Stablecoin Legislation 2022: A Year in Review and Future Outlook

2022 was a pivotal year for stablecoin legislation, with regulatory bodies around the world taking a closer look at these digital assets.

The US Securities and Exchange Commission (SEC) was one of the key players in shaping the regulatory landscape, with Chairman Gary Gensler stating that stablecoins are likely to be securities.

Stablecoin issuers like Tether and Circle were subject to increased scrutiny, with the SEC demanding more transparency and oversight.

The Commodity Futures Trading Commission (CFTC) also weighed in, with Chairman Rostin Behnam expressing interest in regulating stablecoins as commodities.

The Lummis-Gillibrand Payment Stablecoin Act was introduced on April 17, 2024, by US Senators Cynthia Lummis and Kirsten Gillibrand.

This bill aims to foster innovation and promote US dollar dominance while protecting consumers and mitigating illicit finance risks. It seeks to create a US regulatory framework for stablecoins, focusing on the comprehensive regulation of payment stablecoins.

A "payment stablecoin" is defined as any crypto asset used as a means of payment or settlement, with the issuer obligated to redeem it for a fixed amount of US dollars or maintain a stable value relative to the value of a fixed amount of US dollars.

The bill does not regulate stablecoins denominated in or redeemable for non-US currencies or other assets.

Payment stablecoin issuers would be required to maintain reserves of not less than 100% of the nominal value of their outstanding issued payment stablecoins as of the end of each business day.

These reserves would be limited to US dollars, demand deposits at a depository institution, certain US Treasury Bills with a maturity of less than 90 days, certain repurchase agreements backed by US Treasuries and with a maturity date of seven days or less, and, for depository institutions, balances held at a Federal Reserve Bank.

Payment stablecoin issuers would be prohibited from rehypothecation of payment stablecoin reserves, except for the purpose of creating liquidity to meet reasonable expectations of requests to redeem payment stablecoins.

To ensure transparency, payment stablecoin issuers would be subject to certain ongoing mandatory public disclosures, including a monthly summary description of the assets backing the payment stablecoin, the value of the assets, and the number of outstanding payment stablecoins, as of the last day of the month.

Payment stablecoin issuers would be classified as a financial institution for purposes of the Bank Secrecy Act (BSA), and would therefore require issuers to comply with US anti-money laundering (AML), countering the financing of terrorism (CFT), and sanctions rules.

The Bill would also classify payment stablecoin issuers as a financial institution for purposes of the Gramm-Leach-Bliley Act, and would therefore require issuers to comply with applicable customer privacy and nonpublic personal information protection standards.

Here are some key regulatory requirements for payment stablecoin issuers:

Stablecoins carry risks for investors and users, including market and liquidity risks, operational risks, and potential risks to financial stability. These risks depend on factors like the design of the stablecoin arrangement and its applications.

Stablecoins that are fully backed by high-quality liquid assets carry substantially lower risks for investors and users than other stablecoins, particularly algorithmic stablecoins. Algorithmic stablecoins not backed by financial assets are highly susceptible to runs.

There are heightened risks due to unregulated issuers and service providers, opacity and complexity of the crypto ecosystem, and a lack of recourse for lost or stolen crypto-assets. A run on a stablecoin could disrupt funding markets by triggering asset fire sales.

A stablecoin-based payment system could carry new or greater risks, such as the underlying distributed ledger technology, which is relatively new, may have unforeseen vulnerabilities. Banks that have direct exposures to stablecoins could face losses on those exposures in the event they declined in value.

The failure of just one entity could affect the financial stability of the market as a whole, and breakdowns of information systems or operational processes could disrupt transactions. There is no regulatory framework that addresses these risks, which could implicate a wide range of laws and span the jurisdictions of multiple state and federal agencies.

Potential financial stability risks posed by asset-backed stablecoins are akin to those posed by financial products with similar features, including certain types of investment funds, bank deposits, and payment instruments. Banks that issue their own stablecoins may face implications for their liquidity management and operational resilience.

Here are some potential risks to banks from stablecoins:

Regulators around the world are taking a closer look at stablecoin legislation, with a focus on developing technology-neutral regulations. This means that the same activity, same risk, and same regulation will apply to traditional financial systems and stablecoin arrangements.

The Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions recently published guidance on the Principles for Financial Market Infrastructures, which are international standards for the design and operation of financial market infrastructures to mitigate financial stability risks.

Regulators are also working on proposals to address risks arising from stablecoin activity, with a focus on identifying common features with traditional financial systems. This is aimed at producing consistent and effective regulation, supervision, and oversight of global stablecoins.

The Financial Stability Board is consulting on revisions to a set of 10 high-level recommendations for regulating global stablecoins and stablecoins with the potential to become global stablecoins. These recommendations aim to promote consistent and effective regulation, supervision, and oversight of global stablecoins.

The Basel Committee on Banking Supervision has proposed standards for the prudential treatment of bank exposures to crypto-assets, including stablecoins. Under this proposed framework, exposures to asset-backed stablecoins that satisfy certain requirements relating to the composition of their reserve assets and price stability would typically carry a lower capital charge than exposures to other stablecoins and unbacked crypto-assets.

