The Biden administration declined to establish more stringent rules for part of the mushrooming cryptocurrency industry despite evidence that it could be at the heart of a massive scam which threatens broader economic well-being.
The President’s Working Group on Financial Markets, a multiagency initiative tasked with attempting to ensure market orderliness, said in a report released on November 1 that so-called stablecoins should be regulated like banks, but that it would be up to Congress to establish such a regulatory framework.
Cryptocurrencies consist of encrypted public records that demonstrate an entity’s ownership over the record, and transactions that the record facilitates. Advocates claim that cryptocurrencies enhance privacy and revolutionize payment processing, but their use-value has been widely questioned by critics who view the market as a highly speculative bubble waiting to burst. The computing power that can be used to obtain, or “mine,” certain cryptocurrencies also increasingly contributes to global carbon emissions, as those who question the benefit of the industry often point out. Research published by University of Cambridge found that Bitcoin mining uses more energy than the population of Argentina.
While the prices of most cryptocurrencies such as Bitcoin fluctuate wildly, stablecoins are pegged to the value of another asset, like the U.S. dollar. They are primarily used to borrow and lend money on cryptocurrency financial markets and to bet on the prices of various tokens, like Bitcoin.
Stablecoins are attractive for those interested in speculating on cryptocurrency because it’s easier to trade one type of token for another using stablecoins than it is to convert the token into fiat currency, and then into another type of token. The top stock market regulator, Securities and Exchange Commission (SEC) chair Gary Gensler, has called stablecoins “poker chips at the casino.”
Industry trade groups hailed the Biden administration’s decision, with some noting that Congress is very unlikely to act on the recommendations anytime soon. Meanwhile, public interest groups decried the move, saying that regulators are playing with fire by sitting on their hands, and that the government already has the authority it needs to rein in abuses.
“Unless federal regulators take prompt and effective action to deal with stablecoins, there is a grave danger that the $120 billion dollar stablecoin market will pose severe operational and systemic threats to our financial system,” Americans for Financial Reform (AFR) said in an open letter to Treasury Secretary Janet Yellen, which was published on October 19 in anticipation of the report.
Todd Phillips, director of financial regulatory and corporate governance for the Center for American Progress, said he was “very disappointed by the political aspect of this decision.”
“Congress is not going to enact the very narrow statute that the President’s Working Group recommends,” he told Truthout. Phillips said that the report’s authors “have given a big gift to the crypto industry, which has been saying: ‘We need Congress, regulators cannot do it.’”
Phillips explained that the Federal Deposit Insurance Corporation (FDIC) already “has legal authority to decide what are bank deposits.”
“There are likely ways the FDIC could grant deposit insurance to stablecoins, and it’s disappointing that no one has articulated what that would look like, or what actions the FDIC could take to make that a reality,” he remarked.
Renita Marcellin, a senior policy analyst for AFR, bolstered this argument, saying that regulators can already “put stablecoins under the full banking regime,” if they wanted to.
“We can say you have to get a national bank charter and be regulated by the [Office of the Comptroller of the Currency], you have to get deposit insurance, you have to submit to prudential regulation,” she said, referring to rules forcing banks to keep money and other assets on hand to weather rough patches.
Marcellin added that regulators could also decide to treat stablecoins like securities, which are broadly defined by case law as investment products. In the 1982 case, Marine Bank v. Weaver, the Supreme Court ruled that deposits which aren’t subject to federal banking regulations are securities.
The market for stablecoins, which is now worth roughly $138 billion, has increased in size by more than 500 percent in the past year. Growth in the overall market for cryptocurrency has run roughly parallel to this trend and is now worth almost $3 trillion, having ballooned by about 650 percent in the past year, despite sharp market contractions in late spring. The growth has been fueled by hopes that cryptocurrency will one day become widely used in payment systems, and a speculative frenzy driven by aggressive marketing campaigns that have included prominent celebrities, such as Kim Kardashian and Matt Damon, and major nonfinancial corporations such as Burger King.
Growth in the stablecoin market has worried regulators because the market looks set to fail in a time of distress — a scenario that could cause the price of various cryptocurrencies to plummet, considering many token purchases are financed with stablecoins. The financial industry stands to take losses in this scenario with a growing number of hedge funds exposed to cryptocurrency.
Those who are least likely to own any financial assets stand to suffer as a result. Systemic financial distress often causes or exacerbates economic recessions, which tend to hit the poor the hardest.
There are well-documented doubts about the integrity of the most widely used stablecoin, the U.S. Dollar Tether (USDT), which has been advertised as being backed one-to-one by the national currency that bears its name. The company that issues USDTs, Tether, has recently settled allegations leveled by state and federal regulators who had accused it of lacking the assets to back up USDTs. The company is also currently under investigation by the Justice Department, which is looking into charges that it has committed bank fraud.
In February, Tether agreed to pay $18.5 million in a settlement with New York Attorney General Letitia James and to refrain from operating in the state of New York. In October, Tether agreed to pay $41 million in penalties to the Commodity Futures Trading Commission (CFTC), which found that the company only had enough cash to back up its token for “27.6% of the days in a 26-month sample time period from 2016 through 2018.”
Journalists have also found Tether incapable of proving that it has the liquidity to maintain its USDT peg. A Bloomberg investigation published in October found that the company has used its reserves to make risky bets, such as loans backed up by Bitcoin, and that Tether’s chief financial officer has used company reserves to make personal investments. The piece noted that if the company’s critics are correct “and Tether is a Ponzi scheme, it would be larger than Bernie Madoff’s.”
