The Breakdown - Why Stablecoins Are the First Battleground of the Coming Crypto Regulation Wars

Episode Date: December 4, 2020

On Wednesday, three U.S. congressional Democrats announced the STABLE Act, an 18-page bill that would require, among other things, stablecoin issuers to acquire banking charters, get approval from the Federal Reserve and hold FDIC insurance.  The bill’s authors claim stablecoins represent a continuation of the shadow banking system that preys on poor communities. The crypto industry argues this overly burdensome would not only stifle innovation but ensure the only players in this new space are the deep-pocketed fintechs with the resources for compliance.  In today’s episode, NLW argues this is more than just another bill that will go nowhere in Congress, it’s the opening salvo of a new set of arguments that will define the next face of regulatory battles for the entire crypto industry.

One of the biggest blockers to the transmission of monetary policy, including new conceptions of monetary policy like our inherent in MMT or modern monetary theory, require tamping down the power, reach, and breadth of the shadow banking system. And I believe that when they see stable coins, they see Eurodollar 2.0, but in a visible form, in a form that they can snuff out before they begin. That is the real context that we have to contend with, and it's a big one. 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 crypto.com, nexo.io, and all nodes.

And produced and distributed by CoinDesk. What's going on, guys? It is Thursday, December 3rd, and today we have a discussion about something that all of Bitcoin and Crypto-Twitter was absolutely going off about. last night. We're talking about the new Stable Act and more broadly why governments are going after stable coins. Now, I think this is a really important topic and something that we're going to be discussing a lot more. So instead of doing a normal brief, I'm going to dive right in. So let's go back over the course of the last week. There's been a lot of bluster in the macro community about what governments are going to do as cryptos get bigger, right? We talked the other day. We talked the other day, about how Ben Hunt, Raul, George Gammon, all had gotten into TIFs, frankly, with Bitcoin

Twitter about whether government was going to let it continue to exist in the same state, or whether there would be strict guide rails and guardrails put up around it that really railroaded it into the existing system. Part of this was driven by rumors that came out just around Thanksgiving that U.S. Treasury Secretary Mnuchin was planning to rush some new regulations around self-custody issues. So really the biggest source for this was Brian Armstrong from Coinbase, who had a whole thread. Last week, we heard rumors that the U.S. Treasury and Secretary Manuchin were planning to rush out some new regulation regarding self-hosted crypto wallets before the end of his term. I'm concerned that this would have unintended side effects and

wanted to share those concerns. For those who don't know, self-hosted crypto wallets are a type of software that lets individual store and use their own cryptocurrency, instead of needing to rely on a third-party financial institution. Self-hosted crypto wallets are important because they allow anyone to use this new technology to access basic financial services, just like anyone can use a computer or smartphone to access the open internet. The open nature of cryptocurrency is what makes it a powerful tool for innovation, and it is what levels the playing field globally. It is what is fueling innovation, such as in Defi. It has the potential to bring down the cost of financial services and improve accessibility. This proposed regulation would, we think, require financial institutions like Coinbase to verify

the recipient or owner of the self-hosted wallet collecting identifying information on that party before a withdrawal could be sent to that self-hosted wallet. This sounds like a reasonable idea on the surface, but it is a bad idea in practice because it is often impractical to collect identifying information on a recipient in the crypto economy. Let me explain why. Many crypto users are sending crypto to smart contracts to use defy apps. A smart contract is not necessarily owned by any individual or business who could be identified. It is a new type of recipient that doesn't have any direct equivalent in traditional financial

services. Many crypto users are sending crypto to various merchants online, paying for goods and services. Does it make sense to require customers to help verify the identity of a business before they can buy a product there? Many crypto users are also sending crypto to people in emerging markets, where it is difficult or impossible to collect meaningful know-your-customer information. Some of these individuals are living in poverty and may not have any permanent address or form of government ID. Many crypto users are using their crypto with new types of applications online. Imagine if every time you wanted to upvote some content on Reddit or transfer an item in a game, you were hit with a form asking you to verify a recipient. Finally, many recipients in the

