The Breakdown - Stablecoins in the Hot Seat as SEC Investigates Circle

Episode Date: October 6, 2021

This episode is sponsored by NYDIG. On today’s episode, NLW homes in on recent reports surrounding the Biden administration's plans for stablecoins. A new report from the Wall Street Journal says there is a debate between using the Financial Stability Oversight Committee to add new rules for stablecoins and to regulate stablecoin issuers like banks. The crypto industry’s big question seems to be: Will crypto institutions be allowed to play, or will big banks shove them out?  NYDIG, the institutional-grade platform for bitcoin, is making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers, to offer Bitcoin. Learn more at NYDIG.com/NLW. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Only in Time” by Abloom. Image credit: kentoh/iStock/Getty Images Plus, modified by CoinDesk.

Welcome back to The Breakdown with me, NLW. 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 5th, and today we are talking about stable coins in the hot seat. And let me just reiterate what I've said before about stable coins and D5. It seems very, very clear to me. from all of the machinations of government, the bluster of political opponents, that it is these assets, stablecoins specifically, lending products built on stable coins, DFI, etc., that are going to arouse the greatest regulatory ire in the months to come. That doesn't mean that assets like Bitcoin

and Ethereum won't get some scrutiny, but it seems very clear to me that in particular, these new novel areas of finance are likely going to be the big focus. Now, for our specific discussion today, I want to go back to earlier comments from Elizabeth Warren. Speaking to Bloomberg at the beginning of August, she said regarding crypto and stable coins, the bigger it gets and the more it stays outside the financial system, something goes wrong. There's a run on crypto, there's a problem elsewhere in the economy. I don't want the U.S. taxpayer to be the one that gets called on to back this up. In other words, Warren is saying, I don't want to have to bail out crypto. It needs to be said right up front that this logic is truly absurd. Crypto is the most volatile industry in the world.

We routinely see massive, gut-wrenching drops. Sometimes those drops just continue for months, if not years at a time. People get washed out regularly, liquidated entirely, forced to go back to square one, and no one asks for a bailout. What's more, most of the money, most of them, systems handle these chaotic moves, if not perfectly, then at least in a way that continues to improve. The point is that everyone knows these table stakes. This is just a part of what the crypto industry is. This is a part of what unfettered capitalism is. Now, when it comes to the idea of a run on stable coins, well, let's look at what evidence we have so far. China has, of course, been on a mission to well and truly ban crypto this year. First, it was the mining ban that was

announced in May and implemented over the course of the summer, and then over the last couple weeks, it's been this crypto trading ban that has firms actually starting to deny Chinese users entirely to remove existing Chinese users from their platforms, to move employees out of China for fear of their prosecution, etc, etc. When this trading ban was announced, people genuinely started to try to get out of these markets. This is exactly the type of situation you would imagine producing one of these bank runs, these crypto bank runs. that these politicians seem so keen on talking about. But that's not what happened. USDT tether did trade at a discount to its full value when it came to its yuan pair, but only by a

penny or two, I think at most three cents. The point is the sort of cataclysm that these folks are predicting isn't tether trading at 97 cents to the dollar. It's tether trading at 60 cents or 50 cents or 20 cents or something like that. The reality is that there is a huge global arbitrar market that steps into these gaps even when things seem wild. Bringing it back to Elizabeth Warren, let's not forget that she's the same person who recently used this example in her Senate testimony, where she asked what happened to a guy who bought ETH on Monday, only to see it drop 10 or 15% on Tuesday, and the exchanges weren't even working to sell it. That was her literal example of why crypto markets need more regulation, because Coinbase went down when the price of an asset like Eith had dropped

10%, ergo investors needed protection. Let me put this bluntly. If an investor bought ETH on a Monday and tried to sell it the next day because it went down 10%, that person is a bad investor. But all joking aside in all seriousness, the thing about investor protection arguments that gets me so fired up is that they completely ignore that the other side of profit from investments is risk. There is risk inherent in markets. The goal of investor protection cannot be to eliminate risk because without risk, there is no mechanism by which investments actually make a return. This is the two sides of the scale. If you eliminate risk entirely, no one ever gets hurt, but no one ever makes a profit either. None of this is to say that there's nothing to consider

about stablecoins or how they're regulated. What's more, I'm even sympathetic to the notion that stablecoin and crypto interactions with parts of the existing financial system, particularly opaque hedge funds is something that is reasonable to consider if you are a policymaker when you're thinking about things like systemic risk. We've seen from the implosion of funds like Archegos that there can be wide-ranging impacts to the financial system when one of a fund's investments goes belly up. However, even if that is the line that we're taking here as it relates to crypto, the issue isn't the crypto industry as an investment category. The issue is the opacity and disclosures of financial institutions like hedge funds. If we're going to try to solve the problem, we have to diagnose it.