Madoff, a former wealth manager, scammed thousands of people out of $64.8 billion by taking cash from more recent clients and using it to pay older clients instead of investing the money — the textbook definition of a Ponzi scheme. The scam collapsed in 2008 when the global financial system crashed and new clients stopped coming to Madoff. There are some $73 billion USDTs in circulation, $52 billion of which were issued this year alone, meaning that the token comprises roughly half of the global stablecoin market.
Tether was reportedly on the mind of Secretary Yellen when she first convened the President’s Working Group on Financial Markets in July to discuss stablecoins. Yellen was concerned the company “had gotten so large that it threatened to put the U.S. financial system at risk,” according to last month’s Bloomberg investigation. (She was also worried about the stablecoin market because of Facebook’s interest in entering it, citing the firm’s ability to reach almost half the world’s population on a monthly basis.)
Yellen wasn’t alone among regulators worried about Tether posing a wider risk to economic well-being, either. Officials at the Federal Reserve had raised concerns about the possibility of a run on Tether. Runs occur when clients attempt to simultaneously withdraw their money from a financial institution, which lacks the assets to honor the requests. They typically cause the loss of deposits, the failure of the firm, and losses for other entities that have done business with the company that suffered the run.
Though runs are often associated with black-and-white images of long lines for bank withdrawals during the early years of the Great Depression, there have been several high-profile examples of runs in recent U.S. history, mostly centered around nonbank financial firms. During the 2008 meltdown, there was the equivalent of a run on insurance giant AIG, as institutional investors attempted to collect on bets against the imploding housing market. And as the world was roiled by the spread of COVID-19 in March 2020, investors rushed to take their cash out of U.S.-based money market funds, which consist of short-term credit agreements that corporations rely on to stay current on debt payments. Both examples resulted in Federal Reserve bailouts and broader economic turmoil.
The knock-on effects of financial distress heightened the urgency for regulators to do something about the slow-motion car wreck transpiring in the stablecoin market. A readout of the meeting convened in July by Yellen noted that potential risks posed by the growth in stablecoins include “risks to end-users, the financial system, and national security.”
“The Secretary underscored the need to act quickly to ensure there is an appropriate U.S. regulatory framework in place,” the Treasury Department also noted.
But when the President’s Working Group issued its report on November 1, it did not urge regulators to “act quickly.” The group recommended another examination of stablecoin-related systemic risk by another multiagency bureaucracy: the Financial Stability Oversight Council. The report also said that stablecoin issuers should be subject to deposit insurance requirements like banks, but that Congress was required to legislate the matter.
The working group additionally called on Congress to pass legislation that limits business partnerships between cryptocurrency firms that perform different functions, so as to limit the possibility of conflicts of interest. (Tether has also come under scrutiny for mingling its reserves with assets managed by a cryptocurrency exchange called Bitfinex). The report also said that Congress should pass legislation “to require any entity that performs activities that are critical to the functioning of the stablecoin arrangement to meet appropriate risk-management standards.”
With Congress easily swayed by industry lobbyists, cryptocurrency trade associations welcomed the recommendations.
“Prompt action from this Congress on anything is unlikely, let alone on something like stablecoins,” tweeted Jake Chervinsky, the head of policy for a trade group called the Blockchain Association. Chervinsky’s colleague, Blockchain Association Executive Director Kristin Smith said: “Given that there is still a crypto information gap among some lawmakers and that the legislative process takes time, it is unlikely that anything will be signed into law anytime soon.” Meanwhile, Jerry Britto, the executive director of another trade association called Coin Center, reacted to the release of the report saying, “Bottom line: not a big deal from a crypto advocate’s perspective.”
The cryptocurrency industry has spent at least $4.9 million this year on lobbying, an increase from the $2.8 million that it spent last year, according to the Center for Responsive Politics. Though many lawmakers are already ideologically aligned with the laissez-faire ideology that characterizes cryptocurrency, the industry has stepped up its efforts to raise campaign funds for its strongest advocates on Capitol Hill. Cryptocurrency players hosted a fundraiser for Sen. Ron Wyden (D-Oregon) after he unsuccessfully advocated for “the industry’s preferred fix” to tax reporting provisions in the infrastructure bill signed into law on November 15 by President Biden, according to The Washington Post. Sen. Kyrsten Sinema (D-Arizona) raised $180,000 from the cryptocurrency industry in the third quarter after altering an amendment that would have softened the same tax reporting provisions to make the revisions more industry friendly, according to
Though the President’s Working Group report largely relies on Congress to do something about stablecoins, it did, however, leave open the possibility of regulatory action by the SEC and the CFTC. According to AFR’s Marcellin, one of those agencies could act soon.
“The regulators are getting warm to the fact that there are existing authorities,” Marcellin said. “We see [SEC chair] Gensler making a lot of movement and we expect an announcement on that shortly, based on his public statements.”
She noted, however, that rules limiting a financial institution’s risky behavior come primarily from banking regulators, such as the FDIC, and that the President’s Working Group report appears to have foreclosed on that possibility at a crucial time.
“When we’ve had major legislation up before, the banking and tech industry have proven themselves to be very formidable in their lobbying efforts,” Marcellin said. “Putting this before Congress might not lead to good public policy right now.”