Stablecoins: Legal Issues and Regulatory Options (Part 1)

"In 2008, the pseudonymous Satoshi Nakamoto released a white paper describing a peer-to-peer system of electronic cash. The product of that paper—Bitcoin—now boasts a market capitalization of roughly $600 billion. Other cryptocurrencies amount to more than $700 billion, bringing the overall crypto ecosystem in line with the GDPs of many large countries.

Despite this meteoric rise, cryptocurrencies have yet to exhibit a defining feature of cash: widespread useas a medium of exchange. One reason for that failure is volatility. Most cryptocurrencies have exhibited wild fluctuations that may make them unattractive instruments for day-to-day purchases of goods and services.

Enter stablecoins—cryptocurrencies whose value is pegged to a reference asset like the U.S. dollar. While stablecoin issuers attempt to maintain these pegs in different ways, most of the regulatory attention has focused on coins that are putatively backed with reserves of assets denominated in fiat currency. Often, those assets underwrite an issuer’s commitment to redeem its stablecoins for a fixed value upon demand.

That structure raises familiar risks. Like banks and money market mutual funds (MMFs)—the principal sources of private money—stablecoin issuers are vulnerable to runs if their customers lose faith in the adequacy of the assets backing their demandable liabilities. Unlike banks and MMFs, however, most stablecoin issuers are not subject to federal regulations and protections designed to instill faith in those liabilities, such as deposit insurance and portfolio restrictions.

Policymakers have taken notice. In November 2021, the President’s Working Group on Financial Markets recommended that Congress enact legislation limiting stablecoin issuance to insured depository institutions. Other commentators have advocated different regulatory strategies, ranging from a bespoke federal licensing regime to an outright ban on stablecoin issuance.

This Legal Sidebar—the first part of a two-part series—provides an overview of the existing regulatory framework governing stablecoins. The second part discusses proposals for legislative reform of that framework. Both parts focus on stablecoins that are ostensibly backed one-to-one with reserves of fiat-denominated assets. For a discussion of algorithmic stablecoins, which instead aim to maintain their pegs using algorithmically determined supply adjustments or arbitrage mechanisms involving other cryptocurrencies, see CRS Insight IN11928, Algorithmic Stablecoins and the TerraUSD Crash, by Paul Tierno, Andrew P. Scott, and Eva Su.
Stablecoins