Regulators Heading For First Major Cryptocurrency Rules

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WASHINGTON – After being largely on the sidelines for years as cryptocurrency has gone from digital curiosity to a volatile but widely adopted innovation, federal regulators are rushing to address potential risks to consumers and financial markets.

Their concerns only grew as new and established businesses rushed to find ways to profit from the inflow of the massive wealth held in cryptocurrency into the traditional financial system through quasi-services. banking such as interest-bearing accounts and loans.

Now the Treasury Department and other agencies are urgently moving towards a first goal of tighter regulation: a fast growing product called stablecoin.

Issued by a variety of companies that are currently only lightly regulated by a patchwork of state rules, stablecoins serve as a sort of bridge between the cryptocurrency markets and the mainstream economy.

The value of a stablecoin is ostensibly tied to the US dollar, gold, or some other stable asset. The idea is to make it easier for people with cryptocurrency – which is known for its frequent price fluctuations – to make transactions such as buying goods and services, or earning interest on their holdings. in crypto.

The use of stablecoins is increasing rapidly and regulators are increasingly concerned that they are not in fact stable and could lead to a bank run in the digital age. This year alone, dollar-linked stablecoins such as the Tether token, USD Coin, and Pax Dollar have gone from $ 30 billion in circulation in January to around $ 125 billion in mid-September.

“It is important that the agencies act quickly to ensure that an appropriate US regulatory framework is in place,” Nellie Liang, undersecretary of the Treasury who is helping to lead the effort, said in a statement.

The pressure from the Biden administration to exert some control over stablecoins is at the forefront of what will likely be a much larger debate about the role of government in regulating cryptocurrencies – a topic generating a stir. growing concern in Washington.

“I saw a fool’s gold rush up close before the 2008 financial crisis,” Michael Hsu, the currency’s acting controller, said Tuesday. “It feels like we may be about to meet another with cryptocurrencies.”

Widely known as a vehicle for speculation, cryptocurrency is increasingly beginning to transform banking and finance and sparks discussions about whether governments should issue their own digital currencies to augment or possibly replace their traditional currencies. .

Stablecoins now underpin a growing share of cryptocurrency transactions around the world, at a time when the total value of circulating crypto tokens like Bitcoin is around $ 2,000 billion, roughly the same value. than that of all US dollars in circulation.

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The regulatory push has generated a wave of lobbying from cryptocurrency executives. They have lined up in recent weeks in a series of virtual and in-person meetings with banking and financial regulators, seeking to shape the new rules while largely acknowledging that some form of federal oversight is now inevitable.

Regulators are concerned about whether stablecoin companies hold enough liquid assets to safeguard the value of the currency they issue.

In addition to cash and short-term treasury bills – which are considered safe and easy to redeem – issuers of USDT and USDC stablecoins, for example, also at least until recently hold reserve assets like debt. unsecured in businesses, which is much riskier and more difficult to turn into cash quickly, especially in times of financial crisis. This “commercial paper” is linked to other key elements of the financial system.

Treasury Department officials also want reassurance that stable coin companies have the technical capacity to handle large increases in transactions, so that they don’t set off a chain reaction of problems if a large number of customers attempt. to cash in their assets.

Problems have already arisen. The Solana blockchain, a relatively new network that claimed to have seen a “explode”Number of stable transactions, suffered a 5 pm outage on September 14. company blamed “Network resource depletion” that prevented or slowed down customers from buying or selling during the crash.

Federal officials have said in interviews that they plan to use the sweeping powers created under the Dodd-Frank Act, enacted in the wake of the 2008 financial crisis, to initiate a review and potentially declare “systemically important” stablecoins, a finding that would likely subject them to strict federal regulation.

“Regulators really start to care more when the risks to society increase,” said Jeremy D. Allaire, managing director of Circle, a payments and digital currency company that helped create USD Coin. “You can see naturally that regulators want to find ways to deal with these risks.”

USD Coin has grown about 750 percent this year, with around $ 30 billion in circulation. It is expected to reach over $ 200 billion by the end of 2023 at its current growth rate, Allaire said.

