The Breakdown - Has the SEC Won the Battle to Regulate Stablecoins?

Starting point is 00:00:00 Perhaps no one has been a bigger beneficiary than the U.S., which jumped from something like 16.8% of global hash power before the ban to now more than 35%. How does that relate to the regulatory conversation here? Well, it means that U.S. regulation around Bitcoin mining would and will have a proportionally bigger impact now on the shape and the face of the Bitcoin industry. One major economic jurisdiction, going dark, as China has, raises the relevance of the decisions that are made in all the other jurisdictions in which crypto operates. Welcome back to The Breakdown with me, NLW.

Starting point is 00:00:36 It's a daily podcast on macro, Bitcoin, and the big-picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, October 26th, and today we are talking about news that suggests that the SEC may be winning the behind-the-scenes battle to regulate stable coins. Now, I just want to talk first about regulation and coverage of regulation on this show from a meta perspective. Anyone who's been listening frequently has seen this year that there is a ton of regulatory

Starting point is 00:01:14 focus. And here's why. I believe there is nothing more consequential to the next phase of the crypto industry than where the regulatory questions, particularly in the U.S., but in general around the world, land over the course of the next year or so. Let's take the example of China to make this point. When the first regulatory news started coming out of China in April and early May, it seemed like just more of the same.

Starting point is 00:01:42 It seemed like the People's Bank of China reinforcing previous policies that while, yes, limiting the way that people could interact with Bitcoin and cryptocurrencies didn't really say anything new. That, of course, changed towards the end of May when the vice premier of the CCP got involved and actually suggested what would become the China Bitcoin mining ban. That created a major shift in the global dynamics of hash power and Bitcoin network security. What's more, more recently, the Chinese trading ban has impacted significantly how Chinese citizens can interact with cryptocurrencies, as well as the global dynamics of exchanges that used to service those customers.

Starting point is 00:02:21 The point is that what seemed at first to be likely irrelevant ended up being supremely relevant in terms of the global makeup of the crypto community. But you protest, look at how Bitcoin hums merrily along. Who cares? Honeybadger certainly don't care. And that's true in the sense that the conversation about regulation and government involvement with this industry has never really been a question of whether governments could kill Bitcoin or kill crypto or not. That sentiment has always been absurd on the face of it.

Starting point is 00:02:49 But these sort of interactions with government aren't just about whether crypto lives or dies. It's about the context in which we all operate. What do I mean by that? Well, China's complete banning of both Bitcoin mining, as well as crypto trading, has changed the operating context for U.S. regulators in the U.S. crypto industry. And in some ways, it has raised the stakes pretty significantly. As I mentioned before, hash power shifted dramatically out of China after the Bitcoin mining ban. We saw basically a 50% drop in hash power within a few weeks of that ban's announcement, and over the last few months, as hashpower has come back online, it's come back online in different places. Certainly border countries to China, including Kazakhstan and Russia, have been big beneficiaries,

Starting point is 00:03:33 but perhaps no one has been a bigger beneficiary than the U.S., which jumped from something like 16.8% of global hash power before the ban to now more than 35%. How does that relate to the regulatory conversation here? Well, it means that U.S. regulation around Bitcoin mining would and will have a proportionally bigger impact now on the shape of in the face of the Bitcoin industry? What about regulation around the enterprises that build on and surround crypto? Well, again, one major economy, one major economic jurisdiction, going dark as China has, raises the relevance of the decisions that are made in all the other jurisdictions in which crypto operates. So again, the discussion of regulation as whether Bitcoin or crypto lives or

Starting point is 00:04:15 dies has always been silly, but I still contend that this next phase of the industry is going to be shaped by how the current regulatory discussions play out. And going back to China for a second, I do think that the actions of this year have now set the relevant context. The U.S. has jumped almost by accident into a potential leadership role by virtue of China's bow out. And in many ways, what the U.S. regulatory regime decides to do next will shape whether this polity builds on that lead or whether crypto and crypto companies and crypto entrepreneurs flow to other places that have a different take. Within that, one of the most important quandaries in the U.S. is, of course, who regulates what? For as long as I've been in this industry, there's been a classic