U.S. or abroad who value their financial privacy may simply not want to upload more identifying documents to various companies which could be hacked or stolen. This additional friction would kill many of the emerging use cases for crypto. Crypto is not just money. It is digitizing every type of asset. Given these barriers, we're likely to see fewer transactions from crypto-financial institutions to self-hosted wallets. This would effectively create a walled garden for crypto-financial services in the U.S. cutting us off from innovation happening around the rest of the world. This would be bad for America because it would force U.S. consumers to use foreign, unregulated crypto companies to get access to these services. And long term, I believe this

would put America's status as a financial hub at risk. Just like the U.S. benefited enormously by bracing the open Internet, it should embrace the open crypto networks and allow U.S. citizens to move their own money freely in the emerging crypto economy. If this crypto regulation comes out, it would be a terrible legacy and have longstanding negative impacts for the U.S. In the early days of the internet, there were people who called for it to be regulated like the phone companies. Thank goodness they didn't.

So there's a couple things going on in this discussion with Brian Armstrong. First is talking about all these other crypto use cases. But really, for the people who are responding to Brian's thread, the key issue here is that the idea of self-custody is one of the most intrinsic and important. important value propositions of this new asset class. It says you don't need an intermediary, specifically a bank, to interact with your own assets. You're free to do with them what you wish. That is a liberating force that potentially dramatically lowers the cost and increases the access of money services to an entire new set of people. And that idea that question

of increasing access to new money services for an entirely different set of people will be key to this larger conversation that we're about to get into. So far, we haven't seen a lot of follow-up from the U.S. Treasury around whether this is actually a thing that's going to happen. But it's not the only issue that we've seen discussed in terms of crypto regulations over the last few days. In fact, I believe that the big lurking giant is stable coins, and it didn't go away even though Libra just changed its name.

So what I want to talk about now is how governments are going after stable coins or starting to show that they're likely to go after stable coins, and why? Let's start with an acknowledgement of just how sucky it is, that the first time that most U.S. government officials were introduced to what could be a massively democratizing and liberating financial force in the form of stable coins. It was Zuckerberg saying he wanted to do more and have more power. I think that that association is a hugely important taint on this entire space and we'll come back to why that's so bad in a bit. But whatever the case, it happened, and Libra pushed stable coins and the crypto industry as a whole, front and center in the face of global regulators. No matter what they claimed, the U.S., the EU, and China rightly read Libra as a threat to their monetary sovereignty. This is why it was such a starting gun for the CBDC movement. Central Bank digital currencies had been discussed on and off, some research projects, some pilots had happened,

but they weren't a mainstream conversation in the context of the largest central banks in the world. When Libra happened, that changed. Certainly it changed the most aggressively for China, who significantly accelerated and upscaled their efforts that had started a few years before, and the EU has also discussed CBDCs much more since then with ECB President Christine Lagarde, effectively saying that they're likely to happen. A digital euro is likely to happen. And now that that CBDC conversation is heating up, there's also a companion significant focus on private stable coins as well. So let's actually start with the EU. As we heard on Monday's episode of the breakdown, Christine Lagarde this week wrote a magazine article about why private stable coins

threaten monetary sovereignty. Quote, using stable coins as a store of value could trigger a large shift of bank deposits to stable coins, which may have an impact on banks' operations and transmissions of monetary policy. And the key line there for those who are paying attention carefully is the transmission of monetary policy. I believe, and I'll talk about this a little bit more at the end, that the central epic challenge that is faced by private stable coins is the idea that they are the shadow banking euro dollar system in a more visible form, and that the central banks of the world have rightly perhaps identified that system as their greatest impediment to the monetary policy that they wish to implement. Put differently, if there is an entire subaltern money supply

that is not regulated or controlled, how could a central bank possibly influence something like the actual supply of money? When so many things are effectively money, what the central bank actually has the ability to influence or not, is fractional compared to what it seems like they should. The person who is most articulate about this, of course, is Jeffrey Snyder, and I suggest you go listen to everything that he and Emile Kalanowski are putting out. Amil was on the show a couple weeks ago, Jeff was on the show a couple months ago. They've been articulating this argument that central banks are actually rather impotent as compared to what we think because of the shadow banking and euro dollar system. In addition to this question of the transmission of monetary

policy, Lagarde also took clear focus on Libra. She said that stable coins, particularly those backed by technology firms, could also represent risks to competitiveness and technology autonomy in Europe. This was perhaps not a surprising article. It mirrors things that we've heard from high-ranking EU officials for a long time about Libra. But then it got even more interesting because, let's shift back over the pond to the U.S. again. Yesterday, on Wednesday, three Democratic representatives dropped the Stablecoin Tethering and Bank Licensing Enforcement or Stable Act. By the way, I think there has got to be a job that's just writing snarky legislation titles, and I don't think the use of the word tether there is anything other than entirely intentional.

