How should the United States regulate stablecoins?
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How should the United States regulate stablecoins?
Marcelo Prates, a speaker at Consensus 2024, suggested that we should pay attention to the regulatory experiences of international digital currencies in order to properly regulate stablecoins in the United States.
Navigating Web3 tides with focused insightsAuthor: Marcelo Prates
Translation: Mars Finance, MK
Recently, Hilary Allen, a law professor at American University, discussed on a podcast the risks that stablecoins might pose to the banking system and the broader public. She argued that stablecoins could undermine bank stability and potentially lead to government bailouts. Meanwhile, the U.S. Congress is pushing for federal regulation of stablecoins. Although legislation on stablecoins is unlikely to pass during a presidential election year, Allen remains concerned that such bills could encourage public support for stablecoins. She clearly stated that stablecoins "lack essential utility and should be banned."
Marcelo Prates is a speaker at Consensus 2024 and a seasoned expert in financial policy and regulation. He has written extensively on money, payments, and digital assets. In response to Allen’s concerns, he argues that such fears may only resonate with those opposed to competition and resistant to regulatory transparency. He counters that Allen's view reflects an exaggerated and unhelpful trend. In fact, stablecoins represent an advanced form of one of the most revolutionary innovations in finance over the past 25 years: electronic money issued by non-bank entities.
Since the early 2000s, the European Union has recognized the need to promote digital payments through faster and more cost-effective means. To this end, EU lawmakers established a regulatory framework for electronic money, enabling startups to fully leverage so-called fintech to offer payment tools in a regulated and secure manner.
The rationale is clear: banks provide multiple services and have complex structures, exposing them to higher risks and stringent regulatory requirements. As a result, digital payments via bank accounts are often cumbersome and expensive. The solution was to create independent licensing and regulatory mechanisms for non-bank institutions focused on a single service: converting customer cash deposits into electronic money usable via prepaid cards or digital devices for payments.
In practice, these e-money issuers operate similarly to banks but with greater focus. Laws require them to safeguard customer funds, ensuring that e-money balances can always be redeemed for equivalent cash, thus preventing devaluation. Because these institutions are licensed and regulated, customers can be confident their funds are safe—except in cases of serious regulatory failure.
Therefore, most existing stablecoins—that is, those backed by sovereign currencies like the U.S. dollar—actually possess certain characteristics of electronic money: what makes them distinctive is that they are issued via blockchain technology, not bound by national payment systems, and capable of global circulation.
Stablecoins are not dangerous financial products; rather, they are true “e-money 2.0,” with the potential to further fulfill e-money’s original promise: enhancing competition in finance, lowering consumer costs, and promoting financial inclusion. But to deliver on these promises, stablecoins do require appropriate federal-level regulation. Without federal legal standards, U.S. stablecoin issuers will continue to fall under state money transmission laws, which vary widely in design regarding customer fund segregation and reserve asset integrity, and are inconsistently enforced.
Drawing on decades of experience with e-money in the European Union and advanced reforms in other countries, effective stablecoin regulation should rest on three pillars: granting non-bank licenses, direct access to central bank accounts, and bankruptcy protection for backing assets.
First, restricting stablecoin issuance exclusively to banks is inherently contradictory. The essence of banking lies in holding public deposits, which are not always fully backed—a model traditionally known as "fractional reserve banking." This allows banks to extend loans without using their own capital.
In contrast, stablecoin issuers aim to ensure every stablecoin is fully backed by liquid assets. Their primary duty is to receive cash, issue an equivalent value in stablecoins, securely hold the received cash, and return it when users redeem their stablecoins. Lending is not part of their business model.
Stablecoin issuers are very similar to e-money issuers, both aiming to compete with banks—especially in cross-border payments. They are not meant to replace banks, nor should they evolve into banks.
This is why stablecoin issuers should receive specific non-bank licenses, just like e-money issuers in the EU, UK, and Brazil—licenses that are simpler and whose requirements (including capital requirements) match their limited activities and lower risk profiles. They do not need, nor should they be required to obtain, bank charters.
Second, to reinforce their low-risk status, stablecoin issuers should be allowed to hold central bank accounts for their reserve assets. Depositing customer cash in commercial bank accounts or investing in short-term securities is usually considered safe, but under stress conditions, both options can carry greater risk.
