SBC Stablecoins Hearing
Senate Committee on Banking, Housing, and Urban Affairs
Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks?
Tuesday, December 14, 2021
Chairman Sherrod Brown (D-Ohio)
In his opening statement, Brown described the proliferation of digital currency and wild financial speculation in cryptocurrency, making them less useful for payments. He criticized the dynamic of one company controlling the value of certain cryptocurrencies. Brown also said that if investors put their money in stablecoins, there is no guarantee that they will get their money back, which makes stablecoin more like gambling.
Ranking Member Pat Toomey (R-Pa.)
In his opening statement, Toomey touted the benefits of stablecoin and its stability and lack of price fluctuation. He added that stablecoin improves privacy of transactions and that new regulations for stablecoin should be narrowly tailored and do no harm. Toomey added that stablecoin issuers should meet minimum requirements including for reserves and attestations.
Alexis Goldstein, Director of Financial Policy, Open Markets Institute
In her testimony, Goldstein said “Proof of Work” cryptocurrency mining has been exacerbating the shortages of semiconductors. She added that it is unclear how stablecoin issuers plan to mitigate the increasing carbon footprint that follows the ongoing growth of their tokens. Goldstein said there are many investor, national security, and usability concerns with both algorithmic and asset-backed stablecoins and that Congress should continue to examine if there are regulatory gaps that require new legislation, and regulators should continue to monitor stablecoins and ensure compliance with existing laws.
Jai Massari, Partner, Davis Polk & Wardwell, LLP
In her testimony, Massari said currently there is some federal regulation of stablecoin activities, adding that U.S. stablecoin issuers and digital wallet providers are subject to the Bank Secrecy Act’s anti-money laundering requirements. However, she said an expanded federal role may well be appropriate and useful, and it could include an optional federal charter for stablecoin issuers that would preempt the need for state-by state licensing in return for supervision by federal regulators. Massari said the charter could impose requirements for reserve asset composition while tailoring leverage ratios or risk-based capital requirements and other requirements to the nature of the business model. She continued that it could also restrict the stablecoin issuer from engaging in riskier activities, to minimize other claims on reserve assets. Massari argued that even though this option would entail comprehensive oversight, it would likely be welcomed by many stablecoin issuers.
Dante Disparte, Chief Strategy Officer and Head of Global Policy, Circle
In his testimony, Disparte explained that his company, Circle, is a leading digital financial services firm and the sole issuer of USD Coin (USDC) – a dollar digital currency supporting the extensibility of the U.S. Dollar in a global economy. He said that while some argue the U.S. may lose the digital currency space race if it fails to issue a Central Bank Digital Currency (CBDC), he believes we are winning this race because of the sum of free market activity taking place inside the U.S. regulatory perimeter with digital currencies and blockchain-based financial services. Disparte added that these activities are advancing broad U.S. economic competitiveness and national security interests.
Hilary J. Allen, Professor, American University Washington College of Law
In her testimony, Allen discussed two possible approaches to stablecoins and said Congress should first consider whether banning stablecoins is appropriate. She said if Congress does not wish to enact a full ban, a licensing regime could be another solution. Allen said a licensing regime should allow stablecoins to only be authorized if their issuers can demonstrate that the stablecoins have a purpose connected to real-world economic growth, and that issuers have the institutional capacity to manage the risks associated with the stablecoin’s reserve and technology. Allen then discussed more limited interventions and said she has advocated against bringing stablecoins within the perimeter of banking regulation, which means that stablecoins will remain more fragile than they would be if regulated more like bank deposits. She said to limit the fallout of any run on a stablecoin, measures will need to be considered to: (1) limit investors’ expectations about the stability of stablecoins; (2) prevent large tech firms and regulated depository institutions from issuing stablecoins; and (3) prevent regulated depository institutions from accepting deposits from stablecoin issuers.
Question & Answer
Toomey asked about the use cases of stablecoins. Disparte said the original use case was to support crypto capital markets, but now they are seeing emergence of integration of stablecoin-based settlements that are increasingly better, cheaper, and faster alternatives for how to move money. Toomey said there are large financial institutions increasingly pursuing the use of these platforms as an alternative way to settle payments.
Toomey said if Congress bans stablecoins, other countries will inevitably still develop stablecoins. Disparte said it is in the American national interest that we have options for how people can move money in an “always-on” economy.
New Regulatory Framework
Toomey asked how requiring stablecoins to be insured depository institutions makes no sense. Massari said their business models and risks raised are fundamentally different from traditional banks who take in deposits and make long-term loans. Toomey asked what principles to keep in mind with a regulatory regime. Disparte said the state money transmission regulations have been the appropriate starting point.
Daines asked what will happen without action from Congress promoting stable growth for stablecoins. Massari said it would be useful for Congress to consider a federal charter for stablecoin issuers and that a federal regulatory regime would be helpful.
Sen. Tina Smith (D-Minn.) asked what policy makers should consider regarding a stablecoin regulatory framework. Goldstein said we should consider the secondary market and ensure there is not a gap between consumer protections in equity markets and crypto markets.
Reed asked Allen if she sees a role for the Office of Financial Research (OFR) to make recommendations about stablecoins to Congress. Allen confirmed, stating that OFR could be built up to give regulators a more informed foundation to engage on stablecoin issues.
Stablecoin Issuers vs Traditional Banks
Brown asked if stablecoins are a better way to settle payments than our traditional finance system. Goldstein said that to be an effective settlement system requires four things: low fees, predictability, exchangeability for goods and services, and consistent high speed. She added that stablecoin does not meet all of those objectives. Allen agreed. Brown then followed up by asking Allen if, under the condition that stablecoin did show promise, it would be appropriate to bring stablecoin into the traditional finance system. Allen said that would be concerning due to their relationship with Decentralized Finance (DeFi) and run risk.