But either way, the short of the Stable Act is that Stable Coin issuers would be required to obtain bank charters. The act was introduced by Rashida Talib from Michigan, Chui Garcia from Illinois, and Stephen Lynch from Massachusetts. So first, what would the bill require? This is from CoinDesk. The 18-page bill would specifically require stablecoin issuers to obtain a banking charter, require approval from the Federal Reserve, federal deposit insurance corporation, and bank regulator to issue a stablecoin, require those same entities to conduct an ongoing analysis of any systemic risk, and require issuers to have FDIC, insurance, or maintain reserves for easy conversion back into U.S. dollars.

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Go to all nodes.com, the number one enterprise grade hosting and staking platform. Type in promo code CoinDesk 3 and enjoy three months of free hosting for your validator nodes. The platform is easy to use, comes with instant node monitoring and multi-level protection for your validator keys. Five minutes is all it takes to get started staking on AllNotes.com, the platform preferred by people who make a difference. So visit AllNodes.com and use the promo code CoinDesk 3 to get started for free today. Let's start with the argument for it, and let's get a little wonky with one of the advisors to the bill, assistant professor Rohan Gray. He tweets, the bill has two primary purposes. One, unequivocally defining stable coins as deposits under federal law, and two, requiring any entity seeking.

to issue stable coins to obtain a banking license and prior regulatory approval. In this respect, it aims to address a longstanding gap in banking law with respect to the definition of deposits, which is a major factor contributing to shadow money instability. One last note, while this bill is aimed squarely at efforts by tech companies like Facebook to enter the digital payment space with its formerly Libra, now DM project, as well as at acting comptroller of the USOCC, the US Office of the Comptroller of the Currency, Brian Brooks, recent moves to unilaterally extend special purpose payments charters to non-bank financial institutions without first obtaining congressional approval, it is written such as to apply to a wide range

of monetary activities currently undertaken by actors with insufficient regulatory supervision. And in that respect sets a clear marker for progressives in how to think about a broad range of financial regulatory issues, including how best to prevent the kinds of systemic shadow banking risks that led to the global financial crisis of 2007-2008. I'd also note that while proper regulation of privately issued stable coins is critical to preserve systematic stability and avoid repeating the mistakes of the past, it is no substitute for a genuine public digital payment system. The only reason Facebook is even entering this space is because the federal government has failed to provide a safe, secure digital payment system that the public trusts.

So there are a lot of things to unpack here. First, let's talk about going after the Brian Brooks move. So Brian Brooks, as we've discussed on the show, is a former Coinbase chief legal officer who's now head of the Office of the Comptroller of the currency. And one of the things that he has done in his so far short tenure has said that banks officially can work with stable coin issuers. That drew the ire of particularly this set of congressmen and women who wrote a letter, a very kind of fierce open letter to Brooks saying that, one, he shouldn't be doing this unilaterally, and two, why was he focusing on crypto issues when there was so much else going on in the context of COVID-19? So that is a big issue. Basically, Brooks's moves aroused some

version of the Hornets Nest. Number two, this is clearly directed at the power of big tech, one of the largest most unresolved issues in terms of the public-private balance of power, something that has been shifting for decades but is now coming to ahead. This is getting wrapped up in that larger set of issues. Third, it's interesting that Rohan here is pushing for a U.S. native digital currency, and this gets me back to my point that I don't think you can separate the conversation of private stable coins from the conversation about central Bank digital currencies. Now, Rohan wasn't the only one to tweet about this. Rashida Talib, one of the sponsors, wrote, preventing cryptocurrency providers from repeating the crimes against