For example, U.S. stablecoin issuer Circle faced difficulties due to the collapse of Silicon Valley Bank (SVB), temporarily losing access to $3.3 billion in cash reserves held at SVB—nearly 10% of its total reserves. Affected by rising interest rates in 2022, several banks holding U.S. Treasuries suffered losses as bond prices fell, leading to liquidity shortages and difficulty meeting withdrawal demands.
To prevent problems in the banking system or Treasury markets from affecting stablecoins, issuers should be required to deposit their reserve assets directly into the Federal Reserve. This measure would effectively eliminate credit risk in the U.S. stablecoin market and enable real-time oversight of stablecoin backing—without deposit insurance or bailout risks, similar to e-money and unlike bank deposits.
Note that non-bank entities holding central bank accounts is not unprecedented. E-money issuers in countries like the UK, Switzerland, and Brazil already protect user funds directly through central banks.
Third, customer funds must be legally segregated from the issuer’s own funds, and if a stablecoin issuer fails (e.g., due to fraud or operational risk), customer funds should not be subject to any bankruptcy proceedings. With this additional layer of protection, stablecoin users could quickly reclaim their funds during liquidation, since general creditors of the failed issuer would have no claim over customer funds. Again, this is considered best practice for e-money issuers.
In the public debate over stablecoin regulation, these innovative approaches may impress audiences. However, for those who pay attention to details, balanced arguments grounded in successful global case studies and practical experience should carry far greater weight.
Based on decades of experience with e-money in the European Union and advanced reforms in other jurisdictions, effective stablecoin regulation should be built upon three pillars: granting non-bank licenses, direct access to central bank accounts, and bankruptcy protection for reserve assets.
First, limiting stablecoin issuance solely to banks is contradictory. Banking fundamentally involves holding public deposits that are not always 100% backed—what is traditionally called "fractional reserve banking." This enables banks to make loans without deploying their own capital.
For stablecoin issuers, the main objective is ensuring each stablecoin is fully backed by liquid assets. Their core responsibilities include receiving cash, issuing an equivalent amount in stablecoins, securely safeguarding the collected cash, and returning it upon user request. This does not involve lending.
Stablecoin issuers are essentially similar to e-money issuers, both aiming to compete with banks—particularly in cross-border payments. They intend to complement, not replace, banking functions, and certainly should not transform into banks.
That is precisely why stablecoin issuers should receive specific non-bank licenses, just like e-money issuers in the EU, UK, and Brazil—licenses that are relatively simple, with requirements (including capital requirements) aligned with their limited scope of operations and lower risk levels. They do not need bank charters, nor should they be required to hold them.
Second, to strengthen their low-risk standing, stablecoin issuers should be permitted to hold central bank accounts to store their reserve assets. Keeping customer funds in bank accounts or investing in short-term securities is generally seen as safe, but during periods of economic stress, both choices can entail greater risk.
For instance, U.S. stablecoin issuer Circle encountered challenges following the collapse of Silicon Valley Bank, temporarily losing access to $3.3 billion in cash reserves—nearly 10% of its total holdings. Due to rising interest rates in 2022, multiple banks holding U.S. Treasuries suffered heavy losses as bond prices declined, resulting in liquidity shortages and inability to meet withdrawal requests.
To prevent disruptions in the banking system or Treasury markets from impacting stablecoins, issuers should be required to deposit their reserve assets directly into the Federal Reserve. This step would effectively eliminate credit risk in the U.S. stablecoin market and allow real-time monitoring of stablecoin backing—without deposit insurance or bailout exposure, akin to e-money and unlike traditional bank deposits.
Notably, non-bank institutions holding central bank accounts is not unprecedented. In countries such as the UK, Switzerland, and Brazil, e-money issuers can directly protect user funds through central banks.
Third, customer funds must be legally separated from the issuer’s corporate funds, and if a stablecoin issuer fails due to operational risks (such as fraud), customer funds must remain outside the reach of any bankruptcy proceedings. This additional safeguard ensures that stablecoin users can swiftly recover their funds during liquidation, as general creditors of the failed issuer cannot lay claim to customer deposits. This approach is regarded as best practice among e-money issuers.
In the public discourse on stablecoin regulation, these innovative measures may leave a strong impression. Yet, for detail-oriented observers, balanced arguments rooted in global success stories and accumulated experience should prove far more persuasive.
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