Sen. Mike Rounds (R-S.D.) asked why a consumer would want to use a service like Circle over a firm like Visa using dollars as the currency. Disparte said Circle’s innovations provide better price and cost of access than that of a traditional brick-and-mortar bank. Rounds asked Goldstein why she believes it is more costly. Goldstein said USDC runs predominantly on Ethereum, whose network fees are extremely high, and explained that sending money to another country comes with a lot of costs.
Pegging to the USD
Sen. Steve Daines (R-Mont.) asked how a U.S. dollar-pegged stablecoin could advance the role of the U.S. dollar as the world’s reserve currency. Massari said it is not clear that stablecoin would be harmful to monetary policy if backed by bank deposits and U.S. treasuries. She added that stablecoins can be made available for remittance outside the U.S. and that stablecoin can bolster the U.S. dollar as the world’s reserve currency.
Sen. Elizabeth Warren (D-Mass.) asked if someone owning ten dollars of Tether would be guaranteed to get those ten dollars back. Goldstein said no, and that you are dependent on the exchange where you trade it and if there were a run, the peg could collapse.
Similarities to 2008 Fiscal Crisis
Sen. Jon Tester (D-Mont.) asked if comparing cryptocurrency to synthetic financial instruments is accurate. Allen said yes and that the synthetic products leading up to the financial crisis of 2008 showed us to be weary of claims of financial inclusion, especially when the means to provide that goal is unnecessarily complex. Allen then questioned why stablecoins need to be so complex, why they need to run on a distributed ledger with decentralized governance mechanisms, and why there are not innovations that would achieve the same goals in a simpler way. Goldstein said she agrees and that the secondary market for stablecoins and DeFi reminds her of the over-the-counter derivatives markets.
Issues with Decentralization
Tester asked Allen about her testimony in which she said, “if you have problems, there is no one to go to.” Allen explained that if the stablecoin has an issuer behind it, you can go to that issuer, but noted that these things are then not as decentralized as anticipated and the sense of democratizing finance falls apart. Allen added that if it is truly decentralized, that would pose problems if, for example, you need a transaction undone.
Warren asked what a run on stablecoins would look like. Allen said a run on a stablecoin would look a lot like the runs on money market mutual funds in 2008 and 2020 and would potentially mimic the Mexican Peso crisis. Allen added that if stablecoin holders suddenly lose confidence in the ability of the issuer or reserve of assets backing the stablecoin value, a run today would mostly be felt in the DeFi ecosystem and argued that is why we should not provide government support.
Central Bank Digital Currency
Brown asked if there would be a problem if the Fed moves forward with a CBDC and calls that currency U.S. Dollar Coin. Disparte said the Fed would enjoy total autonomy over the name choice and enjoy the experience of stablecoins in circulation that reference the dollar as important prototypes for what could be an opportunity to update our financial infrastructure to support a publicly issued digital currency.
Sen. Jack Reed (D-R.I.) asked about the impact of stablecoins on monetary policy. Allen said the Fed needs to be able to match the amount of money in the system to the needs of the economy, but if the Fed loses control of the monetary supply, they lose the ability to use their monetary policy levers. She then suggested that a more interventionist policy approach may be justified.
Reed asked about data gaps in cryptocurrency markets. Goldstein highlighted self-reporting by the crypto industry and said Congress should look at having standardized data reporting so that regulators have all the information they need.
Access to the Financial System
Daines asked how stablecoins increase access to the financial system. Disparte emphasized how the brick-and-mortar banking structure harms unbanked and underbanked communities. Smith asked how stablecoin works for someone without a checking or savings account. Goldstein said that because stablecoin is not widely accepted as currency, consumers need a bank and that there are not many financial inclusion benefits to stablecoin if stablecoin relies on the existing banking infrastructure.
Sen. Mark Warner (D-Va.) asked how stablecoins can be a viable financial investment with a frictionless transaction structure. Goldstein responded by opining on how Circle is trying to provide other services to make a profit. Warner asked how stablecoin issuers make money with low transaction costs. Massari said issuers would have to provide payment and other kinds of fee-based services. Allen said no one will offer the service if there is no way to make money and that the nature of how issuers make money should be fully disclosed. Toomey asked if a non-interest bearing stablecoin with no expectation of profit meets our definition of a security and should be regulated as one. Massari said a non-bearing stablecoin should not be viewed as a security or regulated as one.
Smith asked what the right role is for stablecoins in retirement plans. Allen said they have no place in retirement plans. Goldstein agreed, adding that no investor wants the volatility of stablecoin without yield.
Preventing Illicit Activity
Brown asked if a company like Circle could create a stablecoin that could be used for electronic payments but not for gambling on cryptocurrencies like Dogecoin. Goldstein said yes. Brown asked what risks are associated with allowing stablecoins to be used both as a payment system and a tool to allow gambling in DeFi markets. Allen said she does not see stablecoins becoming used for everyday goods and services payments absent government support in the form of deposit insurance and that they would then still likely be used for gambling in DeFi markets.
Current Regulation and Redemption
Sen. Kyrsten Sinema (D-Ariz.) asked how an individual holding a stablecoin can know for sure that it is backed by the asset it claims. Massari said stablecoin issuers are regulated by the states in which they offer their services and are regulated by Financial Crimes Enforcement Network (FinCEN), so the state regulators are primarily responsible for oversight and ensuring the issuers live up to their promises. Massari added that a federal option could be explored to achieve the same goals. Sinema asked how much an individual holding $10,000 in a stablecoin could lose after a run on the issuer if the backing on the coin is not credible. Massari said it depends on the assets that are available.
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