WASHINGTON, DC — The crypto sector and some of Wall Street's financial giants were rushing to build out stablecoin infrastructure long before U.S. watchdogs instituted regulations, and Federal Reserve President Michael Barr took time Thursday to remind industry legal experts of the dangers posed by the nominally safe asset.
“Issuing liquid liabilities that are redeemable at par but backed by assets, even high-quality assets, that creditors may question makes private money more susceptible to risk,” Barr said at the DC FinTech Week event in Washington, noting that acceptable reserves such as uninsured deposits can pose a risk.
He served as the Fed's top financial supervisory authority as a former deputy governor, but resigned when President Donald Trump took office. In the digital assets sector, Barr has been seen as part of a “debanking” trend in which industry observers accuse banking regulators of encouraging banks to exit the business, with the Federal Reserve and other U.S. regulators recently reversing the more restrictive crypto policy stance they had taken during Barr's tenure.
But Barr remained on the seven-member Fed board, warning the agency that sets stablecoin rules, including his own, of the “long and painful history of private money created with inadequate safeguards.”
Mr. Barr pointed to the US experience with money market funds as an example, noting that reserve primary funds “lost big” (they lost $1 per share) in 2008 at the start of the global financial crisis, and that the recent coronavirus pandemic has put pressure on these funds again.
Despite the passage of the Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) Act, banking regulators have yet to create the necessary rules to implement it, leaving the industry in a kind of unregulated gray zone. As this situation continues, Tether's USDT, the world's leading stablecoin, is operating offshore and based on a preliminary approach that does not meet pending US standards (although Tether also plans to fully enter the US market).
“Stablecoin issuers traditionally retain the profits earned from the investment of their reserve assets and therefore have a high incentive to maximize the return on their reserve assets by extending the risk horizon as much as possible,” Barr noted. “Expanding the boundaries of allowable reserve assets may increase profits in good times, but risks creating a breach in confidence when the inevitable market stress occurs.”
“For the most part, I agree with everything he says,” said Corey Zeng, vice president and deputy general counsel for global policy at Circle, the issuer of the leading US-based stablecoin USDC.
“There's a lot of work that needs to be done in the rulemaking process,” a Circle official said at the same event in Washington, speaking immediately after Barr. “The last thing we want at Circle is a permissive environment.”
Governor Barr cautioned against including uninsured deposits as potential reserves for issuers under GENIUS, noting that they are a “key risk factor in the event of bank stress in March 2023.” He also pointed to so-called “overnight repos” as a component of reserves that “may include potentially volatile assets.”
During the 2023 tech-heavy U.S. banking crisis, Circle held 8% of reserves worth more than $3 billion in failed Silicon Valley banks, triggering a rush for USDC redemptions and temporarily dropping it from its dollar peg. Other high-profile stablecoins have also deviated from their pegs, such as Terra’s UST implosion in 2022.
Barr proposed the genius theory and suggested Bitcoin was to blame. BTC$110,901.10 Since it is legal tender in El Salvador, there may be an argument for Bitcoin repo as an eligible reserve asset.
Barr said federal and state regulators need to create “a comprehensive set of rules that can fill important gaps and ensure robust guardrails to protect stablecoin users and reduce broader risks to the financial system.”
Still, he cautioned about the risk of arbitrage, where issuers choose the easiest oversight agency, despite the intent of the GENIUS Act to be substantially similar, since issuers can be regulated across a wide range of agencies at both the federal and state levels.
During the 2008 meltdown, American International Group's high-risk financial products division was famously supervised by a weaker federal regulator, the Office of Thrift Supervision, while many of its other operations were supervised by various state regulators, resulting in risks that went unnoticed and ultimately threatened the broader financial system. (OTS has since disbanded.)
Read more: Tether CEO says he will follow GENIUS expansion into the US, Circle says it has already been decided