The first step likely to be taken by the Treasury Department will be to release a report with recommendations this fall. In interviews, industry executives, lobbyists and regulators presented an overview of what they expect to see covered in these recommendations, which will form a template for potential regulations to be drafted over the course of the next year. year to come.

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The rules, they said, will likely dictate that reserves are always sufficiently liquid to meet redemption requests, and that the software systems handling those transactions are robust enough to avoid crashes and severe slowdowns in the face of simultaneous mass transactions. .

They predicted that there would also be requirements regarding the process of creating new stablecoins, security systems to protect privacy and data, and consumer protection measures. Separately, the Treasury Department is also preparing to impose rules aimed at preventing the use of cryptocurrency in illicit activities such as money laundering and tax evasion.

Measures have already been taken to crack down on the sector.

The world’s most popular stablecoin is USDT, issued by Hong Kong-based Tether; it currently represents more than half of the world supply of stable coins. New York state regulators in 2019 opened a Tether fraud investigation, an investigation that was settled this year with a deal banning the company from doing business with clients in New York City and ordering it regularly disclose what types of reserve assets back up its stablecoin.

Circle has already announced its intention to voluntarily shift its reserves to more liquid assets starting this month.

The new rules will create winners and losers, with some industry players better positioned than others to embrace them, who may need to change their business models to align.

Stablecoin issuer Paxos, for example, supports the decision to regulate stablecoins. But he opposes the use of powers created under the Dodd-Frank Act of 2010 which allows an entity called the Financial Stability Oversight Board – made up of the Secretary of the Treasury, the Chairman of the Federal Reserve and from 13 other leading federal and state financial regulators and financial experts – to effectively extend its reach to stablecoins by declaring stablecoins business or companies “systemically important”.

But at Circle, its chief executive said he was not opposed to the appointment.

“Large-scale, asset-backed dollar stablecoins that can be used across the entire Internet will be at this point, they will have that systemic designation,” Circle’s Mr. Allaire said.

Another option would be to create some sort of new type of bank charter for stablecoin issuers that addresses a number of regulatory concerns.

The Securities and Exchange Commission could also use its powers to require certain issuers of stable coins with reserves backed by securities – such as commercial paper, bonds or money market funds – to register as securities, which would force companies to provide more information to investors.

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As SEC chairman Gary Gensler pointed out, this is exactly what the agency did with the mutual fund industry in 2016 after the collapse of a large fund that depended on risky debt and collapsed. had to stop customer withdrawals. Cryptocurrency, he told the Senate Banking Committee, demands similar action.

“Frankly right now it’s more like the Wild West or the old ‘buyer beware’ world that existed before the securities laws were passed,” Gensler said.

In an effort to prevent impending regulations from stifling industry growth, industry leaders have stepped up to advocate with cabinet secretaries, Federal Reserve governors, key members of the White House staff and Congressional officials from the Senate Banking and House Financial Services committees. , as well as financial regulators.

And crypto firms and trading groups are increasingly hiring lobbyists and former regulators to work on their behalf in Washington.

Companies and industry groups whose representatives recently met with Treasury Department officials included major stablecoin issuers such as Tether, Circle and Paxos; cryptocurrency exchanges that are also creators of stablecoin, like Coinbase and Gemini; and old and new financial services companies like BlockFi, Mastercard, and the Blockchain Association.

Industry leaders argued in these sessions that cryptocurrency, partly based on stablecoins, will help expand banking and payments services globally to billions of people who now have a limited access to the financial system.

Stablecoins, they say, are an integral part of this vision. It is this picture that U.S. leaders painted for Salvadoran officials and crypto fans around the world before the recent adoption of Bitcoin as legal tender by the Central American nation.

If regulators severely restrict crypto growth through tough new regulations, industry leaders say the United States will spur innovation overseas, risk dollar primacy and kill the promise of the dollar. digital finance.

“If we think back to the 20th century, you first had key innovations like aviation or the automobile,” said Tomicah Tillemann, former Senate aide to President Biden who now works for Andreessen Horowitz, the capital firm -risk, which is a major investor in crypto. . “And then you have investments in regulatory frameworks that have helped bring these technologies to more people.”