The spokesperson for Consensus 2024, Marcelo Prates, suggested that we should pay attention to the regulatory experience of international digital currencies in order to properly regulate stablecoins in the United States.

Written by: Marcelo Prates

Translated by: Huoxing Finance, MK

Recently, Hilary Allen, a law professor at American University, expressed concerns about the risks stablecoins may pose to the banking system and the general public in a podcast. She pointed out that stablecoins could undermine the stability of banks, potentially requiring government bailouts. Meanwhile, the U.S. Congress is pushing for federal-level regulation of stablecoins. Despite the difficulty of passing stablecoin-related bills in an election year, Allen is concerned that these bills may garner public support. She explicitly stated that stablecoins "lack significant utility and should be banned."

Marcelo Prates, a speaker at Consensus 2024 and a senior expert in financial policy and regulation, responded to Allen's concerns, suggesting that they may only apply to those who oppose competition and transparency in regulation. He argued that Allen's concerns represent an exaggerated and unhelpful trend. In fact, this represents an advanced version of one of the most revolutionary innovations in the financial sector over the past 25 years: electronic currencies issued by non-bank institutions.

Since the early 2000s, the European Union has recognized the need to promote digital payments in a faster and more cost-effective manner. As a result, EU legislators have established a regulatory framework for electronic currencies, allowing startups to fully utilize financial technology in a regulated and secure manner to provide payment tools.

The logic behind this is clear: due to the multiple services and complex structures offered by banks, along with high risks and strict regulatory requirements, conducting digital payments through bank accounts is often cumbersome and costly. The solution is to establish independent licensing and regulatory mechanisms for non-bank institutions, focusing on a single service: converting customer deposits into electronic currencies that can be used for digital payments through prepaid cards or electronic devices.

In practice, these electronic currency issuing institutions operate similarly to banks but with a more specific focus. They are required by law to safeguard customers' cash, ensure that electronic currency balances are always redeemable for equivalent cash, and thus prevent devaluation. As these institutions are licensed and regulated, customers can be confident that their funds are generally safe, except in cases of severe regulatory failure.

Therefore, most existing stablecoins—those based on sovereign currencies such as the US dollar—actually possess some characteristics of electronic currencies: their uniqueness lies in being issued through blockchain technology, not being restricted by national payment systems, and being able to circulate globally.

Stablecoins are not a dangerous financial product, but rather a true "electronic currency 2.0" with the potential to further fulfill the original promises of electronic currencies: enhancing competition in the financial sector, reducing consumer costs, and promoting financial inclusion. However, in order to fulfill these promises, stablecoins indeed require appropriate federal-level regulation. Without federal legal standards, stablecoin issuers in the United States will continue to be constrained by various state money transmission laws, which are not uniformly designed in terms of segregating customer funds and maintaining the integrity of reserve assets, and are inconsistently enforced.

Considering the EU's decades of experience in the field of electronic currencies and advanced improvements in other countries, effective stablecoin regulation should be based on three pillars: granting non-bank licenses, direct access to central bank accounts, and bankruptcy protection for supporting assets.

First, restricting the issuance of stablecoins to banks themselves is a contradiction. The essence of the banking industry is to hold public deposits, which are not always fully supported, traditionally known as "fractional reserve banking." Therefore, banks can lend without using their own capital.

On the other hand, for stablecoin issuers, their goal is to ensure that each stablecoin is fully backed by liquid assets. Their main responsibility is to receive cash, provide the equivalent in stablecoin form, securely hold the received cash, and return the cash when users exchange stablecoins. Lending is not part of their business.

Stablecoin issuers are similar to electronic currency issuers in nature, both aiming to compete with banks, especially in the field of cross-border payments. They should not replace banks, nor should they evolve into banks.

This is why stablecoin issuers should obtain specific non-bank licenses, similar to those obtained by electronic currency issuers in the EU, UK, and Brazil. These licenses are relatively simple, with requirements (including capital requirements) matching their limited activities and lower risks. They do not need banking licenses, nor should they be required to hold them.

Second, to strengthen their lower risk status, stablecoin issuers should be able to have central bank accounts to hold their supporting assets. While depositing customer funds into bank accounts or investing in short-term securities is generally considered safe, both options may pose greater risks during periods of economic stress.

For example, the U.S. stablecoin issuer Circle faced difficulties due to the collapse of Silicon Valley Bank (SVB), as its $3.3 billion cash reserve held at SVB (nearly 10% of its total reserves) was temporarily inaccessible. Several banks holding U.S. Treasury bonds suffered losses due to rising interest rates in 2022, causing bond market prices to fall and leading to liquidity shortages, making it difficult to meet withdrawal requests.

To prevent fluctuations in the banking system or the bond market from affecting stablecoins, issuers should be required to directly deposit their supporting reserves into the Federal Reserve. This measure would effectively eliminate credit risks in the U.S. stablecoin market and enable real-time supervision of stablecoin support—without the need for deposit insurance or bailout risks, similar to the situation with electronic currencies, unlike bank deposits.

It is worth noting that non-bank institutions having central bank accounts is not unprecedented. In countries such as the UK, Switzerland, and Brazil, electronic currency issuers can directly protect user funds through central banks.

Third, customer funds should be managed separately from the issuer's funds in accordance with the law, and if stablecoin issuers fail due to operational risks (such as fraud), customer funds should not be subject to any bankruptcy proceedings. This additional layer of protection ensures that stablecoin users can quickly regain access to their funds during the liquidation process, as general creditors of the bankrupt issuer have no right to seize customer funds. This is considered best practice for electronic currency issuers.

In the public debate on stablecoin regulation, these innovative measures may leave a deep impression on the audience. However, for those who pay attention to details, balanced arguments based on successful global cases and experiences should be more persuasive.

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