Difficulties

Inherent financial risks with blockchain

 Stablecoins run on decentralized blockchains and smart contracts. The software

for the various layers of operation could have flaws or could be vulnerable to
attack. The largest stablecoins run on multiple blockchains but are separate and
distinct tokens on each such blockchain. That means risks associated with the
integrity and reliability of the blockchains and software are multiplied.
 In addition, a stablecoin could become too large in relation to the capacity of
the blockchain itself.

Systemic Risk
 <→ HK reading
 There's a concern among regulators about the ability to redeem stablecoins. If
there's no confidence in redemption, that can cause consumers harm, And that
can create a financial stability risk if the stablecoin is large or if it creates a
contagion or a domino effect if one were to fail."
 Increased used of stablecoin could reduce deposits, limiting the amount of
money in the banking system 
 Treasury Report: high potential for payment related stablecoins to cause
destabilising runs, disrupt payment systems, and concentrate economic power
 HKMA P.23: concern that stablecoins could supplant some unstable fiat
currencies

Illicit Financing
 ML/TF concerns of prone to cyber attacks, used as payment for ransomware
hostage, may be held and changed hands anonymously cross borders
 different entities may be associated with different steps in the stablecoin
process making it harder to capture them under current regulation
 The FATF has found that so-called stablecoins share many of the same
potential ML/TF risks as some virtual assets, in virtue of their potential for
anonymity, global reach and layering of illicit funds. Depending on how they
are designed, they may allow anonymous peer-to-peer transactions via
unhosted wallets. These features present ML/TF vulnerabilities, which are
heightened if there is mass adoption. When reviewing current and potential
projects, so-called stablecoins appear better placed to achieve mass-adoption
than many virtual assets, if they do in fact remain stable in value, are easier to
use and are under sponsorship of large firms that seek to integrate them into
mass telecommunication platforms.
  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.

Financial Inclusion
 Slow and expensive payments burden low income people in many ways. Banks
handle the vast majority of U.S. dollar payments in a safe and well-tested
manner. But the system is characterized by relatively high cost, weak
competition, and insufficient innovation. Americans pay significantly more
than Europeans for payment services, particularly because of high fees paid for
credit cards. The system is also slow relative to real-time payments increasingly
common in other countries.
 The real issue is increasing competition—either from new private sector
entrants or effectively from the government through a CBDC. Regulators can’t
fix the system’s deficiencies as they move to regulate stablecoins, but they can
frame the issue in that context. The big picture is that stablecoins have
grown enormously because they offer distinct advantages in speed.  Banks
have not sufficiently modernized the system nor addressed financial
inclusion.  Changes in regulation may be needed to permit greater
competition and facilitate innovation. 
 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
 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.

How can stablecoin be regulated?

 Regulation in the traditional finance world focuses on issuers and

intermediaries.
o Our securities laws regulate issuers of securities and securities
intermediaries that facilitate securities transactions.
o Our commodities laws regulate intermediaries that facilitate transactions
in commodity derivatives and entities that offer commodity derivative
contracts.
o Our financial regulatory laws, such as the Bank Secrecy Act (the
"BSA"), apply to financial institutions broadly and require transaction
monitoring, reporting, and recordkeeping in a variety of contexts.
  All of these frameworks are implicated by developments in stablecoin.

What should stablecoin be regulated as?

