Regulators Growing Concerned Over Stablecoin Risks

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In Brief
  • As the market capitalization of stablecoins surpassed $100 billion in May, regulators are growing increasingly concerned about the risks they pose.

  • Although purportedly backed by physical assets, they still pose risks to investors and potentially the financial system.

  • Some say that central bank digital currencies offer the advantages of stablecoins without the risks.

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As the market capitalization of stablecoins surpassed $100 billion in May, regulators are growing increasingly concerned about the risks they pose.

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Stablecoins are generally seen as being much more secure than typical cryptocurrencies. This is because they usually have a fixed price due to being backed by physical assets. However, their growing use has regulators concerned over the risks they pose. This concern extends not only to investors, but also to the stability of the financial system. Lev Menand, an academic fellow at Columbia Law School, highlighted this point in his testimony to a Senate Banking subcommittee last week.

Additionally, although stablecoins are frequently backed by the US dollar, many never pass through the US banking system. This has also raised concerns over their potential use for illicit purposes, such as money laundering. 

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Stablecoin perspectives

Some administration officials worry that many stablecoin investors don’t fundamentally understand the asset. For instance, consumers may not know that money held in stablecoins isn’t protected by the Federal Deposit Insurance Corp. This means they could potentially lose money on a stablecoin without having any recourse.

US Senator Elizabeth Warren compared stablecoins to “wildcat notes,” which poorly capitalized banks issued in the Wild West during the 19th century. Warren added that if the Federal Reserve issued its own digital currency (CBDC), consumers could get stablecoin benefits without the risk.

The Fed’s approach

Fed Chairman Jerome Powell echoed this sentiment in an address last month. Powell acknowledged stablecoins’ “potential to enhance payments efficiency, speed up settlement flows, and reduce end-user costs.” Despite this, they still lack appropriate protection, he added. Issuing CBDCs could utilize these advantages, while providing proper protection.

Following this address, Fed Governor Lael Brainard warned that widening use of stablecoins could fragment the financial system. This could potentially raise costs for U.S. households and businesses. Other Fed officials have also warned that if consumers lose confidence in privately-issued stablecoins after they become widely used, it could result in the kind of “run on the bank” panic, threatening financial stability.

Meanwhile, the Federal Reserve Bank of Boston plans to publish research and open-source code later this year, demonstrating technology that could underpin a digital dollar. During his address, Powell said lawmakers and the public would have to weigh in for the project to advance. However, this process could take years.

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Nick is a data scientist who teaches economics and communication in Budapest, Hungary, where he received a BA in Political Science and Economics and an MSc in Business Analytics from CEU. He has been writing about cryptocurrency and blockchain technology since 2018, and is intrigued by its potential economic and political usage. He can best be described as an optimistic center-left skeptic.

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