Regulatory approaches are being developed to address the risks posed by stablecoin arrangements, including the risk of user losses due to failure of the issuer to meet their obligations. The Australian Treasury is working on options for incorporating payment stablecoins into the proposed regulatory framework for stored-value facilities.

The STABLE Act, introduced in the US, would require stablecoin issuers to have a banking charter, be FDIC-insured, and maintain adequate reserves. This would also require approval from the FDIC, Federal Reserve, and other appropriate agencies for any individual or entity seeking to provide stablecoin products or services.

Here are some key regulatory approaches being developed around the world:

The McHenry stablecoin bill, introduced in the US Congress, aims to regulate stablecoins and provide better protection for users. This bill proposes that law enforcement will act on anyone intending to act maliciously, particularly by executing rug pull schemes.

The bill also proposes that stablecoin issuers will be subject to close oversight by regulatory bodies, which will protect users from issuers who fail to enact sufficient security measures.

The McHenry bill has five standout issues that are likely to cause significant ripples in the cryptocurrency industry. These issues include requirements for entities with the legal authority to issue payment stablecoins, bank-like regulation for federal-qualified nonbank payment stablecoin issuers, and state-level regulation of stablecoin issuers.

Here are the five standout issues highlighted in the McHenry stablecoin bill:

The STABLE Act, introduced in 2020, also aims to regulate stablecoins by requiring issuers to have a banking charter, be FDIC-insured, and maintain adequate reserves. This act hinges on the fact that Article I, Section 8, Clause 5 of the U.S. Constitution gives Congress the power to coin money and regulate its value.

The McHenry stablecoin bill has the potential to significantly impact crypto users, particularly those who use stablecoins like USDt, which has a market capitalization of $110 billion.

The bill's lack of an effective enforcement date has raised concerns about the classification of existing stablecoins as illegal. This could have far-reaching consequences for the stablecoin market.

Tether, the issuer of USDt, is domiciled in the British Virgin Islands but must comply with the legislation to issue its assets to US residents. This highlights the extraterritorial clause in the Senate version of the bill.

The bill proposes close oversight of issuers by regulatory bodies, which would provide better protection for crypto users. This is a welcome development, especially after the collapse of TerraUSD, which wiped out over $50 billion in market value.

The bill also aims to prevent rug pull schemes and protect customer holdings from creditor claims. This would give users more confidence in the stability of their investments.

The Lummis-Gillibrand Payment Stablecoin Act seeks to promote responsible innovation and preserve US dollar dominance, while protecting consumers and digital asset market participants.

The market and economic aspects of stablecoin legislation in 2022 are crucial to understanding the impact of these regulations. The growth of stablecoins has been remarkable, with a total market capitalization of over $150 billion by the end of 2022.

Regulators have taken notice of this growth, with many countries implementing or discussing stablecoin legislation. In the United States, the Office of the Comptroller of the Currency (OCC) has issued guidance on the national bank charter for stablecoins. This guidance has significant implications for the industry, as it opens up the possibility of stablecoins being issued by national banks.

The economic implications of stablecoin legislation are far-reaching, and it's essential to consider the potential effects on financial stability and consumer protection.

Funding Market Disruptions can be a major concern if a stablecoin experiences a run. A run on a stablecoin could trigger fire sales of reserve assets, such as short-term government debt or commercial paper.

This can cause dysfunction in important funding markets, especially if the event occurs during a period of broader market stress. Runs on Money Market Funds (MMFs), which invest in similar assets, have exacerbated disruptions in commercial paper markets during previous episodes of market-wide stress.

The three largest stablecoins are comparable in size to some US MMFs, although the total value of stablecoins on issue is much smaller than the MMF market. Total holdings of reserve assets remain small relative to measures of market depth – such as turnover or issuance – limiting systemic risks for the time being.

The market has been on a steady rise over the past few years, with a notable increase in the GDP of developed countries.

This growth can be attributed to the significant investments made in infrastructure development, which has led to a boost in economic activity.

The GDP of developed countries has increased by an average of 3% per annum, making it one of the fastest-growing sectors.

Investments in emerging markets have also shown a remarkable rise, with the GDP of these countries increasing by an average of 5% per annum.

This growth has been fueled by the increasing demand for goods and services, driven by a growing middle class in these countries.

The rise in market has also been accompanied by a significant increase in trade, with global trade volumes increasing by 10% over the past year.

This increase in trade has been driven by the growing demand for exports, particularly from emerging markets.

The market rise has also been accompanied by a significant increase in stock prices, with the S&P 500 index increasing by 15% over the past year.

This increase in stock prices has been driven by the growing confidence of investors in the market, particularly in the technology sector.

The market rise has also been accompanied by a significant increase in consumer spending, with consumer spending increasing by 4% over the past year.

This increase in consumer spending has been driven by the growing disposable income of consumers, particularly in developed countries.