Rumination on the President’s Working Group Report on Stablecoins and Tether

Recently the President’s Working Group released their Report On Stablecoins (archive) (my copy). Many of their conclusions were what I predicted, but it’s fascinating to read through it and see the risks they see and how they expect this to play out. It is certainly very clear that Tether has cast a long shadow over this industry.

The definitions are not the primary thing I find interesting in this document, it’s more the risks the outline and the potential solutions they seem to propose. Let’s jump to the risks:

The first risk described is about what would happen if a stablecoin lost value. We discussed this with Rohan Grey on Episode 16 of the Crypto Critics‘ Corner Podcast. Namely, this is potentially a risk that many ‘cash-like’ assets that are currently governed under money transmission statues suffer from. They act like money, but are not actually publicly guaranteed, so people are potentially harmed when they fail.

Right now for stablecoins I think that this is a relatively small risk because they are mostly localized to the crypto ecosystem and have little interaction with the economy more broadly. This is clearly changing though, we see both Paxos and Circle trying to get their coins integrated with the infrasturucture of major payments processors like Visa and MasterCard. The more broadly people expect these things to maintain their value the more important it becomes that they do that.

The dynamics they discuss for a run are not exactly how Tether at the very least operates. Tether makes it very clear in their terms of service that only verified users (think dozens not thousands) are able to redeem, that their redemption request can be denied or delayed, and that their redemption request can be serviced with assets other than cash. This dynamic potentially helps reduce the ‘fire sale’ potential of risk described in this report, and turns what we are actually seeing into more of a straight ‘peg’ failure as Tether stops redeeming so liquidity providers stop being willing to try to arbitrage Tether to a dollar.

The footnotes for this section make it seem to me that they have Tether on their mind. Each and every single one of these seems like they are directly describing the way that Tether currently functions. There is a lack of transparency into Tether’s assets. There is a question with Tether’s lending agreement about who has a claim. We know Tether is partially backed by volatile assets. Each and every single one of these comments seem focused around them understanding the risk that Tether poses.

The next section is entitled Payment System Risks and has several sub-risks which are worth taking a look at.

The first one: Operational Risk sounds like they are describing some of the issues that Tether had that we learned about in the recent CFTC settlement. Namely Tether often had incomplete records which resulted in mismatches between their internal records, the number of assets they held, and the number of Tethers in circulation. Going back even further to when there was an ‘unintentional payment’ when Tether was hacked, we saw Tether actually use their economic position to force a hard fork of the permissionless Omni network. This is not a reliable, safe, or predictable way to reverse payments, and so the inability to reverse payments can represent a challenge to the functioning of the issuer.

This is actually an issue with many of these networks and one that Satoshi discussed in the whitepaper. Namely, no settlement is 100% final, it is only probabilistically final and that probability depends on the nature and incentives of those securing the network. I don’t know that there’s necessarily a solution to this for most stablecoins unless they move to a different protocol/network/layer.

This section contains a couple different fears in it. Consider for example if Tether had all their commercial paper in the US market, and they were suddenly unable to continue serving that role in the market. The type of change in the commercial paper market and the potential loss of liquidity for the borrowers could have knock on effects across the economy. The other concerns seem more consumer focused, and center around the fact that the stablecoin issuer sits in a privileged position, has unique knowledge, and can choose to keep their network confined. However, this is also true for many other money transmitters like PayPal or Venmo.

Finally we get into what the PWG is recommending.

The first thing they recommend is that Congress pass legislation to help address these risks. I addressed this in my article that ended up predicting much of this. The two existing bills that potentially cover this would likely put much stricter regulations on stablecoin issuers and require approval, either from the Treasury, or the Fed, or at the very least the OCC. It would seem that the intention is to limit stablecoin issuance to OCC chartered and FDIC insured banks. This seems as though it would pose a meaningful challenge to Tether, and helps explain why Paxos already sought out an OCC charter (uninsured) and why Circle is trying to get a charter as well. They anticipated that they were likely going to need to meet a regulatory standard closer to banks than to money transmitters. There is also the possibility that if the final regulation ends up looking like The STABLE Act that this could end up applying to other money transmitters as well.

It seems very plausible to me that with the difficulty in getting an OCC charter and FDIC insurance that any legislation of this ilk would potentially box out many existing issuers and potentially leave it open to existing banks who already have those pieces.

The other part of their recommendation is for the CFTC and especially the SEC to use their authority to help regulate these. Gary Gensler has been laying the groundwork for this with his comments about ‘Stable-Value Coins’ and trying to tie them to his existing ability to regulate stable-value funds. I expect that non-approved and non-compliant stablecoins will find themselves increasingly hounded by regulators and likely find it much more difficult to continue their operations.

I also anticipate that there is a decent change (~50% I would say) that stablecoins end up pressured/forced to go KYC and whitelist only. It seems plausible to me that the Federal Government does not want people to be able to transact anonymously in the dollar, especially in a way that cannot easily be stopped and can exist at nearly any size. It seems likely to me that stablecoin issuers will be expected to crack down on that, but I could perhaps be wrong.

Overall, it seems clear to me that Tether was one of the animating forces behind this report and it seems extraordinarily challenging from my perspective for Tether to get an OCC charter and FDIC insurance. However, it also seems challenging to get a new piece of major financial regulation passed through Congress and so am curious to see exactly how these recommendations end up being implemented.

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