Stablecoin hearings are full of controversy, and the two major players in USD go in opposite directions

Produced by | Bai Ze Research Institute

Last week, the crypto industry had its first congressional hearing, "Digital Assets and the Future of Finance: Understanding the Challenges and Benefits of Financial Innovation in the United States", hosted by Maxine Waters, chair of the House Financial Services Committee, and attended by more than 50 members of the committee, who had the opportunity to express their own views on the crypto industry and regulation. The crypto representatives attending the hearing included executives from Circle, FTX, Bitfury Group, Paxos, Stellar, and Coinbase, who defended the crypto industry at the meeting and explained to lawmakers the promising future of crypto technology.

Through online live broadcast, many members of the crypto community believed after the hearing that lawmakers were much less hostile to cryptocurrencies than before, and the friendly tone between executives and lawmakers surprised people. Sam Bankman-Fried, CEO of FTX, said in an interview: "Congressmen are very receptive, which is exciting."

As a continuation of Congress’ dialogue with the crypto industry, yesterday, the Senate Banking, Housing, and Urban Affairs Committee held a hearing on stablecoins, chaired by committee chairman Sherrod Brown and Senator Patrick J. Toomey, with the theme of “Stablecoins: How do they work, how are they used, and what are their risks?”

Those present at the hearing were:

-Alexis Goldstein, director of financial policy at the Open Markets Institute.

- Jai Massari, crypto-focused attorney and partner in Davis Polk’s Financial Institutions Group.

-Dante Disparte, chief strategy officer and global head of policy at stablecoin issuer Circle.

-Hilary J. Allen, professor at American University Washington College of Law.

The focus of this hearing is on the safety and legality of stablecoins. As Committee Chairman Sherrod Brown pointed out in his opening remarks, as the crypto market continues to grow, recently surpassing a total market capitalization of $3 trillion, this big number brings great hope. However, the wild price volatility and high transaction fees of many cryptocurrencies make them unusable for payments, and stablecoins should solve this problem. Cryptocurrency advocates believe that stablecoins are superior to real dollars because they are decentralized and transparent, but I believe that stablecoins are neither.

Last month, the Banking Commission sent letters to several stablecoin issuers, including Coinbase, Gemini, Circle, Paxos, TrustToken, Centre, Binance US and Tether. In the letter, the Commission asked the issuers to provide stablecoin purchases, minting processes, restrictions, and issuance and redemption data, and summarize their own company's redemption mechanism (including its conversion into US dollars).

At the hearing, Brown revealed that the responses from stablecoin issuers were not very clear, making it difficult for lawmakers to believe that most ordinary customers could get more protection after purchasing stablecoins.

“Cryptocurrencies may crash along with the crypto market, plummeting nearly 30%, one day history tells us that we should worry when any investment becomes so detached from reality, see the 1929 stock market crash. So far, what’s happened in crypto has stayed within crypto. We saw this with Dogecoin, a satirical cryptocurrency that was suddenly worth billions when a tech billionaire tweeted about it. But stablecoins create a very real link between the real economy and this new fantasy economy.”

“I have heard many times from experts in the crypto industry that there should not be too much regulation, it will hurt innovation, the free market will solve all problems, and the United States needs to be globally competitive. However, without order and rules, innovation will only be exposed to potential dangers.”

Although the speeches of the representatives of all parties in this hearing were short, only 2 hours, they were more controversial than the 5-hour crypto hearing last week. At the hearing, critics and defenders of stablecoins expressed their opinions and put forward a series of conflicting views. Below, Bai Ze Research Institute has selected the important speeches of the representatives of all parties.

Senator Patrick J. Toomey

As another moderator of this hearing, Toomey has a different view from the chairman. He believes that stablecoins can speed up payments, especially cross-border remittances, they can reduce costs, and they can help combat money laundering and terrorist financing through immutable and transparent transaction records.