 The FSOC has broad powers to get information from institutions engaged in an
activity that it has reasonable cause to believe meets the standard for such a
designation. That type of inquiry is much needed given the lack of transparency
about stablecoins.
o Under Title VIII, the FSOC has designated two operators of business
payment systems as systemically important financial market utilities, but
it has never designated an activity generally nor an entity engaged
primarily in retail payments.
o The PWG report is a step toward the Financial Stability Oversight
Council's classifying certain nonbank stablecoins as systemically
important financial institutions under the Dodd-Frank Act.That
designation would signal that stablecoin issuers are likely to become
large or influential enough to pose a risk to overall financial stability if
they were to fail. SIFIs are subject to consolidated supervision by the
Federal Reserve and face enhanced requirements to guard against
liquidity risk that are in line with federally regulated banks. 
o The FSOC may also designate nonbank stablecoin issuers as financial
market utilities under Dodd-Frank. FMUs are also subject to heightened
supervisory provisions in line with banking, including providing advance
notice of changes to operations that could affect their risk. The
organizations typically designated as FMUs move massive volumes of
payments,
o Classifying nonbank issuers of stablecoins as FMUs or SIFIs would
subject them to banklike regulations, but without access to FDIC deposit
insurance, access to the Federal Reserve's discount window, the Fed
Account Service and other services
 Should be regulated as securities: One reason existing stablecoins do not pass
interest earned on reserve assets through to coin holders is to avoid being
classified as securities and becoming subject to SEC regulation. If Congress
defined stablecoins as securities it would close this loophole.
o Should not be  regulated as securities: They are fundamentally payment
devices and not investments. Classifying them as securities would also
appear to pre-empt a systemic importance determination as part of the
payment authority given by Dodd Frank since the definition of
“payment, settlement and clearing activity” for purposes of FSOC’s
 jurisdiction excludes “any offer or sale of a security under the Securities
Act.”
 Regulators should require that reserves are invested in bank deposits,
Treasuries, or other safe, liquid assets, and that there are liquidity requirements.
If the Federal Reserve were to broaden who is eligible for a master account,
then stablecoin providers which are not banks could park reserves at the Fed, an
option some would argue is even safer because it would avoid the operational
risk of a particular bank.  
o Regulators should require a capital buffer even if reserves are invested in
cash or other safe assets. That is because capital can protect against other
types of losses, such as operational ones.
o Regulators may also want to ban the payment of interest to discourage
users from maintaining large deposits. That plus requiring reserves to be
invested in cash or other safe assets would likely mean that stablecoins
would be attractive only as payment instruments, not as investments.
o A prohibition on interest would put stablecoins at a disadvantage relative
to bank deposits if interest rates rise, but regulators might desire that in
these early days of the industry. Compliance with “know your
customer,” anti-money laundering, and other laws combatting the
financing of terrorism is crucial.
 CFPB: 
o As the Report on Stablecoins notes, established players with large user
bases could accelerate the adoption of stablecoins as a payment device,
and lead to an excessive concentration of market power.
o Second, the CFPB is actively monitoring and preparing for broader
consumer adoption of cryptocurrencies. Currently, stablecoins are
primarily used for speculative trading in cryptocurrency markets.
However, stablecoins may also be used for and in connection with
consumer deposits, stored value instruments, retail and other consumer
payments mechanisms, and in consumer credit arrangements. These use
cases and others trigger obligations under federal consumer financial
protection laws, including the prohibition on unfair, deceptive, or
abusive acts or practices.

How is regulation in the US currently happening?