low and moderate income residents of color traditional big banks have is critically important. That's why I'm proud to introduce the Stable Act. Especially amid the COVID-19 pandemic, their vulnerabilities could be exploited and obscured by bad actors looking to issue stable coins, like other shadow money issuers in the past. The Stable Act combats that threat. Representative Stephen Lynch and I previously sent this letter to the U.S.OCC Brooks blasting the Bureau's unilateral actions in the digital finance activity space. While they have yet to respond, we know action is urgent. Our communities need the Stable Act protections now. So again, we're seeing one, going after Brian Brooks, two, going after big tech, and three, the language of community vulnerability. Basically, things that come from the

private sector must inherently be bad for lower-income communities. And frankly, I think that it's understandable how this perspective could be inculcated, but it's really hard or, I think, inaccurate to necessarily draw the same connections between traditional private sector actors and the crypto industry. And that's a lot of what the critique coming from our space was. So let's talk about responses. They come in a few different categories. The first is the standard, let us build. You'll stomp innovation fair, right? That was always going to be the case. any regulation will be looked at with scorn with some portion of the populace, and God bless, we need those people pushing as hard as they can to have as much space as we can.

A second category of response was almost like sympathy to the mission, but feeling of it being backwards. And Professor Tanya Evans responded to Rashida Talib and said, this is a very troubling direction, and I am happy to meet to talk about it. Protecting black and brown communities from systemic economic disparities is a top priority, but allowing unneigh of hyper-regulation of democratizing means of transactions is not the future of money. And this is the central disagreement. Because of the genesis of Libra being Facebook and this idea that it's big tech trying to get into the finance sphere, this opinion that's represented in the Stable Act suggests or thinks or looks at every innovation from the Stablecoin and the larger cryptocurrency

space as coming from quote-unquote tech, whatever that means. They don't see a democratizing force. They don't see democratizing means of transacting to use Professor Evans' language. They see another overreach from a set of actors that are already troubling in the context of government power. The interesting thing, and this was another part of the conversation that just kept coming up, is that big regulatory burdens concentrate power in the hands of who can afford to pay. This act basically just says, only big banks and yes, fintechs are going to be able to pay the compliance cost to do this. In other words, if you wanted to go after Facebook, all you did here was make it so that Facebook all of a sudden has a new compliance cost moat. And I'm not just speaking theoretically.

We've seen this play out over the last few years. Look at the context of the GDPR in Europe. This is an act, a directive that was meant to preserve users' privacy. In point of fact, all it has done is enrich Google and Facebook. In 2019, a year after GDPR went into effect, the Wall Street Journal published a piece GDPR has been a boon for Google and Facebook. That article featured a quote from Mark Reed, who's the CEO of WPP, which is one of the biggest advertisers in the world. He said, GDPR has tended to hand power to the big platforms because they have the ability to collect and process the data. It has entrenched the interests of the incumbent and made it harder for smaller ad tech companies who ironically tend to be European.

Melton brought this argument into the cryptosphere, retweeting to Leib's argument about protecting poor income communities and saying this has the opposite effect. Cryptocurrencies lower the cost of servicing populations that have historically been excluded from the banking sector. Raising costs and compliance obligations forces companies to cut access for unprofitable clientele. Another great threat on this comes from former Coinbase legal officer Ruben Bramanathanathan, who says, The Stable Act is a confusing attempt at regulating perceived harms that are not actually caused by the technology, but are ironically inherent in the existing financial system that

cryptocurrencies are designed to replace. Stablecoins by their nature can only increase access to financial services. Unlike the existing system, they do not require the use of a bank account. The existence of stablecoins does not prevent consumers from using any other traditional payments, savings or credit offerings. In contrast, people can and do lose accounts to financial services when banks freeze or close their accounts. This happens when banks make arbitrary and opaque risk decisions that are in turn based on cumbersome regulations, which deputize banks to do the government's jobs. According to the press release, one, stablecoin issuers could take advantage of low-income consumers. Two, stablecoins are an outsourced