Toomey agreed that stablecoins need a new regulatory regime, “Regulation of stablecoins should be strictly tailored and coordinated in the United States and globally. In addition, regulation should seek to maintain the United States’ international competitiveness. Regulators should recognize that privately issued stablecoins will not undermine the international status of the dollar, but well-managed stablecoins can actually support it. Finally, regulation should allow stablecoins to interoperate with the current financial system.”

Before the hearing, Toomey published the principles for stablecoin regulation on the Banking Commission’s website, but it was the exact opposite of the “Report on Stablecoin Regulation” released by the President’s Working Group on Financial Markets last month: “The issuance of stablecoins should not be limited to insured depository institutions.”

Toomey proposed the following principles that will influence his upcoming stablecoin legislative framework:

Stablecoin issuance should not be limited to insured depository institutions.

o First, the business model of stablecoin issuers is different from that of traditional banks.

o Second, requiring all stablecoin issuers to become banks would stifle innovation.

o Third, regulation of payment activities should create a level playing field.

Stablecoin issuers will choose from at least three regulatory regimes depending on their business model:

o Operate under traditional banking charter;

o Obtaining a special purpose bank charter designed for stablecoin providers under the new legislation;

o Register as a money transmitter under existing state systems and as a money services business under FinCEN’s federal system.

All stablecoin issuers should adopt clear redemption policies, disclose requirements regarding the assets backing the stablecoins, and potentially meet liquidity and asset quality requirements.

Commercial entities should be eligible to issue stablecoins as long as they comply with these regulations.

Non-interest bearing stablecoins are not necessarily regulated like securities.

Regulation should protect the privacy, security, and confidentiality of individuals using stablecoins, including by allowing customers to opt out of sharing any information with third parties.

Financial supervisory requirements under the Bank Secrecy Act should be modernized in light of emerging technologies such as stablecoins, including for existing financial institutions.

Jai Massari

Jay Marsali, a partner in Davis Polk's Financial Institutions Group and a lawyer well-versed in the crypto industry, supports reasonable regulation of stablecoins.

“Stablecoin issuers should be limited in the types of assets they hold in reserve to ensure the liquidity of those reserves,” Massari said.

She also noted that issuers should comply with existing federal rules regarding monitoring and preventing illicit financial activity such as money laundering, and that the opaque nature of the cryptocurrency and decentralized finance (DeFi) markets is a major issue in the space.

The thorny question, however, is whether stablecoin issuers should be regulated as insured depository institutions (i.e., like regular banks) or should be registered under special banking charters tailored to their specific business models. The President’s Working Group on Financial Markets, the Biden administration’s lead on stablecoins, has called for this approach. But critics of this approach emphasize that stablecoin issuers fundamentally do not operate like banks because they are not allowed to use leverage to lend money.

“Stablecoin issuance is different from traditional banking, so it doesn’t make sense in my opinion to overlay the regulations of a normal bank on top of a stablecoin issuer.”

Dante Disparte

Dante Diparte, chief strategy officer and global head of policy at stablecoin issuer Circle, told lawmakers that stablecoins are steadily growing in their role as a payment method, especially among traditional financial institutions. Visa recently enabled settlement of USDC, and Circle recently formed a partnership with MoneyGram to process global cash transfers.

Additionally, he believes that decentralized finance (DeFi) will enable faster, cheaper, and more transparent transactions, echoing arguments made during last week’s crypto hearing.

“I think it has profound implications for America’s national interest and our public interest in a new, always-on economy where people have choices about how they move their money,” Disparte said. “Our financial needs and our money don’t need a bank holiday.”

Disparte did not deny that some blockchains are currently slow or costly, but urged lawmakers to be hopeful about innovation in areas that speed up transactions. “Early blockchains are a bit like dial-up internet, and because current experience with some early blockchains may be a bit slow and a bit costly, the argument to ban stablecoin innovation ignores the fact that innovation has not stagnated.” (Response to Goldstein)

Alexis Goldstein

Alexis Goldstein, director of financial policy at the Open Markets Institute, disagrees that stablecoins can speed up payments, arguing that they are inefficient in payment settlements due to high fees, which disproportionately affects low-income communities.