Starting point is 00:04:55 trope of discussion around U.S. regulation where the IRS sees crypto as property, the CFTC sees crypto as commodities, the SEC sees crypto as securities, and you get the joke. Everyone sees in the crypto industry their thing, the thing that they are tasked with regulating and keeping track of. So perhaps then it's not surprising that there has been behind the scenes something of a regulatory turf war. The CFTC has done the most actual regulating. Previous leaders in the CFTC have said that Ether and Bitcoin were in their estimation commodities. During the end of the Trump administration, the OCC, the Office of the Comptroller of the currency, which is the U.S.'s biggest bank regulator, emerged as a major player in the crypto

Starting point is 00:05:37 regulation space, particularly around stable coins. Brian Brooks, who was at the time running the and who was, of course, the former General Counsel at Coinbase and would go on to be very temporarily the CEO of Binance U.S. made it much easier for banks and financial institutions to interact with stable coins, which was obviously transformative in how those instruments were being used in both the crypto economy as well as finding their way into the traditional economy. The SEC has, of course, been for a long time, if you were just to look at Bitcoin and Crypto Twitter, the arch nemesis, right? The great villain of this industry. For the Bitcoin or specifically, that's been about their unwillingness to consider instruments like a Bitcoin

Starting point is 00:06:17 ETF for fear of volatility or market manipulation, and for everyone else, for other crypto industry folks, it's been because they seem so hesitant to even explore the possibility that crypto assets might have a different feel, flavor, texture, and ultimately regulatory need than securities that are regulated under 90-year-old statutes. Now, many in crypto thought for a while that the Gary Gensler-led SEC would be more friendly to crypto, given his background and interest in the crypto industry and in the blockchain space more broadly. But that friendly attitude has not always come to pass. It's been clear that this Gensler-led SEC has been trying to get more power relative to other peers in terms of what it's allowed to regulate. It has enlisted allies such as Elizabeth

Starting point is 00:06:58 Warren to try to make that case. And finally, the other actor that's worth noting is the Treasury Department. The Treasury Department under Janet Yellen emerged in a big way during the infrastructure battle as something of the Wizard of Oz when it comes to the Biden administration's take on crypto. They were the ones who were pushing Senator Rob Portman and his allies to get that crypto provision into the bill, and then were fighting against the amendments that would have made it clear who was and wasn't subject to the new definition of a broker, which caused so much consternation among this industry. Nidig, which is the sponsor of this podcast, is at Money 2020 this week. So if you're in the banking industry and you're thinking about

Starting point is 00:07:39 offering Bitcoin to your customers, bring your questions over to the Nidig booth. Throughout all this turf battle, the aspect of the crypto industry that has been perhaps most in focus is stable coins. And there are two major reasons for that. The first reason has to do with financial stability. Many regulators are worried about the opacity of the instruments that are actually used to back stable coins. In their heads, and sometimes not so in their heads, they're articulating what if scenarios. What if there is a run on stable coins at the same time as the value of the commercial paper backing one of them is collapsing? What would happen then? And what if those instruments are held by not just crypto players, but big opaque hedge funds?

Starting point is 00:08:24 And that causes a financial contagion, which spills over into other parts of the financial markets. We've discussed this before, but I think in general, regulators have two modes of concern. Mode one, which is sort of easy mode or calm mode, is investor protections. Mode two, which is the one that particularly folks who lived their way through and in some cases regulated their way through the great financial crisis, have much more anxiety about, is that financial stability piece? Now, on top of that, there is a concern that these instruments are two dollar-like, and that means inherently a loss of control. And I think this is where the Treasury Department comes into all of this. There already exists in the world today, an immense Euro-dollar market. These offshore dollar-like