This podcast is sponsored by NIDIG, and they put out a research newsletter that's one of the best ways to track market insights and track the turning points of Bitcoin adoption. Sign up at NIDIG.com slash NLW. That's NYDIG, forward slash NLW. There are more parts of this regulatory saga when it comes to stable coins as well. Gary Gensler, the SEC chairman, recently calling them stable value coins, trying to make it makes sense for his SEC to regulate them. Jay Powell saying that they're like money market funds and should be regulated as such in testimony last week. But let's now move to news from the weekend. The Wall Street Journal writes, Biden administration seeks to regulate stable coin issuers as banks.

Subtitle, the move would aim to address concerns that the digital currency could fuel financial panics. That subheader is exactly why I thought it was worth taking a little detour into this larger logic of how these assets could fuel financial panics. The TLDR of the article. Effectively, this article is saying that the Biden administration is considering two broad paths. The first is having stablecoin issuers register as banks. The second is to have FSOC, the Financial Stability Oversight Committee, designate stablecoins as systemically important, which brings other types of requirements. Now, within the register them as banks approach, there's actually more nuance to it there as well. Apparently, one consideration is to potentially create a special purpose charter that is tailored

specifically to the stable coin business model, rather than forcing them into the old version of what a bank is. If they were, however, to go with the other approach, the FSOC approach, it would come with more stringent standards, and apparently this is not the Biden administration, or we should be clear, the Treasury Department, who's spearheading this effort's preferred approach. There is a group putting together a much-teased Staplecoin report right now that is led by the Treasury Department, and it's called the President's Working Group on Financial Markets. The report is expected to be published later this month, and the group includes Treasury Secretary Janet Yellen, Federal Reserve Chairman Jerome Powell, Securities and Exchange Commission Chair Gary Gensler.

So what to make of all this? Well, frankly, not everyone is particularly concerned. Senator Cynthia Lummis, who's obviously a big bitcoinser, says it may be the case that Stablecoin should only be issued by depository institutions. Circle, one of the backers of USDC, called these developments encouraging. Noel Atchison, who is head of market insights at Genesis and a former coin desker, wrote, the long-rumored stablecoin regulation in the U.S. seems to be gradually surfacing, with the Biden administration reportedly considering ways to impose bank-like regulation on stablecoin issuers. If this transpires, it would make stablecoin issuance more expensive in terms of compliance, and presumably introduce requirements regarding the quality

of reserves backing the crypto assets. This could make the stablecoin business less profitable by lowering income while raising costs, but it would boost confidence in the advantages of these monetary tools and perhaps encourage their use beyond crypto payments by both investors and banks. It could also encourage more banks to issue their own tokens, which could boost monetary liquidity and economic growth, while limiting systemic risk. It could also boost innovation and money, allowing the private sector to issue stable coins with coded functionalities and the support of vetted reserves and perhaps even insurance. The potential ramifications for this are vast. It is not clear, what this will mean for algorithmic stablecoins and for the use of stable coins in defy.

The regulation is mainly about protecting the financial system from risks of a run. Dye and others may be deemed not a threat due to no reserves or the market size, for now. So effectively, Noel here is taking the line that, yes, there are serious implications of this in terms of compliance costs, but there also could be big new markets open by this regulatory clarity. What about Caitlin Long from Avanti, who is trying to build a crypto-focused, bank-like institution. She wrote, this is where we always thought the stablecoin regulatory direction would go, which is why Avanti chose to get a bank charter. Anything that touches the USD financial system

was always going to fall within the Fed's purview, directly or indirectly, especially once it became big. Plus, it makes sense policy-wise. Non-bank stablecoin issuers gum up the repo market by siloing T-bills and other level one high-quality liquid assets. The repo market already finds these assets too scarce. If stablecoin issuers are banks, though, dormant Fed reserves can be used instead. The very high velocity of stablecoins comes from their superior tech versus traditional payment systems, not from leverage. Traditionally, monetary velocity came from leverage, but thanks to stable coins, it no longer needs to. Creating monetary velocity without leverage is inherently safer and more stable to the USD financial system than using leverage to create velocity, which again

is how the banking system traditionally worked. Really, this policy is win-win from the U.S. financial system stability point of view. But achieving this requires the Fed to grant payment systems access to stablecoin issuers once they become banks, as Avanti already is. Big banks, DC lobbyists are fighting all of us like mad. They want this market to themselves. What's interesting about DC news flow on stable coins is that DC seems to forget that the U.S. has a dual banking system. 80% of the banks in the U.S. are state chartered, not federally chartered. State regulators matter and they're already ready to go before DC is. States like Wyoming have ready-made bank charter for stablecoin issuers that could be adopted by DC today. Note, Avanti's application for Fed Payment System access has been pending for one year,

