Notes 4/22: Stablecoin Regulation

Privately issued currencies used for daily transactions are a long-held goal for libertarian crypto enthusiasts distrustful of fiat money issued by government. Stablecoins, or coins that can be exchanged at par for fiat, are the best bet to carry forward the crypto torch of payments that is not beholden to government diktat.

But two legislations, one proposed and another whose draft is finalized, in the United States and the European Union respectively are the end of that dream. Crypto diehards applaud the bills as victory and progress in a confusing regulatory maze for crypto.

But the bills signal an end to the current stablecoin ecosystem. If and when there is a revival, the new stablecoins will not be a libertarian dream.    

Two Expensive Bills

In the last two years, the U.S. government has stressed the importance of formulating stablecoin regulation. A stablecoin bill introduced by Republicans in the United States earlier this week is the latest effort in that direction. It ringfences the operations of stablecoins with government regulations and fiat currencies. For example, reserves used to back the tokens can only consist of government-issued instruments. Stablecoins cannot be pledged, rehypothecated, or reused except for redemption.

The bill also proposes to regulate subsidiaries of financial institutions that issue stablecoins as banks and imposes many reporting requirements, such as the production of diversity & inclusion reports, for stablecoins with more than $150 million in payments.

The dissensions between Democrats and Republicans will ensure that the bill’s chances of being passed or bringing regulatory clarity in stablecoin operations anytime soon are remote. “This bill, that we have posted, in no way represents any final work,” said Rep. Maxine Waters (D-Calif.) emphasized in her opening remarks during the hearing.

An Onerous Bill

Across the pond, although there are signs of progress, things may not be much better. A draft of the Markets in Crypto assets (MiCA) bill was approved by members of the European Union by a majority. Stablecoins are asset-referenced tokens (ARTs) within the MiCA framework and will also be regulated under the EU’s stringent banking laws. The effect of those laws can be “onerous” in the requirements they place on capital buffers for stablecoin-issuing firms. The buffers are necessary to ensure that stablecoin firms remain solvent.

The bill also imposes strict anti-money laundering (AML) and Know Your Customer (KYC) requirements on stablecoin firms. Customer identification is anathema to crypto purists. According to them, crypto’s raison d’etre is privacy from government interference.   

The network effects required to qualify as an ART in the EU are also high. Tokens will need to have more than 10 million holders or a market capitalization of more than five billion euros. They will also need to have conducted more than 2.5 million transactions or transactions worth more than 500 million euros.

Hardly any stablecoin in the current crypto setup of wash traded volumes would qualify or be able to operate under the EU’s stringent definitions. What’s more, the EU draft also imposes constraints on the number of stablecoin transactions that can be conducted in a single day.   

All of this means that the expense, both in terms of cost and regulation, to operate a stablecoin in either jurisdiction is not for companies with modest budgets.

Stablecoins or Government-Regulated Currencies?

Many in crypto are celebrating the MiCA’s passage in the EU as the formulation of “new rules” for cryptocurrencies. It is, they say, vindication of their claim that crypto is a novel asset. Actually, they are similar rules as those applied to money market funds, except they are stricter.

In fact, the new rules are a death knell for stablecoins, like Tether, that currently operate without much oversight from legal authorities. It is also not clear how the proposed EU regulation benefits existing stablecoins, like USDC, that claim to be regulated by authorities since they increase the cost of operations and foist transparency in myriad ways, whether it is related to customer identification or transaction processing numbers.  

To that end, one could say they are a purge of the existing stablecoin system. Whether they pave the way for new coinage is unclear. In an earlier federal register release, the Federal Reserve discouraged banks under its watch from dealing in transactions involving them, effectively punting their regulation to states.

New York’s Department of Financial Services (NYDFS) has formulated guidelines but the cost of regulation and, also, beholden to the regulator’s wishes. This was amply demonstrated in the case of Binance’s stablecoin BUSD, which stopped issuance because NYDFS asked it to, after filing a case against it.

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