The national bank regulator in a speech Friday stressed the need to establish an intentional architecture for stablecoins that will help protect people, the dollar, and “reflect our values,” and he outlined three preliminary factors that should be addressed in its development.
“Getting stablecoins right from a regulatory policy perspective is important because getting them wrong could result in ordinary people getting hurt. Policy errors could also impede the potential for the dollar to serve as the base currency in a future digital economy,” Acting Comptroller of the Currency Michael J. Hsu said in prepared remarks before the Institute of International Economic Law at Georgetown University Law Center.
Hsu pointed to stability, interoperability, and separability as the preliminary policy factors that should be considered in the development of a stablecoin architecture.
Stability: Hsu noted that the President’s Working Group report on stablecoins cited run risk as a leading risk for stablecoins. He noted that currently there are broadly two approaches to mitigating run risk and promoting stability. One is based on money market fund regulation, grounded in disclosure and high-level requirements regarding asset holdings; the other is based on bank regulation and supervision, grounded in prudential standards to protect depositors. Hsu supports the latter, but he also said he agreed that full application of all bank regulatory and supervisory requirements would be overly burdensome. “Provided that the activities and risk profile of a stablecoin issuing bank could be narrowly prescribed, a tailored set of bank regulatory and supervisory requirements could balance stability with efficiency,” he said.
How much variability across stablecoin issuers can be tolerated? Hsu noted that unlike in the pre-Civil War period known as “free banking,” which was marked by frequent bank runs and panics, today’s system maintains variability across banks within a range of “safety and soundness” determined at the federal level.
“With stablecoins, one question is whether to require all stablecoin issuers to comply with a fixed set of safety and soundness-like requirements (as is the case with banks), or to let them pick from a wider set of licensing options, each with distinct risk-reward tradeoffs,” he said. “While there are pros and cons to consider, in my experience, the wider the variability the more likely a risky issuer blows itself up sparking contagion across peers.”
Interoperability: Hsu said that to the extent stablecoins get used for payments and to support other Web3 activities (“Web3” referring to an eventual blockchain-based digital economy), interoperability is likely to become a bigger issue. The two levels of interoperability to consider: interoperability within a stablecoin across blockchains; and interoperability across stablecoins.
Hsu noted that the largest stablecoins exist on multiple blockchains, e.g., Ethereum, Solana, Tron, Algorand, etc., and these blockchains are not interoperable. “Each blockchain has its own rail gauge so to speak, because different blockchains are written in different coding languages and have different dependencies and cryptography, among other things,” he said. “This lack of full interoperability means that for any given stablecoin issuer, like Tether, its tokens are not fungible across blockchains.” He noted the possible use of a cross-chain solution but said cross-chain solutions “have proven to be highly vulnerable to hacks.”
Hsu also noted that stablecoins within today’s crypto ecosystem are not interoperable with each other or with the dollar.
“Without interoperability amongst USD-based stablecoins, the risk of digital ecosystems being fragmented and exclusive (with walled gardens) is heightened,” Hsu said. “In the long-run, interoperability between stablecoins and with the dollar – including a CBDC [central bank digital currency] – would help ensure openness and inclusion. It would also help facilitate broader use of the U.S. dollar – not a particular corporate-backed stablecoin – as the base currency for trade and finance in a blockchain-based digital future.”
Separability: Hsu said blockchain-based money holds the promise of being “‘always on,’ irreversible, programmable, and settling in real-time.” But he said these benefits come with risks, especially if commingled with traditional banking and finance. He called “intraday liquidity risk” a particular concern. Hsu noted that in traditional banking, intraday liquidity risk refers to the risk associated with differently timed payments, and large banks with material intraday liquidity risk profiles have controls to help manage these risks.
“Now imagine a world where a bank engages in both traditional payments and blockchain-based payments. Banks’ intraday controls and risk management systems for traditional Fedwire payments may not be effective for blockchain-based payments, which are on 24/7, irreversible, and settle in real-time,” he said. “The accumulation of blockchain-based payments over, say, a weekend could outstrip a bank’s available liquidity resources. Several blockchain advocates have cited this as a concern.
“One way to mitigate these and other blockchain-specific risks would be to require that blockchain-based activities, such as stablecoin issuance, be conducted in a standalone bank-chartered entity, separate from any other insured depository institution (IDI) subsidiary and other regulated affiliates,” he said. “Additional safeguards could be considered, including enhancements to restrictions on interaffiliate transactions applicable to IDIs.”
These factors aside, Hsu said core values such as privacy, security, and preventing illicit finance “may also have architectural implications and warrant discussion and consideration.”