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3 February 2022: Stablecoins have been a center focus of federal investigations recently as adoption of different coins like US Dollar Coin (USDC) have exploded since 2020. Stablecoins not only provide a "safe haven" for investors during times of extreme market volatility, but they also dominate overall transaction & trading volume.
Despite their obvious benefits, concerns have grown over their use as calls of foul play grow. At the center of these controversies is Tether, whose executives have fallen under investigation for bank fraud themselves.
Any regulations concerning stablecoins will undoubtedly have significant ramifications for the crypto-economy overall. In the latest Federal Reserve report that was released, the researchers outline three different scenarios in which stablecoin regulation and adoption could occur.
The three proposed scenarios are the following:
- Narrow Banking - This scenario is essentially the creation of a de facto central bank digital currency (CBDC). All physical cash would effectively become tokenized while stablecoin issuers would be required to hold their reserves with the central bank itself. This would help guarantee the peg of stablecoins by turning them into state-controlled digital currencies.
- Two-tiered Intermediation - This scenario would require stablecoins to hold deposits at accredited commercial banks. Those banks could then lend these deposits out under the guidelines of fractional reserve banking. Doing this would require stablecoins to be treated the same as other currencies.
- Security Holdings - This scenario is the approach most major stablecoins operate today. Stablecoin issuers would simply have to hold cash-equivalent securities for their reserves. This can be anything from cash, commercial paper, bonds, etc.
The researchers in the report come to the conclusion that two-tiered intermediation could "support both stablecoin issuance and maintain traditional forms of credit creation", effectively leading to no disruption in the traditional financial system. In contrast, the narrow bank approach is cited to "bring the most stability but at the potential cost of credit disintermediation."
The Potential Implications of Stablecoin Regulation
It is important to discuss both the benefits of such regulation as well as the negatives. Generally, the topic of regulation is a double-edged sword.
To begin, regulation under the two-tiered intermediation scenario would establish far more transparency in stablecoins, allowing for a reduction in fraudulent activity. This includes full audits, more transparent reserves, and increased stability of the stablecoin peg. This helps to avoid depegging events or significant price fluctuations during demand shocks.
In addition to increased stability, expanded use cases through commercial banks would create new, potentially significant adoption channels for the crypto-economy. This would create new on ramps for traditional financial options and digital financial options to blend.
Households and businesses could hold stablecoins instead of cash, taking advantage of faster settlement times and lower fees. This even has a positive effect for banks as their reserves would either remain neutral or expand.
original motivation for the creation of Bitcoin & the crypto-economy was to build an alternative to the traditional financial system, not become an extension of it. In fact, let us not forget that Bitcoin was created in response to the 2008 Global Financial Crisis
If stablecoins are backed through commercial or central banks, increased stability comes at the immediate cost of decentralization. Not to mention that this would also mean stability becomes reliant on the solvency of commercial banks - the very same banks who created the 08 crisis.
Ultimately, it is clear that the key takeaway from the discussion in the FED research report is to quantify the FEDs desire to limit the impact and potential disruption of the rapidly growing crypto space.
The Takeaway
If state-regulated stablecoins remain the dominant source of volume within the crypto-economy, decentralization and true separation from the traditional banking system are nullified.
There is zero incentive for abuse and corruption to stop in the traditional system as central control over a majority of the volume remains in what is basically fiat. Abuse will only stop with accountability of which is created through a legitimate alternative financial system.
If it is possible for financial capital to leave the system altogether, this creates the incentive for large institutions to act in the best interest of the majority as not doing so could lead to that capital moving to the alternative - in this case crypto / DeFi.
The importance of stablecoins potentially serving as major on ramps to the crypto-economy should not be overlooked however. As the research study suggests, more stability and transparency in stablecoins creates new adoption channels - some of which may prove to be significant in reaching real mainstream market adoption.
Therefore, a balance is needed to allow channels of adoption to expand without compromising the ability of the crypto-economy to remain functionally independent and decentralized. For the crypto-economy to become a legitimate alternative to the traditional banking system, decentralized units of account are needed alongside centralized stablecoins.
An example option here is Ampleforth (AMPL) - the only decentralized, algorithmic unit of account so far to always return to its price target without collateral.
Importance of Decentralized "Safe Havens" to Counter Stablecoins
Significant adoption of a decentralized unit of account like AMPL within the crypto-economy allows for the adoption on ramps of stablecoins to remain without compromising the decentralization or stability of the space.
Without a decentralized unit of account, commercial banks could actually benefit from disruption in the crypto space because it would result in their reserves increasing due to stablecoin purchases from those looking to escape volatility. This almost incentives risky behavior as volatility generates expanded lending power and higher returns.
The idea here is that significant utilization of something like Ampleforth creates an option for capital to completely escape influence of the traditional system, helping to establish accountability in both systems.
The same benefits of stablecoins - stability, “safe haven” from volatility, etc. - would be held in the decentralized money, but it would be just that: decentralized. DeFi is nothing more than doublethink if it is primarily reliant on state-regulated money.
The takeaway of the FED research report comes down to this simple problem - through what regulatory practices can disruption to the traditional financial system be minimalized?
Minimal disruption removes any and all incentives to stop fraudulent activity and corruption which led to the development of Bitcoin in the first place.
Ultimately, the future of the space comes down to what the investors and adopters of the crypto-economy choose to transact in. If significant use of stablecoins like Tether and USDC continue even under regulation, higher stability will be reached at the expense of true separation from traditional banks.
However, if decentralized units of account like AMPL grows in significance, a better balance is achieved between the growing crypto-economy and traditional economy. Balance is key to accountability - the only way to always incentivize financial practices that benefit the majority to avoid any loss of capital (or more accurately, power).
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