forward, a nation’s digital infrastructure choices may be as important in shaping its geopolitical alignment as NATO or the Warsaw Pact membership was in earlier generations. USD-denominated stablecoins can help preserve the dollar’s continued primacy and the U.S. financial system’s central role in the global economy.

These ideas are not fully appreciated by lawmakers and regulators. Some recent bills would give the Treasury Secretary discretion to ban fiat-backed stablecoins altogether. Others have argued that the Glass-Steagall Act already gives the Department of Justice the relevant authority to seek criminal penalties against issuers. Instead of taking advantage of the opportunities created by dollar-based stablecoins, these strategies would damage core national interests — which leads us to the need for careful regulation.

Good regulation does more than discourage bad actors and control downside risks; good regulation sets out a framework and a vision for how technology can positively serve people. With that in mind, we suggest three principles for responsible stablecoin regulation: it should expand equitable access, ensure the integrity of stablecoin issuers and reserves, and strengthen the technological and operational resilience of stablecoin networks.

Advance Equitable Access

• Build equity into the regulatory structure. The stablecoin regulatory framework should first and foremost guarantee equal access for all consumers, and make it possible to overcome existing barriers to access. As Senator Robert Menendez (D-NJ) noted in a recent hearing, underbanked Americans, especially those without easy access to credit cards, find it hard to take part fully in the economy. This is due in large part to the costs, inefficiencies, and barriers built into the traditional financial system. Rather than copying the mistakes and limits of today’s financial system, policymakers should treat stablecoins as a basic building block through which society can begin to reduce or eliminate these barriers by modernizing our core financial infrastructure — laying new rails that boost efficiency and competition.

• Greater public awareness and understanding of stablecoins is needed so consumers can safely benefit from financial innovation. The private sector, government, and civil society all have a duty to promote transparency and teach consumers so they fully understand the risks and opportunities tied to new products and services. The advantage of blockchain-based infrastructure is that consumers can gain stronger auditing and disclosure than anything available in consumer finance today. Traditional disclosure-based systems can and should be updated to take advantage of the technology, making sure disclosure standards emphasize real consumer understanding of the products and services available to them.

Ensure the Integrity of Stablecoin Issuers and Reserves

• Offer a clear and predictable route for issuers to enter the market and satisfy regulatory expectations. So far, the states rather than the federal government have led the licensing of stablecoin issuers as money transmitters. The federal government should also carefully consider whether stablecoin issuers could be authorized under federal law. The OCC started this effort by granting three conditional National Trust Bank charters to Paxos, Anchorage, and Protego, along with a range of stablecoin-related guidance, including guidance on national banks’ authority to custody stablecoin reserves and guidance on their authority to use stablecoins as a means of payment. While the Biden Administration reviews this work, regulators should seriously consider creating pathways for new stablecoin issuers to enter the market based on their individual circumstances. For example, some stablecoin issuers may want bank charters (which could speed up fractional-reserve stablecoin banking) or narrow bank charters (if they are prepared to hold only central bank reserves and U.S. treasuries). At the same time, some stablecoins are governed by protocols made up of highly auditable smart contracts that create price stability algorithmically without any human involvement. For these protocols, a bank charter would be both mismatched and unnecessary. Given this variety, policymakers should offer a menu of stablecoin regulatory options that fit the purpose. There are real-world consequences tied to continued regulatory ambiguity. Regulatory uncertainty led to the shutdown of a promising project in this area two years ago, and the lack of clarity continues to choke innovation and push talent offshore.

• Create a clear framework for how asset-backed stablecoin issuers should audit and disclose their reserves. Since 2018, Circle and the Centre Consortium have issued attestations from Grant Thornton LLP covering the reserves backing USDC. Regulators should work with issuers and auditors to adopt specific standards governing what periodic attestation must be provided about asset-backed stablecoin reserves. In addition, regulators should ensure that — like the Grant Thornton reports — disclosures are brief and understandable to the average consumer. For their part, stablecoin issuers must be proactive about ensuring transparency. For decentralized asset-based (crypto collateralized) protocols, the data is on-chain, so collateral can be checked relatively easily; for issuers with off-chain assets, disclosures should include regular public audit reports by recognized accounting firms.

• Take advantage of the compliance benefits of stablecoins. Because they are auditable, blockchains give national security and law enforcement agencies new ways to spot illicit activity and enforce sanctions. Fast technological progress also offers the possibility of building regulatory compliance into smart contracts, cutting down or removing operational weaknesses that have long affected traditional compliance programs. With the right privacy-first architecture in place, public-private cooperation on stablecoins — such as building shared analytics tools and data repositories — can greatly improve on the current system. Despite common assumptions, the existing system does not do enough to identify or discourage such conduct.

Strengthen Technological and Operational Resilience

• Work with market participants on targeted guidance for crypto-collateralized and algorithmic stablecoin validation and governance. Algorithmic stablecoins can unlock substantial economic potential by providing a stable, decentralized medium of exchange. Many projects in this area are governed by DAOs, which can be difficult for regulators. Accordingly, policymakers should begin by working with established participants to develop guidance on suitable standards for validating their underlying financial models and governing their protocols. A great deal of thought has gone into the promise of DAOs running projects such as stablecoins and into ways to address the associated risks. Policymakers and regulators have a chance to catch up and engage directly in this discussion. In addition, a large majority of crypto-native stablecoin projects are transparent and auditable in their stabilization mechanisms, which could fit naturally with disclosure-based frameworks updated for the realities of the 21st century. That openness gives supervisors a practical basis for oversight without abandoning innovation or decentralization.

• Prioritize resilience and redundancy. The discussion of stablecoins goes hand in hand with a discussion of CBDCs, or central bank digital currencies, cryptocurrencies issued by governments that represent sovereign obligations. But CBDCs bring their own challenges, especially for privacy and security. Those problems are worsened when authoritarian regimes hold them. These privacy and security risks can and should be addressed, but CBDCs and stablecoins can coexist. The key goals should be making sure U.S. developers do not fall behind and that the U.S. dollar stays the base currency for this emerging industry. Encouraging a variety of USD-backed stablecoin projects will advance those goals and strengthen the resilience of our financial infrastructure by preventing a single point of failure. That diversification also reduces systemic exposure and supports market confidence.

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Stablecoins are well placed to become the foundation of a better, more inclusive financial system. Productive engagement between the public and private sectors has been the foundation of America’s success in building a financial sector that is both trusted and dynamic. There is no reason this cannot remain true as the financial sector goes through its most radical transformation in a century.