issuance of U.S. dollars, and three, stable coins pose market, liquidity, and credit risk. But all of these concerns are misplaced. The press release compares stable coins to shableness, banks, e.g. mortgage and payday lenders, that lend on a fractional reserve basis and often take advantage of consumers. That is the opposite of stablecoins like USDC, which are fully collateralized and don't charge interest or fees. It is reasonable to want to ensure fair lending and credit practices, but the existing lending laws should be clarified or expanded to cover lending and stable coins. This objective does not justify regulating the issuance or transactional use of stable coins. Second, stable coins such as USDC do not represent an issuance of U.S. dollars. They are, at

most, the issuance of a promise to redeem one stable coin for one US dollar, the same way as a check or money order. This issuance is already regulated under state money transmission laws. Finally, the concerns about market, credit, and liquidity risks are vague and poorly articulated. Perhaps they refer to the risk that stable coins could become too big to fail or somehow cause a 2008-style financial crisis, which of course is absurd because, again, stable coins do not inherently involve any credit or fractional reserve. But again, there are existing laws state money transmission, which require issuers of stable coins to have fully collateralized reserves with one-to-one backing. All of this is to say the Stable Act is overly broad and poorly

targeted. Under the premise of financial inclusion, it will do nothing to protect consumers, but will concentrate more power in banks, reduce competition, and ultimately reduce financial inclusion. Now, one more interesting argument has to do with the idea that maybe this will be good for decentralized alternatives to centralize Fiat-backed stable coins. Maybe this will be good for the algorithmic stable coins. Andreas Antonopoulos tweeted, the most interesting thing about the Stable Act is not whether it will be enacted. It won't.

It's that it can only apply by definition to centralized fiat-backed stable coins, thereby making decentralized alternatives even more attractive. Now, this argument didn't necessarily hold water with a lot of folks in this space. Jake Schrovinsky wrote, not necessarily. The draft bill is extremely broad, applying to any person who issues any type of stable coin or otherwise engages in any stablecoin-related commercial activity. So technically, it would require a banking charter for anyone who wants to mint die as well.

Alex Gladstein from the Human Rights Foundation actually tweeted at Rohan Gray, who we heard from before and who was an advisor on the bill saying, would die and maker-dao company and investors escape the proposed regulation? Rohan responded, the focus of the bill is on the obligation, not the theory of asset backing that enforces the obligation. So if it promises what a stable coin promises, it's liable. Andreas responds, but there's no. no financial institution behind a decentralized stablecoin? Who would you apply the regulation to?

It's issued automatically by software. It's not a matter of illegality or flaunting the regulators. It's more simply a problem of enforcement and application. Rohan Gray responds, people write and run the software. The idea there is no one behind decentralized systems is a myth. Jay Chervinsky continues. The software self-executes on public blockchains, quote, run by minors. In your view, would the Stable Act require such minors to obtain banking charters? Rohan says, the miners could certainly be held liable if they were contributing to running a network engaging in banking activity without a license required by law, just the same as if me and 10

mates started to issue banknotes. So very clearly this is not going to stand up, this idea that somehow it's just good for decentralized stable coins. There is a clear intent here that is inclusive of those assets. So for me, let's wrap this up. I've gone much longer than I thought I was going to. The reason that I think it's significant is this. One of the most enduring legacies of the Obama administration was the failure to punish anyone involved in the great financial crisis of 2008. To young progressives, there was no power recalibration whatsoever. And frankly, this is one area where even many Bitcoin and crypto folks who don't necessarily agree with Occupy Wall Street on anything else would find some common cause, a frustration that these people who leveraged the system to the hilt just got off scot-free.

And for some, this issue with the Obama administration is about fairness. But for others, it's about a fundamental reimagining of the role of governments with regard to the economy. They are recognizing this group that one of the biggest blockers to the transmission of monetary policy, including new conceptions of monetary policy like are inherent in MMT or modern monetary theory, require tamping down the power, reach, and breadth of the shadow banking system. And I believe that when they see stable coins, they see Eurodollar 2.0, but in a visible form, in a form that they can snuff out before they begin. That is the real context that we have to contend with, and it's a big one.

We are going to be paying for and fighting for the sins of a lot of institutions, many of whom, to be fair to these folks, have been predatory in the past. Engaging in good faith on that basis seems really important to me. So I hope that you enjoyed the show. I hope it got you thinking. I hope that you'll go read more, and I appreciate you listening. Until tomorrow, guys, be safe and take care of each other. Thanks.