Regulators Might Yet Head Off a Stablecoin Disaster

(Bloomberg Opinion) -- The U.S. government has unveiled a much-awaited plan to address one of the most pressing issues in the realm of cryptocurrencies: how to regulate stablecoins, digital representations of fiat currency that present grave dangers but also hold great promise.

The proposals are good, and should be implemented as quickly as possible.

Stablecoins remedy the volatility of cryptocurrencies by tying their value to government-issued money. They’re used primarily in the unregulated realm of decentralized finance — to park funds between speculative bets, to earn interest in lending pools, or to avoid detection by law enforcement. But as a unique form of digital bearer instrument, they also have the potential to make global payments much easier, faster and cheaper, saving consumers billions of dollars a year and helping to connect the world’s unbanked. The technology could also help governments to issue their own digital currencies, if and when they choose to.  

Problem is, stablecoins aren’t necessarily stable. It’s often unclear what backs the promise to redeem each token for a dollar. A Bloomberg Businessweek investigation into Tether — among the largest issuers with about $70 billion outstanding — found a questionably managed mix of investments including short-term Chinese corporate debt and loans collateralized by Bitcoin. If doubts about issuers’ finances arise, they could trigger devastating runs, as everyone rushed to redeem before the money ran out. The bigger stablecoins get, the greater the threat of broader contagion.

This week, a working group headed by Treasury Secretary Janet Yellen published a report that acknowledges the risks and calls on Congress to empower officials to address them. This would involve regulating stablecoin issuers as the bank-like entities they are, providing a potentially essential payment service. It would entail limits on issuers’ investments, and capital and other requirements to protect against hacks, technical glitches, conflicts of interest, consumer mistreatment and crime. And it would insist on interoperability, so that customers’ dollars wouldn’t be tied to a specific issuer.

The report also recognizes that somebody needs to be in charge while legislators get around to legislating. To that end, it emphasizes the powers regulators already have. The Financial Stability Oversight Council, for example, can enable much of the necessary oversight by designating stablecoins as systemically important, and by coordinating the efforts of often-uncooperative regulators, including the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Consumer Financial Protection Bureau. The Department of Justice, for its part, can police the unauthorized issuance of deposit-like instruments, which stablecoins arguably are.

Getting a grip on financial innovation is never easy. The working group’s report is an excellent start. It’s pragmatic about what can be done in the short term, without losing sight of the overarching goal: Anything that purports to represent a dollar must be worth a dollar in any state of the world. The sooner Congress and regulators act on this guidance, the better.

Editorials are written by the Bloomberg Opinion editorial board.

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