Regulating Stablecoin Issuances is the Height of Hubris & Ignorance

A recent Democratic move to attempt to regulate stablecoin issuers shows just how disconnected politicians are from technology.

“That one is four dollars,” comes the smattering of heavily-accented English from a shopkeeper at Vientiane’s famous Ban Anou Night Market, along the crowded streets of the Laotian capital.

Across the city and indeed, across this mountainous, landlocked Southeast Asian country, the dollar is widely accepted, even though the official currency is the Lao kip.

From taxi drivers to hotel owners, across Laos and many countries around the world, boxes and stacks of dollars are used, exchanged and treasured, without a single greenback ever having to pass through the international dollar-backed banking system centered on a clutch of New York’s biggest banks.

Dollars to Donuts

According to estimates by the Bank of International Settlements, banks outside the U.S. hold over US$13 trillion in dollar-denominated assets.

And with as many as 80% of all US$100-dollar bills circulating outside of the United States, the world appears to be a much larger user of the dollar than America itself.

Yet until fairly recently, Washington wasn’t particularly interested in how those dollars moved, comforted by the knowledge that if the greenbacks became sufficiently substantial, they would inevitably flow through the U.S. banking system where anything from scrutiny to sanctions would be possible.

That was of course until the advent of dollar-backed stablecoins.

To be sure, dollar-backed stablecoins are not a new invention, with USDT or Tether having been around since 2014.

During that time, the amount of Tether, and more importantly, the velocity of its circulation has exploded along with Bitcoin.

In September, the U.S. Comptroller of the Currency, issued a clarification that U.S. banks could accept fiat currency deposits that were intended to back stablecoins, provided that they adhered to existing regulatory requirements, especially with respect to anti-money laundering and know-your-customer laws, news that saw a surge in Tether’s market cap.

Today, the most widely used cryptocurrency isn’t Bitcoin or even Ether, it’s Tether.

And despite facing several lawsuits in New York with regards to whether or not Tether is actually fully-backed by U.S. dollars (it likely isn’t), that hasn’t affected Tether’s price versus its fiat currency counterpart, or its popularity.

Over the course of 2020, the coronavirus pandemic has seen the market capitalization of Tether surge from around US$4 billion in January to about US$19 billion as of December.

Helping fuel Tether’s rise has been the wide availability of cryptocurrency derivatives that are also priced, sold and traded in Tether as well.

A Dollar By Any Other Name Would Spend as Sweet

But as 2020 draws to close, a stable of U.S. Democrats in the House of Representatives are looking to lower the boom on what some view as a major loophole in the current currency regime — unregulated stablecoins.

Known as the Stable Act, if ushered into law based on its current reading, the goal of the legislation is to prevent the creation of a dollar-based shadow banking system.

If passed, the Stable Act would oblige any prospective or existing stablecoin issuer to obtain a federal banking charter, with far more onerous compliance requirements than existing state regulations or money transmission laws.

And these obligations are over and above the requirement to comply with existing banking regulations.

Stablecoin issuers would also need to obtain the approval of both the Federal Reserve as well as the Federal Deposit Insurance Corporation (“FDIC”) at least six months before their issuance.

And finally, rather than working with existing financial institutions which already have FDIC coverage, the stablecoin issuers themselves would need to obtain FDIC insurance or deposit dollar reserves directly with the U.S. central bank.

Needless to say the cryptocurrency community was up in arms over the proposed legislation, with many arguing that the Stable Act would only entrench legacy financial institutions and stifle innovation.

If enacted in its current form, the Stable Act would most severely affect those stablecoin issuers which have at least tried to walk within existing regulatory boundaries, specifically Gemini U.S. dollar or GUSD, USDC, issued by Circle and Paxos.

But others such as Tether, which have always moved beyond the realm of U.S. regulators and have never attempted to even be regulated, will be more or less unscathed.

If nothing else, tightening the screws on stablecoin issuers that have tried to work under existing law could see larger inflows into unregulated issuers such as Tether.