Citing a recent report from the World Economic Forum, Goldstein said: “Stablecoins are not good for financial inclusion because they face the same or higher barriers as existing financial options, including the need for an internet connection via a smartphone. As someone who enjoys sending [stablecoins] both personally and at work, especially as the Ethereum blockchain gets crowded, it often makes Western Union look cheap.”

She added that any speed advantage is lost whenever users exit a cryptocurrency exchange to transfer coins from one wallet to another or exchange for fiat currency.

“I do think that secondary markets, and DeFi in particular, remind me of the over-the-counter derivatives markets during the financial crisis,” Goldstein said, referring to his financial experiences in 2007 and 2008.

In addition, Goldstein criticized Circle's agreement with Coinbase in the hearing statement, which allows Coinbase to "profit from USDC." The statement reads: "These profits may be substantial because USDC has achieved rapid growth in 2021. Coinbase does not charge users to buy USDC, but it charges them to buy competing stablecoins such as Tether (and other crypto assets), which raises the issue of price discrimination and turning customers to USDC."

Hilary J. Allen

Hilary Allen, a professor at American University Washington College of Law, agrees with Massari that stablecoins need reasonable regulation, but she is an opponent of cryptocurrencies.

She believes that stablecoin issuers should not be regulated like banks, but for different reasons. In her view, treating them like banks would further legitimize stablecoins and, by extension, the entire DeFi space, which could pose a systemic threat if left unchecked.

“I think DeFi can’t grow without stablecoins, and at the moment, I think DeFi is contained to the point where it doesn’t affect financial stability. But if it grows, I think DeFi will be a real threat, especially if it becomes intertwined with our traditional financial system.”

Therefore, until the risks of DeFi are better understood, stablecoins will only fuel a massive unregulated market.

The two stablecoin giants have very different journeys

On the same day of the hearing, Circle announced that it had launched the USDC stablecoin on the Avalanche blockchain network. Circle said that USDC's support for Avalanche can enable more developers to build eco-friendly decentralized financial (DeFi) applications.

USDC is currently deployed on the Ethereum, Solana, TRON, Stellar, Avalanche, and Hedera blockchain networks.

At the hearing, Circle's Disparte and Massari jointly proposed a stablecoin regulatory framework that would limit the types of reserve assets that stablecoin issuers can hold and establish a universal system for minting and redeeming stablecoins.

On the same day, Tether, the issuer of the leading stablecoin USDT, faced a class action lawsuit.

According to official documents, two plaintiffs in the U.S. District Court for the Southern District of New York, Matthew Anderson and Sean Dolivka, accused Tether of misleading consumers about the properties of the USDT token; they also accused Tether of "illegal and deceptive misrepresentations" that USDT is not a complete stablecoin and is not backed one-to-one with the U.S. dollar; they also accused Tether of maintaining less than 4% of cash reserves and not undergoing professional audits despite promising transparency to consumers. It also claimed that Tether breached the contract, which qualifies the plaintiffs and members for "compensatory and consequential damages."

In response, Tether slammed the lawsuit as “nonsense” and a “copycat,” which was filed by two plaintiffs and their law firm who want massive damages for “unsubstantiated claims.”

Tether is often sued for its mismanagement of funds and misleading users about its USDT reserves. In early September this year, the United States District Court for the Southern District of New York dismissed a class action lawsuit, in which five cryptocurrency traders formed the plaintiffs, accusing Tether of being deceptive, market manipulative and anti-competitive, causing financial losses after purchasing tokens at high prices in 2017.

It is worth noting that Tether did not attend last week’s cryptocurrency hearing or this stablecoin hearing.

According to data from The Block, while USDT is still the dominant stablecoin, USDC has become one of its fastest-growing competitors, accounting for nearly one-third of the total global stablecoin supply.