Biden Administration to Get Tough on Stablecoins

Stablecoin providers may have to register as banks and follow similar regulations.

Months of speculation about the shape of increased stablecoin regulation might be about to end. According to The Wall Street Journal, a Biden administration committee is working on a set of proposals that target the risks presented by stablecoins. The recommendations are due to be published at the end of this month.

There are some heavy hitters on the committee -- called the President's Working Group on Financial Markets -- such as Treasury Secretary Janet Yellen, SEC Chair Gary Gensler, and Federal Reserve Chair Jerome Powell.

Why are stablecoins important?

Stablecoins are in regulators' crosshairs because of the potential risk they pose to the financial system. They are cryptocurrencies whose value is pegged to a traditional commodity like the U.S. dollar or the price of gold.

One reason investors use them is that fiat trading (using traditional money) on cryptocurrency apps and exchanges can be expensive and take time. Stablecoins are also a key part of the burgeoning decentralized finance (DeFi) industry. A number of crypto platforms pay high rates of interest on stablecoin deposits.

There is an estimated $130 billion held in stablecoins right now, and authorities are concerned about the levels of risk and transparency. The key question is this: If there was a run on a particular stablecoin tomorrow, would that coin have enough cash in reserve to support it?

In the case of Tether (USDT), the biggest stablecoin by market cap, the answer is: Maybe not. Tether holds about half its reserves in a form of short-term debt called commercial paper. Indeed, according to Financial Times, it is the seventh largest holder of this type of debt in the world.

Lawmakers would like to see more transparency about what type of commercial paper Tether holds -- for example, which companies and which countries that debt is in. But there's also a bigger worry that if something went wrong with Tether, it could have a considerable ripple effect for the global credit market.

Global credit rating company Fitch Ratings warned in July that "A sudden mass redemption of USDT could affect the stability of short-term credit markets."

What type of regulation will we see?

It looks like the Biden committee will push for bank-like controls on stablecoins. As Powell told the House Committee on Financial Services last week, "Stablecoins are like money market funds, they're like bank deposits, but they're to some extent outside the regulatory perimeter and it's appropriate that they be regulated. Same activity, same regulation."

This could mean stablecoins need to actually register as banks. Sources also told The Wall Street Journal that the committee may push Congress to introduce some kind of special charter that's specifically tailored to stablecoins.

The moves in the U.S. mirror international measures announced this week. A report from the International Organization of Securities Commissions suggests that stablecoins should observe international standards for payment, clearing, and settlement.

Even so, given the global nature of the cryptocurrency market, questions remain about how any new rules will be enforced at an international level.

What it means for investors

The good news is that there are currently no plans to ban cryptocurrencies in the U.S. as China did this year. Moreover, pushing stablecoin providers to demonstrate there's enough cash in reserve to support the coins they issue will likely strengthen the crypto industry in the long run. However, increased regulation may lead to short-term market jitters. And we may also see a reduction in the interest rates offered by DeFi platforms.

Given Tether's size and market dominance, if the new regulation has a significant impact on its operations, this will likely have a ripple effect on the crypto industry. Regulators will be reluctant to implement measures that damage investors. Nonetheless, if you hold USDT, it might be worth converting your funds into a more transparent stablecoin to mitigate that risk.