 One focus of the SEC’s enforcement actions has been DeFi arrangements. For
example, according to Coinbase,24 it received from the SEC last summer a
Wells Notice related to its crypto lending program called Lend. In response to
allegations made by the SEC, Coinbase revised its plans to launch the program.
 o The SEC also recently settled an enforcement action with a DeFi
platform and its two individual promoters. The SEC alleged they failed
to register their offering, which raised $30 million, and misled
investors.25 The SEC’s action resulted in disgorgement of $12.8 million
and penalties of $125,000 each for the two individuals.
 The CFTC has regulatory authority over the trading of derivatives (swaps,
futures, options on futures, and commodity options) on a broad range of
underlying or reference assets, except for certain securities-related derivatives
that are jointly regulated by the CFTC and the SEC, and other securities-related
derivatives that are regulated by the SEC alone. 
o The CFTC also has anti-fraud and anti-manipulation enforcement
authority with respect to the sale of commodities in the US cash
markets.11 Specifically, Commodity Exchange Act (CEA) Section 6(c)
(1)26 broadly prohibits any person, directly or indirectly, from using or
employing, or attempting to use or employ, in connection with any
contract of sale of any commodity in interstate commerce, any
manipulative or deceptive device in contravention of any CFTC rule.
CFTC Rule 180.127 prohibits “intentionally or recklessly … mak[ing]
any untrue or misleading statement of a material fact or … omit[ting] to
state a material fact necessary in order to make the statements made not
untrue or misleading” in connection with any swap or with a contract of
sale of any commodity in interstate commerce, or for future delivery on
or subject to the rules of any registered entity.
 On October 15, 2021, the CFTC issued an enforcement order against Tether
Holdings Limited and certain of its affiliates (Tether), issuers of a US dollar
tether token (USDt).28
o In particular, the CFTC claimed that Tether had intentionally or
recklessly made untrue or misleading statements of material facts and
omissions of material facts, including representations that Tether would
fully back USDt with fiat currency in accounts held in Tether’s own
name; omissions regarding the actual backing of USDt including non-
fiat assets, such as commercial paper; representations that Tether would
undergo regular professional audits; and omissions regarding the pre-
disclosed timing of one of the two reviews that Tether did undertake. 
o In the Tether Order, the CFTC made clear its view that the USDt, “a
virtual currency stablecoin, is a commodity and subject to applicable
provisions of the [CEA] and Regulations.”29 The CFTC is apparently
staking its claim to anti-fraud and anti-manipulation enforcement
authority over at least some cash market transactions involving virtual
currency stablecoins. 
  SEC Chair Gary Gensler, only one month prior to the issuance of the Tether
Order, had mentioned in a Senate Banking Committee hearing on September
14, 2021, that stablecoins “may well be securities” under US securities laws.
The CFTC’s and the SEC’s both asserting authority over different stablecoin
activities is a reminder that the activities in which a stablecoin issuer, wallet
provider or intermediary engages may give rise to compliance obligations
under the federal securities laws and the CEA – as well as US banking laws, the
Bank Secrecy Act/AML/CFT rules and consumer protection laws.
 On November 18, 2021, the OCC issued Interpretive Letter 1179, which
clarifies the circumstances under which national banks and federal savings
associations (Banks) may engage in certain cryptocurrency, distributed ledger
and stablecoin activities.30 Interpretive Letter 1179 makes clear that the
cryptocurrency activities addressed in three prior interpretive letters issued in
2020 and 2021 (Prior Interpretive Letters) “are legally permissible for a Bank
to engage in, provided the Bank can demonstrate, to the satisfaction of its
supervisory office, that it has controls in place to conduct the activity in a safe
and sound manner.”31

State

 “Wyoming Stable Token Act.” If signed into law, the bill would authorize the
treasurer to issue a U.S. dollar-pegged stablecoin redeemable for fiat held in an
account by the state.
o Wyoming has often been at the forefront of a state-centered approach to
crypto regulation with many pieces of legislation seemingly favorable to
the space and a U.S. Senator who holds Bitcoin (BTC), Cynthia
Lummis. Kraken became the first crypto business to receive a Wyoming
bank charter in September 2020, with the State Banking Board later
approving a charter for Avanti.
o Was vetoed: In a letter to Secretary of State Ed Buchannan, Gordon
acknowledged the act had “good ideas” and was in keeping with
Wyoming’s foray into cryptocurrency — in 2020 Wyoming became the
first U.S. state to approve a banking charter for an institution handling
digital assets. However, Gordon said there had been not been enough
time to consider the implications of the act, and that already
overburdened state treasurers might be ill-equipped to handle it. 
o Gordon said Wyoming also needed more information technology staff
dedicated to the security and dispensation of the technology, and a
greater legal assessment of the currency’s use in the currently murky
regulatory environment.
  Under the Arizona proposal, the state would recognize the most popular
cryptocurrency, Bitcoin, as legal tender. 
o The Arizona bill, according to Grey, faces a greater risk of being deemed
unconstitutional because it seeks to designate a cryptocurrency as “legal
tender.” This has broader implications than the Wyoming proposal,
which is limited to tax payments.

End with Yellen quote