Starting point is 00:09:07 instruments are basically used in substitution for dollars, but come from institutions that aren't regulated by U.S. financial regulators. Euro-dollar's already caused, problems from monetary policy. Basically, if monetary policy is in part about expanding and contracting the supply of money, then having more than half of the quote-unquote dollars out there be dollar-like things that aren't actually subject to that monetary policy, pretty well undermines the efficacy of that monetary policy. At least that's the thesis of some like Jeff Snyder, who basically argue that the reason that the Fed leans so hard into signaling, into press conferences, into marketing their policies, both the ones that they have and the ones that they think are coming,

Starting point is 00:09:49 is that their best tool is actually getting the market to behave as though they'd made a change rather than actually force the market to wait for the change to happen to make the shift. So, imagine this financial stability concern, coupled with the loss of control of monetary policy concern, but amplified by the entrance of a huge player. This is already concerning enough for regulators as they watch these stable coins go from a few billions of dollars to hundreds of billions of dollars, but what if someone like Facebook actually created an alt dollar? Remember, regulators' interest in this space really goes back to the announcement of Libra. That was, as I've said before, and I will inevitably say again, the starting

Starting point is 00:10:29 gun for this modern phase of regulatory interest in the crypto industry. All of that brings us to now. Yesterday, Bloomberg published a piece called The SEC Gets Path to Rain in Stable Coins as U.S. ways new rules. Wall Street's top watchdog won concessions in a debate between U.S. regulators over how to protect stable coins, clearing a path for the Securities and Exchange Commission to crack down on the $131 billion market. First paragraph. The Treasury Department and other agencies will specify in a highly anticipated report expected to be published this week that the SEC has significant authority over tokens like Tether, said people familiar with the matter.

Starting point is 00:11:05 The report will also urge Congress to pass legislation specifying coins should be regulated similarly to bank deposits, one of the people said, asking not to be named because discussions are private. So the article makes clear that SEC Chair Gensler has been pushing for this authority behind closed doors. He wants to be able to regulate stable coins now and not just to wait for Congress. And this gets to the key tension here. Earlier versions of this report apparently called for lawmakers to pass legislation to create

Starting point is 00:11:32 a new type of bank charter for stable coin issuers. but Gensler has been arguing that the SEC already has clarity to oversee these tokens when they're involved in investment transactions. There are definitely big differences of opinion here. In September, when Chair Gensler was testifying before the Senate, Senator Pat Toomey pushed him on whether he thought Stablecoins were securities. When Gensler said they very well might be, Tumie responded, to me a stable coin doesn't meet the second prong of the Howie test, that there has to be an expectation of profits from the investment.

Starting point is 00:12:03 If it doesn't meet the Howie Test, it looks to me like it's not a test. security. Now, maybe you've got a good argument for why some are and some aren't, but I think we need to have clarity on this. So again, what he's referring to, for those of you who haven't gone deep on this, the Howey Test is the commonly held standard for securities. It's from an old court case in the 30s, and there are four prongs of this so-called Howey test. For something to be a security, it has to have, one, an investment of money. Two, the expectation of profits. Three, that investment has to be in a so-called common enterprise. And four, it has to be based on the efforts of a promoter or third party, i.e. it's not based on the work you do yourself. So what Toomey is calling

Starting point is 00:12:39 into question is this expectation of profits. If a stable coin doesn't return any sort of interest or dividend, does it have the expectation of profits? On the flip side, one conception of how some are thinking about stable coins, including notably Fed Chair Jerome Powell in recent testimony, is akin to money market funds. From that loveliest of resources investopedia, quote, a money market fund is a kind of mutual fund that invests in highly liquid near-term instruments. These instruments include cash, cash-equivalent securities, and high credit rating debt-based securities with a short-term maturity, such as U.S. Treasuries. Money market funds are intended to offer investors high liquidity with a very low level of risk.

