Turning stablecoin issuers into banks is a recipe for disaster

The President’s Working Group on Financial Markets issued its report on stablecoins in November. It makes a number of recommendations, of which the most important is that stablecoin issuers be insured as depository institutions, both at the institutional and the holding company level.

Stablecoins here refers only to those which are linked to a ‘fiat’ currency, such as the dollar, euro or yen, with the majority being linked to the dollar. Stablecoins were introduced as an alternative to Bitcoin, which is not only highly volatile over time but also intraday when its price swings can be as much as 10 percent within a few hours. Bitcoin and other cryptocurrencies are obviously not suitable for everyday use. That is why the majority of stablecoins were introduced and marketed as maintaining a one-to-one exchange rate with the dollar (or other fiat currencies). 

The working group rightly cites all of the problems with stablecoins: The nature of the reserve assets; redemption variations; the lack of transparency among ‘permissioned blockchains,’ governance issues, custody of the reserve assets, the unreliability of the wallets and settlement and distribution issues. 

Some stablecoins, such as Dai, could not be licensed as a bank since a decentralized autonomous organization called MakerDAO maintains the coin’s price through smart contracts. It is backed by USD coin and Ethereum, which means that all of its reserves are other stablecoins — hardly appropriate ‘reserves’. Counting other stablecoins as reserve assets could pose significant risks to the financial system as a whole. 

Almost all stablecoins, even the most popular, have been found wanting. 

Tether has never been able to demonstrate that it has the reserve assets to keep its promise to redeem tether tokens with dollars. It was fined $41 million for making misleading or untrue statements about the sufficiency of U.S. dollar reserves to back up its U.S. dollar coin. 

Bitfinex agreed to a $1.5 million penalty over charges that their controls did not prevent U.S. customers from illegally engaging in retail commodity transactions on the exchange. 

Binance is the fastest growing exchange in the digital currency world, trading $76 billion daily, including spoof tokens, such as Dogecoin. Binance coin was a utility token for discounted trading fees, but can now be used for travel bookings, online services and financial services. Its CEO, Changpeng Zhao, claimed that it does not make sense for an internet company to have a physical headquarters. That is simply a way of avoiding licensing and regulation in any particular jurisdiction. 

These are the leading issuers of stablecoins, presumably designated to become banks. Quite apart from their checkered pasts, issuers simply do not have the expertise required to run banks, such as balance sheet management, loan asset generation and risk management strategies. Stablecoin issuers, at best, can only be classified as deposit takers and payment processors. Their claims to provide faster and cheaper money transfers are being overtaken by events as licensed providers such as international money transfer firm Wise offer stiff competition. The costs of exchanging dollars for stablecoins and then transferring stablecoins to other parties, and the risks involved, are not made clear to potential customers. Stablecoins are simply parasites on fiat currencies, not serving any useful purpose.

Should stablecoin regulation wait for legislation? A much simpler and immediate approach would have U.S. regulatory agencies require stablecoin issuers to provide websites with full information about their activities. This would include the location of their headquarters together with contact details, such as telephone numbers and email addresses, and names and profiles of all senior staff. The website should also include full audited financial statements, including the amount and composition of the reserves and how and where reserves are held, and should also cover the issue of settlement and fees, which will be charged by many cryptocurrency exchanges for the purchase of stablecoins. 

Tether, for example, states that since its tokens are “native” to various blockchains, there are “inherit settlement assurances from the underlying network” because “All blockchain networks inherently provide settlement with every transaction.” Tether tokens do not have to be converted into U.S. dollars but anyone with an internet connection can hold the value denominated in dollars, even if they do not have access to a bank that holds dollars. Tether does not charge fees between tether wallets but there are standard blockchain fees, which are not public.

Coin issuers that do not provide the required information via easily accessible forms on their websites should be banned from operating in the U.S. That should serve to weed out those issuers that should not be licensed as banks. 

Generally, stablecoin issuers should not be licensed as banks since history shows that compensation for their losses could cost millions of dollars and bring critical stresses to global financial systems. The Financial Stability Oversight Council should be tasked with deciding which issuers qualify to become banks, beginning with those which have already been fined or banned in other countries, such as the United Kingdom.

Dr. Oonagh McDonald CBE is the author of “Cryptocurrencies: Money, Trust and Regulation.”