Stablecoins are increasingly being taken seriously as a potential part of the U.S. financial system, though how the digital assets should be regulated is still being debated by officials and industry leaders.
“Stablecoins can certainly be a useful, efficient, consumer-serving part of the financial system if they’re properly regulated,” Federal Reserve Chairman Jerome Powell said at the Federal Market Open Committee (FOMC) press conference on Wednesday. “And right now, they aren’t.”
“They have the potential to scale, particularly if they were to be associated with one of the very large tech networks that exist,” Powell added. “You could have a payment network that was immediately, systemically important that didn’t have appropriate regulation and protections. The public relies on the government and the Fed, in particular, to make sure that the payment system is safe and reliable, as well as the dollar, to provide a safe and reliable trusted currency.”
Federal Reserve Chairman Jerome Powell speaks during a Senate Banking Committee hearing on Capitol Hill in Washington, Tuesday, Nov. 30, 2021. (AP Photo/Andrew Harnik)
What are stablecoins?
Stablecoins are cryptocurrencies that are usually backed by a reserve asset. This secondary asset helps the currency maintain price stability, unlike other forms of cryptocurrency — such as bitcoin (BTC-USD) — that can see high levels of volatility and more extreme swings in prices day-to-day.
As a result, stablecoins can be useful as a store of value or medium of exchange. And because they work through the blockchain, they can move very rapidly between peers without having to go through the kinds of intermediaries that slow down traditional bank transfers.
Many of the most popular stablecoins, like tether and USD coin, are pegged to fiat currencies like the U.S. dollar, cash equivalents, or other assets like gold. Other stablecoins are backed by cryptocurrencies. MakerDAO’s DAI, for instance, is tied to ethereum (ETH-USD).
Stablecoins are backed by a variety of assets.
Some stablecoins are non-collateralized, meaning they are not backed by any other asset. Instead, they rely on an algorithm that runs autonomously to monitor the supply and demand of the coin, much like a central bank does when printing banknotes, to retain a stable price.
Many see the applications of stablecoins fitting into existing payment systems. And some payment platforms, such as Circle, have issued their own stablecoins.
At the same time, as Powell stressed, stablecoins are largely unregulated. That means that issuers can hold other assets that may or may not redeem a coin’s value and may even introduce leverage, thereby increasing risk. In other words, while stablecoins are seen as safe havens in the crypto world, their actual value may be somewhat more inscrutable.
Tether is one notable example of this. Created in 2014, the popular stablecoin was designed to track one-to-one with the dollar. However, just 5% of tether’s holdings are in cash. Its reserves are comprised largely of commercial paper (a form of short-term corporate debt), gold, and bonds, leading some market participants to doubt its stability.
A breakdown of reserves of the top four stablecoins. (Source: CRS)
What does ‘properly regulated’ look like?
Sen. Sherrod Brown (D-OH), the chairman of the Senate Banking Committee, told Yahoo Finance earlier this week that he would like to see stablecoins brought under banking rules.
At the same time, he’s open-minded about how regulation would play out.
“Right now,” Brown noted, “the Securities and Exchange Commission, the Federal Reserve, and the Department of Treasury are all looking at what we do about stablecoins generally.”
Rep. Patrick McHenry (R-N.C.), a top ranking member of the House Financial Services Committee, also told Yahoo Finance that regulating stablecoins could offer an entryway into regulating cryptocurrencies more broadly.
“We need to have, at the federal level, changes in law in order for stablecoins to be in the marketplace,” McHenry told Yahoo Finance earlier this month.
Rep. Patrick McHenry speaks during a House Financial Services Committee hearing on December 8, 2021. (Photo By Tom Williams/CQ-Roll Call, Inc via Getty Images)
How exactly that regulation would actually play out is the big question going forward.
On Wednesday, Powell noted that he “would support the views expressed” in a report by the President’s Working Group on Financial Markets, which called on Congress to develop a framework that would regulate stablecoin issuers much like traditional banks.
Other officials see it differently.
“I understand the attraction of forcing a new product into an old, familiar structure,” Federal Reserve Governor Christopher Waller said in November. “But that approach and mindset would eliminate a key benefit of a stablecoin arrangement — that it serves as a viable competitor to banking organizations in their role as payment providers.”
Grace is an assistant editor for Yahoo Finance.