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The US Treasury has claimed that stablecoins will "likely" need to be replaced by central bank digital currency (CBDC) to ensure the safety and soundness of digital asset markets.
Last week, the US Treasury submitted a presentation to the Treasury Borrowing Advisory Committee (TBAC) outlining a range of options for regulating stablecoins.
Comparing stablecoins to “wildcat” money of the 1800s, the Treasury said that stablecoins will ultimately need to be “strictly regulated” to prevent “panics” and “collapses in value”.
“If history serves as any guide, stablecoins will need to be regulated like narrow banks or money market funds,” it said.
A narrow bank is one that is restricted to holding only liquid and safe government bonds, as opposed to other equities (such as loans) against depositor's money.
Similarly, a money market fund is an open-end mutual fund that invests in short-term debt securities, such as US Treasury bills and commercial paper, on behalf of investors.
Regulations that would force stablecoin issuers to back their stablecoins using only these low-risk assets would help to protect against runs and depegging, the Treasury said.
However, in the long term, the agency sees the evolution of stablecoins following the same path as wildcat money — first towards greater regulation and then to displacement.
“Prior to a centralized monetary authority, banks in the US used to issue their own individual banknotes that were poorly collateralized, prone to runs, and regularly traded at a discount in secondary markets,” it said.
In response, most state governments began requiring these notes be backed one-for-one with government bonds, although this proved to be a temporary solution.
Ultimately, wildcat money was driven out of circulation by the National Bank Act of 1863, which established the US dollar as the only national-level currency.
A similar process will likely occur, and may “need” to occur, in the Treasury’s words, to replace stablecoins with CBDC.
In future, the agency expects CBDC to take over from stablecoins as the “primary form of digital currency in tokenized transactions”.
A fast-growing, high-risk asset
The Treasury acknowledges that stablecoins have seen rapid growth in issuance and usage alongside the rise of crypto-assets such as Bitcoin and Ethereum.
In 2015, one year after the launch of Tether, the world’s first stablecoin, there were less than $1bn of stablecoins in circulation worldwide.
Fast-forward to 2024, and there are now $166bn of stablecoins in circulation, with Tether making up $120bn of the total.
Stablecoins play an “integral role” in digital asset markets, the Treasury writes, with more than 80 percent of all crypto exchange trades taking place using stablecoins.
The two other “main use cases” of stablecoins, according to the Treasury, are depositing them on crypto exchanges to receive interest, or depositing them to decentralised finance (DeFi) platforms.
When crypto exchanges pay interest on stablecoin holdings, the Treasury said, these entities are in effect offering unregulated and uninsured deposits.
Similarly, DeFi platforms that allow users to lend money to and borrow money from one another are acting as unregulated credit unions.
However, the greatest risk identified by the Treasury in the current stablecoin market is the growing use of US government bonds as a primary reserve asset.
Although US Treasury bills are low risk in and of themselves, when used to back rapidly growing stablecoins, this could lead to concentration and contagion risks, the agency said.
“Stablecoins have increasingly elected to hold significant short-dated US Treasury collateral, and we expect regulatory efforts in the years to come to encourage this trend,” it said.
“Despite the improved collateral backing of stablecoins, significant risks remain. Runs on stablecoins have been a common occurrence in recent years, with stablecoins losing their peg to the US dollar or collapsing entirely.
“A collapse of a major stablecoin like Tether could result in a ‘fire-sale’ of their US Treasuries holdings.”
In the report, the Treasury notes that the collapse of FTX caused Tether and other stablecoins to depeg, as contagion worries spread and investors rushed to exit the crypto markets into fiat.
At the time, the total market cap of Tether was $65bn — almost half what it stands at today — so the potential impact of a “fire sale” of Tether’s treasuries would have been limited.
However, as the Treasury notes, with continued growth in stablecoins, the concentration and contagion risks will multiply.
In Tether’s Q3 2024 attestation, which provides a snapshot of its unaudited reserves, the world’s largest stablecoin issuer claims to hold $102.5bn in US treasuries.
Assuming the attestation is correct, this means that Tether now holds more T-bills than all but 18 of the world’s countries, having leapfrogged both Germany and Mexico, according to the Treasury’s latest data.