Starting point is 00:13:16 So that sounds similar, right? But again, what we get into is this issue of the expectation of profits. Money market funds often come with an interest rate while stable coins don't have an interest rate. They offer no promise of anything, so it's different, right? Maybe then it's just a bank account, right? I mean, an earlier version of this Treasury document apparently suggested a special type of bank charter for stablecoin issuers, so maybe that's the right framework. The point of all of this is that it's confusing, right? Let's try to wrap up by breaking apart some of the pieces of this.

Starting point is 00:13:45 First, in my estimation, it is somewhere between okay to actively good for this conversation to be happening. Stable coins are frankly a better market instrument than today's version of quote-unquote digital dollars. There should be a focus on figuring out how to make them work in the broader economy. What's more, from a crypto perspective, you don't have to be a tether-truther to think that the more transparent these things are with their proof of reserves, the better this industry is going to function long-term. Second, there is an interesting discussion to be had around defy and whether defy stable coins need to have a wholesale separation of labeling from fiat-backed or redeemable coins.

Starting point is 00:14:20 Adam Cochran tweets with the discussion around regulating stablecoins, I think we as a an industry have to get something clear. Stablecoin equals backed by one USD or other fiat held in trust. Anything else shouldn't be called a stable coin and wrapped up in those regulations. Third, there are real questions of jurisdiction here. In other words, what authority does the Treasury Department actually have to say that the SEC has authority here? If the SEC did have authority here, wouldn't they just already be asserting it? And if the Treasury Department was convinced that the SEC already had authority, why would they also be asking Congress to legislate as such. Ultimately, the Treasury Department is just providing their perspective, but ultimately

Starting point is 00:14:56 this is a question for lawmakers. Legislators imbue these offices of non-elected officials with their power. To me, I think this is going to be a pretty significant fight, and I'm not sure that Congress and the Senate is going to give up this authority easily. Fourth, all of this gets sum to the idea that you can't really have the stable coin regulatory conversation without having the larger digital dollar or central bank digital currency conversation. Rohan Gray, who many Many of us disagree with frequently around crypto and stable coins, but who is very consistent in his approaches and always articulate even if you disagree. In a recent interview with CoinDesk said when asked how he would approach Gary Gensler's role

Starting point is 00:15:34 specifically, quote, I would tell him to have a phone call with all of the banking regulators and tell them to do their jobs, because it shouldn't be his job to fix the stable coin industry. I think the securities regulation framework is already a losing framework. If you start at that point, you're at best getting a half loaf for putting it within a framework that is not actually able to deal with the major problems of the industry, which is that it's fueled by shadow money. Which gets back, of course, to what I was discussing before with Eurodollars and the recreation of the Eurodollar and shadow banking market on the internet. Fifth and finally, though, for me, anything is better than nothing. This weird legal gray area around stable coins

Starting point is 00:16:09 needs to be hashed out. They are a huge part of the liquid crypto markets. It would be a major short-term knock to the space for them to be regulated out of existence in some way. It would disrupt trading, it would potentially undermine a huge array of defy protocols, but ultimately we'd get along. We got along with crypto-native trading pairs before. Remember, Bitcoin went up so much in 2017 in part because you had to buy Bitcoin to buy into ICOs. People weren't really using tether yet for that type of purpose. In fact, I can see some sort of weird bifurcation if that worst-case scenario of these stablecoins being regulated out of existence coming to pass. Some would turn to Bitcoin or ether pairs for trading, but for a lot of the functionality,

Starting point is 00:16:47 particularly around defy, people would likely move to more exotic or even more questionable stables that are fully decentralized. This could ironically have the opposite effect that regulators want, which is the ability to reduce the risk of financial instability. All in all, though, it is time to get this sorted out for once and for all. Lucas Chiant tweeted, feels like we're getting close to some sort of clarity. Looking forward to the Treasury report, even more than being taxed on my unrealized gains. And boy, are those unrealized gains proposals something for another day. But for now, I appreciate you listening. I hope you're doing well. And until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Has the SEC Won the Battle to Regulate Stablecoins?

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