The Federal Reserve is Not the Ideal Regulator for Stablecoins

For a long time, stablecoin legislation has been on the verge of being enacted. The latest attempt is the renewed effort by Ranking Member of the House Financial Services Committee Maxine Waters to reach a compromise with Committee Chair Patrick McHenry to pass a bill before the end of the year. Although it is uncertain whether the Senate will take up the issue, Senator Bill Hagerty recently proposed a bill that could serve as a starting point for discussions. The exact details of a regulatory framework that could garner sufficient legislative support remain to be seen, but proposed approaches have centered around giving the Federal Reserve a significant role in regulating stablecoin issuers. This approach is misguided. There is widespread agreement that legislation is necessary to address stablecoins, which are crypto tokens pegged to the value of another asset, such as the US dollar. The general idea behind these tokens is that their stable value will promote their use as a digital medium of exchange. Stablecoin use has been growing globally, with applications including cross-border payments and remittances, as well as facilitating crypto trading. Because transactions with stablecoins can settle nearly instantaneously, some view them as improvements to existing payment systems, which are slower and more costly. This innovation would benefit from a clear framework that addresses the limited risks stablecoins pose. For stablecoins backed by assets, the biggest risk is that the token is not, in fact, stable. The Federal Reserve is poorly suited to oversee a regulatory regime designed to address this risk. Firstly, the Fed would be conflicted, as stablecoins compete with the Fed's own payment infrastructure, including FedNow, the central bank's instant payment service. The Fed's consideration of a central bank digital currency would further conflict with its role in regulating privately issued stablecoins, as these two digital representations of the dollar can be seen as substitutes. Any government body, including the Fed, would struggle to objectively analyze private payment innovations that compete with its own services. Giving the Fed the authority to regulate stablecoins would unfairly stack the deck against payment alternatives. If the conflicts of interest were not enough, the Fed is not well-suited to the task of regulating stablecoins. The Fed is a monetary policy specialist that already struggles with its regulatory responsibilities for bank regulation. Giving the Fed regulatory authority over stablecoin issuers would double down on this failing framework, potentially resulting in subpar regulation of the sector and distracting the Fed from its already ambitious statutory responsibilities. Moreover, the bank regulatory framework that the Fed is most familiar with is not suitable for stablecoin regulation. Issuers of fully backed stablecoins should not be treated as if they were fractional reserve banks. The 'financial stability' concerns that lead regulators to consider bank-like regulations for stablecoins are misplaced. Stablecoin issuers provide a payment tool, not banking services. The main risk for a stablecoin is that it will lose 1:1 redeemability with the asset it's pegged to, such as the US dollar, because the issuer doesn't have the reserves it claims to. Basic requirements around collateral and disclosures subject to anti-fraud authority would directly address this risk. Other regulators are better suited to oversee such a regime, including those more familiar with disclosure-based regulation. Congress should be commended for engaging on stablecoin regulation. However, such a framework should not give substantial regulatory authority to the Fed, which would lay the groundwork for regulatory decision-making that could decrease competition. If the Fed must remain involved, Congress can mitigate the risks by reducing any discretion granted to the Fed and by narrowly focusing any regulatory regime on disclosures regarding reserves and restrictions on appropriate collateral. Stablecoins offer the promise of faster, cheaper digital payments. But a Fed-heavy regulatory regime would place private stablecoins at a disadvantage, hindering this innovative technology's potential.