Too Big to Tether

Whether or not Tether is even backed by dollars anymore no longer seems relevant.

It has become so much a part of the cryptocurrency ecosystem that many who deal and trade in Tether shrug off the inherent risks involved with the stablecoin as if it’s “too big to fail.”

Many investors and traders who deal in Tether say that they are unconcerned about Tether because if it fails, “it’ll take Bitcoin and the entire cryptocurrency ecosystem down with it.”

Where there is some evidence of Tether’s “too big to fail” quality is in the sheer volume of derivatives that are traded in the stablecoin.

Although Tether has a market cap estimated at around US$19 billion, the notional value of the cryptocurrency derivatives that it controls is estimated to be well over US$1 trillion based on data derived from Tokeninsight’s study of over 42 different cryptocurrency exchanges conducted earlier this year.

And far from having a detrimental effect on the value of Tether, the over-the-counter or OTC rate for Tether, versus the dollar, still attracts a premium, with some OTC providers quoting US$1.02 for every one Tether, a premium of around 2%.

Where Tether is most popular though may come as no surprise — China.

As an ERC-20 token, Tether works atop the Ethereum blockchain, making it easy to access so-called “mixers” which help to obfuscate Tether sources and fund flows, making it a favorite for transferring money out of the Middle Kingdom.

According to some estimates, the premium for swapping Chinese yuan into Tether can go as high as 10%.

Instead of preventing the development of a shadow banking sector, the Stable Act may instead encourage the formation of one, much like the U.S. Prohibition Act, which banned alcohol, gave rise to bootlegging and the Mafia.

For now at least, the risk that the Stable Act will be passed is limited.

While almost 30 blockchain and cryptocurrency bills were proposed or debated by Congress this year alone, no substantive legislation has been passed.

And with just weeks to go before a fresh session of Congress, the Senate and the Biden administration are sworn in, it’s difficult to see how cryptocurrency legislation will become a priority, especially with a US$900 billion stimulus bill still being debated on the floor of Congress.

Nonetheless, some would argue that even proposing the Stable Act should be indicative of how a Democrat-controlled House might more closely scrutinize the nascent cryptocurrency sector.

And with Bitcoin continuing to set new all-time-highs with each passing week, more media attention may bring unwanted attention to this sector of the cryptocurrency ecosystem — stablecoins.

If You Can’t Beat Them

But the Stable Act may also allude to an issue that the U.S. Federal Reserve had earlier dismissed, but may be want to reconsider — its own issuance of a central bank digital currency.

With China taking the lead in issuing its own digital yuan, as well as a successful trial of its central bank-issued digital currency, as many as 80% of all central banks are now considering the same, according to data from the Bank of International Settlements, a clearing bank for central banks.

House Democrats in early pandemic stimulus packages already considered a Fed-issued digital currency, but that language was ultimately dropped in the final legislation.

The Stable Act may be a sign that House Democrats are considering a Fed-issued digital currency far more seriously.

But the assumption that the Stable Act would magically bring the “pirate” dollars such as Tether under the ambit of Washington is misguided at best and naïve at worst.

Tether didn’t ask for permission to be born, it was simply written into existence using software code.

Just as the dollar is no longer backed by gold and few question its value, few question the value of Tether, regardless of whether or not it’s backed by dollars.

The assumption, as with most currencies is that as long as someone else is willing to exchange something of value for it, it’s a valid currency — it only becomes a problem when that exchange stops.

That politicians believe they can corral stablecoins, in particular those that exist outside existing regulatory frameworks, demonstrates a lack of understanding of cryptocurrency and the blockchain bordering on ignorance.

To be sure, any initial attempts at regulating novel areas will never be fully formed at inception.

Just as how politicians failed to recognize the significant influence and impact of social media on elections in 2016, they may be attempting to regulate financial flows before cryptocurrencies become completely unregulatable.

However the approach should not be one of stifling private enterprise and innovation but by offering viable alternatives, perhaps even a digital dollar.