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US regulators have called on lawmakers to introduce federal stablecoin legislation, in an effort to guard against the risk of runs and fraud posed by “opaque” issuers.
Last week, the US Financial Stability Oversight Council (FOSC) published its 2024 Annual Report, which offers legislative recommendations for enhancing the integrity, efficiency and stability of the US financial markets.
In this year’s report, the FOSC identifies stablecoins as posing a major risk to US financial stability, and calls for federal prudential rules to protect investors from failures within the stablecoin market.
The report is critical of the stablecoin sector as a whole, but it raises the alarm most explicitly in relation to Tether, issuer of the world’s largest stablecoin, USDT.
The three main risks of the stablecoin market according to the FOSC are its concentration, its opacity and its complexity.
With a market cap of $140bn, Tether controls more than 70 percent of the world’s stablecoin market — a dominance that could severely disrupt the US financial system if the company or its stablecoin were to fail.
The concentration of the stablecoin market is compounded by its opacity, the FOSC adds, which amplifies the risk of runs and market manipulation.
“This opacity poses a challenge for effective market discipline and increases the risk of fraud,” said the FOSC. “Regulatory requirements for reserves, capital and reporting would help mitigate these risks.”
The FOSC is chaired by Treasury Secretary Janet Yellen, and also includes the heads of the Federal Reserve Board, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).
Tether’s opaque reserves and the risk of ‘fire sales’
In July this year, as covered by Vixio, the US Treasury warned that Tether poses a significant threat to the US government debt markets, due to its growing portfolio of US Treasury bills.
The FOSC makes similar warnings, arguing that “fire sales” of US T-bills could occur if Tether’s customers were to redeem their stablecoins en masse.
This could happen if Tether’s customers had reason to doubt the safety and soundness of its reserves, or if heavy selling in the crypto markets led to a mass exodus back into fiat currency.
“If Tether continues its alleged current rate of Treasury purchases, it could become a significant holder of US Treasuries and could present risks to the stability of the Treasury market if it experienced a run,” said the FOSC.
“Contagion risks between stablecoins suggest that potential fire sale risk should also be considered in aggregate across all stablecoins.”
Since 2021, when US Treasury bills first appeared in Tether’s reserve attestations, the company’s purported holdings of US T-bills have increased to just over $105bn.
The FOSC refers to Tether’s “alleged” Treasury bills, due to the “lack of trustworthy information” published about these holdings by the stablecoin issuer.
Though Tether has been in operation since 2014, the company has never been audited — unheard of for a financial institution of Tether's size.
Similarly, Tether does not publish the unique CUSIP numbers associated with each of its Treasury bills.
This practice, which is followed by rivals such as Circle, Paxos and PayPal, would allow third parties to verify the existence of Tether’s Treasury holdings and their current value.
Howard Lutnick, CEO of Cantor Fitzgerald, the company that has managed Tether’s Treasury bill holdings since 2021, has dismissed concerns about the lack of transparency of Tether's reserves.
In July this year, while speaking at the Bitcoin Conference in Nashville, Lutnick repeated his assurances that he has “seen the money” and that Tether “has every penny”.
For the members of the FOSC, however, these assurances have been less than convincing.
“A lack of trustworthy information about stablecoin issuers’ holdings and reserve management practices poses not only risks to holders of the stablecoin, but also fraud risks if the extent or nature of the stablecoin’s reserves are misrepresented,” they said.
If an issuer misrepresents its reserve assets, the FOSC also warned that holders of the stablecoin may have no protection against losses if redemptions cannot be honoured.
Similarly, reserve assets may be held in a “non-bankruptcy remote way”, meaning that if the issuer went bankrupt, out-of-pocket customers would have no claim on the bankruptcy estate.
State regulatory initiatives lacking
Stablecoin issuers typically operate outside of existing federal prudential frameworks, or in non-compliance with them, says the FOSC.
Several states have implemented regulatory frameworks for stablecoin issuers, but these are few in number, and the number of major issuers that are subject to these frameworks is even smaller.
The FOSC notes that the New York Department of Financial Services (NYDFS) was a first mover in implementing a specific prudential framework for crypto-asset firms, including stablecoin issuers.
Under New York’s BitLicense and trust company charter system, licensed stablecoin issuers must ensure that all outstanding stablecoins are fully backed by insured bank deposits or cash equivalents.
These include US Treasury bills with a maturity of three months or less, as well as government money market funds.
Issuers must also publish attestations at least once per month, signed by a certified public accountant (CPA), verifying the value of reserve assets.
As the FOSC points out, however, only one of the world’s five largest stablecoin issuers is licensed by the NYDFS — that being Circle, issuer of USDC.
The report also warns that attestation rules vary with regards to what information they require stablecoin issuers to disclose, and that there is no requirement for these attestations to comply with auditing standards.
