Treasury Report Says Stablecoins Threaten Market Integrity and Investor Protection

New report pushes for urgent action and says stablecoin issues should follow bank-like regulation.

In a long-awaited report, the Treasury urges Congress to take immediate action to address the risks presented by stablecoins. It sets out some of the biggest dangers stablecoins present and how they might be addressed.

Stablecoins are cryptocurrencies whose value is tied to a different asset, such as gold or, more commonly, the U.S. dollar. They are a cornerstone of the cryptocurrency industry, providing a quick and easy way to trade and a convenient medium for decentralized finance applications, such as borrowing and lending.

The agencies involved in the report are the President’s Working Group on Financial Markets, a panel led by Treasury Secretary Janet Yellen, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.

How stablecoins could threaten market integrity and investor protection

The 26-page report acknowledges that the total market cap of major stablecoins today is about $127 billion -- up 500% from the year before. This rapid growth shows no signs of slowing down. In theory, fiat-backed stablecoins have enough assets in reserve to support each coin they issue. But, as the report points out, there's not enough consistency around how those reserves work.

"Stablecoins differ in the riskiness of their reserve assets, with some stablecoin arrangements reportedly holding virtually all reserve assets in deposits at insured depository institutions or in U.S. Treasury bills, and others reportedly holding riskier reserve assets, including commercial paper, corporate and municipal bonds, and other digital assets," it says. If you're unsure about why commercial paper is problematic, read our article on reasons to be cautious about Tether (USDT).

These potentially unstable reserves lead to a bigger concern: The market might not be able to withstand a run on stablecoins. Let's say a particular coin failed to meet consumer expectations, causing lots of people to try to withdraw their funds. According to the report, this could create "a self-reinforcing cycle of redemptions and fire sales of reserve assets."

Not only might this disrupt other financial markets, but a run on one coin could prove contagious -- leading to runs on several different stablecoins. Worst case scenario? This could have an impact on the economy as a whole. "A run occurring under strained market conditions may have the potential to amplify a shock to the economy and the financial system," it says.

Additional areas of concern around the stablecoin market include:

• Consumer exposure to fraud
• Market manipulation and insider trading
• Lack of trading or price transparency
• Potential non-compliance with compliance anti-money laundering rules

What should be done about the stablecoin market?

In the short term, the report stresses that the various agencies involved in regulating stablecoins need to use their existing authority to address risks that fall within their jurisdictions and collaborate on those where there's crossover.

Right now there are several agencies involved in keeping stablecoins on track. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) are leading the charge. The Department of Justice, Consumer Financial Protection Bureau (CFPB), and the Financial Crimes Enforcement Network (FinCEN) also have roles to play.

However, there's some overlap that can muddy the waters, and some issues fall outside the remit of any single organization.

In the longer term, the report's authors believe urgent legislation is required.

• Only allow insured depository institutions -- banks or savings associations with FDIC insurance -- to issue stablecoins. Right now, if your cash is in a savings account, it is insured for up to $250,000 against bank failure. If you have stablecoins, there's little protection in place if the platform or coin issuer fails.
• Require federal oversight for custodial wallet providers. Crypto investors can use different types of wallets to store their assets. Custodial wallets are often run by cryptocurrency exchanges. Investors who use custodial wallets don't control their keys and may not always know what the wallet provider is doing with their funds.
• Ensure any organization involved with stablecoins introduces sufficient risk management measures. Traditional payment processors have various systems in place to minimize risk, whether it's to guard against human error or an external breakdown. Similar steps would make the stablecoin market more resilient.
• Ensure interoperability between stablecoins or stablecoins and payment processors. The concern here is that one stablecoin could become dominant and then squash any competition. Enshrining interoperability in law would reduce the chances of an excessive concentration of power.

Long road ahead

While the report repeatedly stresses the need for prompt action, legislation is not a speedy process. It could take years to enact the proposals above. In the meantime, cryptocurrency investors would be wise to tread carefully.

Don't assume all stablecoins give you the same level of protection. Look for coins that have a decent amount of accessible funds in reserve, rather than those that tie up their assets in various forms of short-term loans.

Stablecoins can be a great way to earn high rates of interest and are extremely useful for active traders. But they're not all as stable as the name suggests.