Tom Curry

On Nov. 1, the President’s Working Group, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. issued a report on stablecoins which, among other things, recommended  that Congress enact legislation to address the financial stability and other risks inherent in stablecoin systems, digital asset trading and technology. The report goes further to recommend that this legislation limit stablecoin issuance to entities that are federally insured depository institutions.  

On the heels of this recommendation, on Nov. 23, the Federal Reserve, FDIC and OCC issued a joint statement discussing crypto-asset policy and their “sprint initiative” to continue discussions regarding policy recommendations for treatment of cryptocurrency through 2022.  

These actions by the U.S. federal bank regulatory agencies create a decidedly proactive, risk-based approach with respect to the growth of cryptocurrency and other digital assets in the U.S. economy. 

Kate Henry

In our October 2021 column in these pages, we discussed U.S. financial regulators’ wary approach to cryptocurrency amid international tumult surrounding cryptocurrency. In the face of significant disruption caused by cryptocurrency and other decentralized digital assets, some countries such as Iran and China banned cryptocurrency and exchanges. The Basel Committee on Banking Supervision announced its plan June 10 to require banks with exposure to cryptocurrency to hold higher capital to reflect the higher risks associated with cryptocurrency exposures.  

The report and joint statement described above underscore the U.S. agencies’ alignment with the Basel Committee’s approach to cryptocurrency. While the agencies seem willing to embrace the potential advantages of digital assets, they are keen to ensure that certain prudential safeguards are in place to protect the safety and soundness of the U.S. financial system. 

Three Basic Risks Highlighted 

Although the report acknowledges the possible advantages of stablecoins, such as the ability to create faster, more efficient and more inclusive payment options, the report identified a number of significant risks associated with the integration of stablecoins into the U.S. economy. 

Armand J. Santaniello

One inherent risk with stablecoins generally is the risk of uncontrollable loss of value based on, for example, degradation of the assets underlying the digital assets or loss of confidence in the value of a stablecoin. This volatility could cause a “run” on a stablecoin, leading to fire sales of reserve assets and a subsequent disruption in funding markets.  

Additional risks exist at the functional level for the operation, management and settlement of stablecoins. Whereas traditional payment systems have developed robust systems for protecting against operational error, inconsistencies with settlement procedures and misalignment between settlement timing, these newly-minted systems present these same risks in evolved formats, requiring an innovative approach to these risks and the potential market issues they present. 

Lastly, although stablecoins traditionally accounted for a very small portion of the economy, the stablecoin space has experienced exponential growth in recent years, forcing regulators to consider a bevy of new risks inherent in a scaled-up version of what was historically a microcosm of the economy. The growth of the stablecoin economy could also have an impact on traditional financial institutions by reducing deposit levels and other financial transactions typically held or conducted by in insured depository institutions, possibly leading to increased credit costs or impairing the availability of credit in the real economy. 

Congress Called to Act 

The overall recommendation from the agencies is for Congress to enact legislation to address the risks outlined by the report. In particular, the agencies recommend that legislation address supervision on a consolidated basis, prudential standards for stablecoins and digital assets, and access to certain portions of the federal safety net.  

Perhaps most significantly, the report calls for legislation to prohibit entities other than insured depository institutions from participating in stablecoins and other digital asset activities. The agencies’ rationale for this recommendation is centered on the fact that insured depository institutions incorporate regulatory safeguards that could account for the risks associated with stablecoins and digital assets, which could be supplemented to account for unique issues or risks inherent in digital assets. Theoretically, starting from a more robust regulatory framework could provide at least initial protections against the risks associated with an ever-growing digital asset market. 

In the joint statement issued on Nov. 23, the agencies further emphasized the need for increased scrutiny and understanding with respect to stablecoins, digital assets and cryptocurrency. The joint statement highlighted the “policy sprint” model that they are using to approach further research and understanding of the digital asset market in an effort to develop an efficient, effective and coordinated regulatory approach.  

The joint statement underscored the focus of policy sprints in recent months, which included: developing a commonly understood vocabulary to discuss the use of crypto-assets by banking institutions; identifying and assessing key risks associated with crypto-assets; and the analysis of the applicability of existing regulatory structures to mitigate these key risks. 

The joint statement went on to announce that these policy sprints would continue throughout 2022, with a particular focus on developing guidance for banking organizations on crypto-asset safekeeping and traditional custody services, loans collateralized by crypto-assets, the issuance and distribution of stablecoins and activities involving the holding of crypto-assets held on balance sheets.  

Taken together, the joint statement and report signal that the U.S. financial regulators acknowledge the inevitable growth of cryptoassets in the U.S. economy and the need for an appropriate regulatory structure to effectively mitigate risks to the economy and the financial system. 

Thomas J. Curry is a partner in Nutter’s corporate and transactions department. Kate Henry and Armand J. Santaniello are associates in Nutter’s corporate and transactions department. Curry is former U.S. comptroller of the currency and all are members of the firm’s banking and financial services group.