Stablecoin Regulation | What Is It and How to React?

United States regulators are concerned about the systemic failure of top stablecoins, leading many to believe this cryptocurrency will be the first one to see regulation.

Treasury Secretary Janet Yellen voiced her concerns at American University this week. Most issuers say they back their coins with traditional assets that are safe and liquid, allowing crypto investors who hold them to access their value at any time they wish. But “right now, no one can assure you that will happen,” Yellen said Thursday. “In times of stress, this uncertainty could lead to a run.”

Although Bitcoin and Ethereum are the most popular crypto investments, stablecoins are an important $190 billion subset of crypto’s ecosystem. The potential new guidance comes with President Joe Biden’s executive order spurring federal agencies to look closer at crypto’s risks and benefits. And the focus on stablecoins has even been endorsed by billionaire investors like Mark Cuban, who tweeted in September that “stablecoins will be the first to get regulated. … It needs standards.” So the question comes down to what you should do if stablecoins are part of your crypto strategy.

Why Stablecoins Are Prime Targets for Regulators

The fact that stablecoins can be moved so easily — combined with their stable value — leads government officials like Yellen and Securities Exchange (SEC) Commission Chairman Gary Gensler to be concerned they pose some unique risks to the financial system and wider economy. And thus, need to be regulated.

Stablecoins are pegged to other types of assets, typically ones that are not as volatile as crypto such as fiat currency or precious metals, and can be valued at roughly the same. In theory, that makes the coins more “stable” than other types of cryptos, which see their value ebb and flow with the markets. “The benefits of stablecoins are myriad in my mind, and one of them is that they have a more stable price as compared to the other [cryptos],” says Marco Santori, the chief legal officer at Kraken, a digital cryptocurrency exchange. They’re fluid, he adds, which is another element that makes stablecoins attractive to investors, and “you don’t need a financial services company to move them around.”

Stablecoins can make it easier and cheaper to conduct trades on an exchange without fiat currency, serving as a bridge between cryptos on different blockchains. This can help diminish or eliminate any potential fees you might pay on your transaction, as some exchanges favor trades from stablecoins to other cryptos rather than from a dollar-based bank account. Many exchanges, such as Coinbase, don’t charge fees when exchanging U.S. dollars for USD Coin, which in turn can be used to buy other crypto investments. 

But some stablecoins may be used to circumvent money-laundering laws, or even finance rogue states or terrorists, according to a recent report from the President’s Working Group on Financial Markets (PWG), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC). This has become even more top-of-mind for policymakers in the wake of Russia’s invasion of Ukraine, with the idea that Russia could use cryptocurrencies to evade sanctions.

But there are also concerns that stablecoins could undermine traditional U.S. banking systems, leading to problems in the financial system. In particular this could happen when a stablecoin’s market cap gets large, says Joshua White, an assistant professor of finance at Vanderbilt University, and a former financial economist for the Securities and Exchange Commission. “It can have systemic risk implications, as well as fraud and security issues,” says White. In other words, the more investors use stablecoins, the more likely it is that any issues with them can affect the economy at large. White says the systemic risks are what spook regulators the most, which is why stablecoins may be at the tip of the spear when it comes to regulation. 

“What regulators are going to look for is companies issuing [digital] currencies backed by reserves. They’ll want to know that the issuer actually has those reserves and that the entity is stable,” says White.

For example, if you bought $1,000 worth of stablecoins to reduce or avoid fees on your crypto trades, but that stablecoin collapsed before you could use it, you’d be out that $1,000. And given that stablecoins do represent a considerable chunk of the crypto market, a shakeup concerning a top stablecoin could have wide-ranging ripple effects throughout the entire financial landscape.

In that sense, it’s “similar to the housing crisis” of 2008, White says. The deep impact that left on many Americans is one of the primary sticking points for regulators, who would like to avoid anything even resembling a similar systemic breakdown.

What Should Crypto Investors Do?

From regulation to the risk of systemic failure, anything could happen to stablecoins, so you’ll want to protect your investments and avoid any negative fallout. The way to do it: Stick with business as usual for now.

Experts advise you never invest more than 5% of your portfolio in crypto, and that you only invest after you have an emergency fund in place and have paid down any outstanding high-interest debt. 

Working in your favor, many experts think regulation could be a good thing for the crypto markets, as it signals an end to the Wild West era of trading and offers investors a little more peace of mind. 

In fact, some stablecoin regulations have already been proposed. The government report, mentioned earlier, recommends that stablecoin issuers be required to be insured as depository institutions, and be subject to federal oversight, among other things. In effect, stablecoin issuers would be classified as banks.

“There’s been an effort of late to look at the rules that stablecoin issuers should be subject to, and what sort of licenses ought to be required for the issuance of a stablecoin,” says Santori. 

Stablecoin regulation could mark the first wave of rules for the crypto markets, but different types of virtual assets could be regulated in different ways. The rules governing Tether may not necessarily be the same as those concerning Ethereum, for instance. 

The good news for investors is that time is on your side. Any new rules likely won’t be unveiled or implemented for at least a few years, according to White, so we won’t know what those new rules will look like for some time. That’s because Biden’s executive order asks government agencies to produce reports that will help inform those new rules.

Until those reports have been published, it’s difficult to ascertain what stablecoin regulations may look like, says Nicole DeCicco, the founder of Washington-based CryptoConsultz, a digital currency consulting service. The government’s approach will largely depend on what’s produced as a result of Biden’s executive order.

“I think the next move is going to be based on the data collected from those reports,” she says.