and our business plan includes issuing a stablecoin-like bank deposit called Avid. So regulatory picture is playing out pretty much as we at Avanti expected. The big question now is if the big banks will succeed in blocking out crypto-native companies like us. As I've said before, the knowledge frontier in crypto isn't in big banks. It's where the big banks. It's where the big banks. the developers are. Now, one more bit of commentary, this time from FinTech Law, TLDR, which is a great little substack. In discussing the bank route versus the Financial Stability Oversight Committee route, they write, FSOC was established after the 2008 crisis as a tool to monitor broader financial system threats. It's made up of the heads of all the main U.S. financial regulators, SEC,

Fed, OCC, CFBP, etc. FSOC's most notable tool is they can declare an institution systemically important, which makes it subject to elevated risk management standards and increased oversight. So, for example, if FSOC designated stablecoin provider's circle as systemically important, circle could be subject to reserve requirements and or reporting obligations. The FSOC approach would likely be overbroad, but if Biden wants to regulate stable coins, it's probably a more likely path than passing new legislation, and would probably be a more flexible way to manage a still evolving tech. So on the one hand, you have some folks saying that the bank route is the way to go, especially if

all players are treated equally and given equal access to try to be these new types of bank like institutions. And also, the Wall Street Journal is reporting that that's the preferred route of the Biden administration. However, on the other side, you have someone arguing that the FSOC approach is the most likely from a political standpoint because it doesn't involve passing new legislation. One more note that's outside of the scope of this show but is worth paying attention to is this argument that was hinted at by Caitlin that having non-bank stablecoin issuers in the market is potentially challenging to system-wide liquidity because they're siloing T-bills when they could otherwise be using other types of assets. That, I think, is for another show,

but worth putting a pin in. When you sum all this up, I think it's pretty clear that the question isn't whether there are going to be stable coins. It's a question of how they're backed, how they're regulated, and most of all, who gets to play. The big outstanding issues seem to me to be, one, will smaller issuers be allowed to participate, or will this effectively be the government saying you have to be a traditional bank, a Bank of America, J.P. Morgan, to play in this game. Second, this doesn't really deal at all with algorithmic stable coins which are backed by math and process and protocol rather than by actual assets. Ultimately, this all remains speculative and we won't know until the end of October or whenever this Working Group's report is issued. Now, even according to this article

in the Wall Street Journal, the exact recommendation, of that piece are still being debated, so it's not like they know and they're just not telling us, they genuinely still haven't committed to a path forward. While that may be speculative, there is still news that is very real. Circle Financial, who's obviously one of the main backers of USDC, has disclosed that it received an investigative subpoena from the SEC's enforcement division, that subpoena requested, quote, documents and information regarding certain of our holdings, customer programs, and operations. The context? Well, regular listeners won't be surprised, but this happened about a month after Circle launched its yield product,

which is their high-interest yield product akin to the Coinbase product that was the subject of Brian Armstrong's big long tweet thread, where he said the SEC was being sketchy, a product which later they decided not to issue because of the threat of lawsuit from the SEC. Now, unlike Coinbase Circle does have licenses for their product, at least in Bermuda, which is more than Coinbase can say, and what's more, this investigatory subpoena was actually disclosed in regulatory filing in August, but no one really noticed. Also in August, Circle agreed to pay the SEC over $10 million

to settle accusations that Polonex, the exchange that they purchased a few years ago, had operated as an unregistered digital asset exchange. The stable coin question is undeniably and undoubtedly coming to a head. I think there are some real ways for it to be shi, frankly, in the short term, but it also seems to me again, and I started to articulate this the other day, that almost any amount of clarity that doesn't involve fully blocking out an entire category of participants is preferable to this weird sort of in-between status. I have a feeling that over the next few weeks before we actually get this report, there will continue to be drips and dribbles and leaks, and I will be here to capture all of them for you. But for now, I appreciate you listening, and until tomorrow,

be safe and take care of each other. Peace. Hello, listeners. If you're a financial advisor, manager, or CFA looking to learn more about Bitcoin, investment strategies, and tools to share with your clients, then you're invited to attend CoinDesk's Bitcoin for Advisors event on October 6th. It's a fully virtual event experience designed for advisors by advisors who have found ways to get compliance ready in order to add Bitcoin advising to their practices. You can head over to coindesk.com slash events to secure your complimentary registration today. That's coindesk.com slash events where you can register for free. We'll see you on October 6th and thanks for listening.