Stablecoin Reserves Must Be ’Publicly Transparent’, Says Fed Chair

September 30, 2022
Federal Reserve chair Jerome Powell argues that private stablecoin issuers must face greater transparency rules to build trust and protect against insolvency in a roundtable discussion on digital asset regulation.

Federal Reserve chair Jerome Powell argues that private stablecoin issuers must face greater transparency rules to build trust and protect against insolvency in a roundtable discussion on digital asset regulation.

Speaking at an event hosted by Banque de France, Powell said that if stablecoins are to move beyond the world of crypto exchanges and into areas such as retail payments, they should expect to be “substantially regulated”.

Taking the principle of “same risk, same regulation”, Powell said that although stablecoins share similarities with bank deposits and money market funds, they currently offer almost no equivalent protections to users.

“We need to make sure that if the public is going to be facing and dealing with stablecoins, the reality is that the reserves need to be publicly transparent,” he said.

“These are private forms of money that will be subject to runs if their reserves are not full of very high-quality assets.

“They need to consist of the kind of credit assets that will always be there when there's a need to fund withdrawals.”

Alluding to the TerraUSD stablecoin crash of June this year — which was effectively a run on its collateral token, LUNA — Powell said that users and investors will be harmed again without clear and transparent guardrails for issuers.

“Otherwise, the structure will not be run-proof and we saw that in the last few months in a couple of cases where stablecoins were not able to handle the withdrawals,” he said.

“We saw it regularly with money market funds in the last two financial crises. In both of those cases, some of the money market funds were not able to or really struggled to keep up and the Fed had to step in and provide liquidity to that part of the market.”

Channelling the Congressional Research Service, which published a report on the same topic in June this year, Powell noted that the current lack of regulation on stablecoin issuance is likely to favour the riskier options.

Bill Nelson, executive vice president of the US Bank Policy Institute (BPI), said as much in an article on stablecoins in September last year.

“Liquidity transformation always finds the path of least regulation,” he said. “But when that happens, the result is always increased instability in the financial system.”

Aside from solvency and liquidity concerns, Powell went on to say that stricter disclosures are necessary for private stablecoins to ensure that the public does not confuse them with central bank money.

“We know from our experience over time that they will look at a form of private money like that and they'll assume that it has the central bank’s backing, so they can trust it,” he said.

“From our standpoint at the Fed, we think that the central bank is and will always be the main source of trust behind money.

“Stablecoins essentially borrow that trust from the underlying issuer, and in many cases, these are dollar stablecoins, so they are really borrowing that trust.”

If stablecoins are to be issued as private money across the US, Powell argued that it is only logical that the task of regulating them should fall mostly, but not completely, to federal agencies.

Powell compared his vision for stablecoin regulation to the current dual-track system that is used for banking in the US, where state agencies issue banking licences, for example, but federal agencies take care of areas such as deposit insurance.

“In the case of stablecoins, which is a kind of money creation, we really think it should be the Fed that plays that role, so that's our principal focus now.”

In terms of regulatory avenues currently under consideration, Powell praised the US Treasury Department for leading the group of federal agencies that has helped to craft the Waters-McHenry bill.

As reported by VIXIO, the bipartisan stablecoin bill is being led by Maxine Waters (D-CA), head of the House Financial Services Committee, and Patrick McHenry (R-NC).

At the end of July, Waters announced that the passage of the bill would be put on hold for the August recess, although she and Treasury secretary Janet Yellen would continue to work on its content.

At the time, both Reuters and Politico reported that Yellen was seeking changes to the bill that would require digital wallet providers to segregate customers’ assets as a protection against insolvency.

Ravi Menon, managing director of the Monetary Authority of Singapore (MAS), also took part in the Banque de France roundtable, and shared Powell’s open but firm stance towards stablecoin regulation.

In future, Menon said he expects private stablecoins, tokenised bank deposits and wholesale central bank digital currency (CBDC) to be part of a new digital asset-based financial system. But in order for that happen, stablecoins must first be properly regulated.

“Then there are the decentralised governance issues with stablecoins that rely on algorithms, and then third there are systemic risks,” he said.

“Even if stablecoins are backed by low-risk, high-quality assets, they can pose concentration risks.

“In times of stress, multiple stablecoin issuers can concurrently suffer from mass redemptions, leading to a fire-sale of underlying financial assets, because the class of assets we regulators would deem low-risk, high-quality is limited.”

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