The New US Stablecoin Bill Is a Critical Moment in Dollar Hegemony
Understanding the upcoming bill and its implications through our musings on stablecoins.
The world ran on dollars. The eurodollar, which refers to the offshore US dollar outside the supervision of U.S. banking regulations, emerged in the 1960s due to global energy trades settling in the U.S. dollar as a result of Bretton Woods. Not only did businesses use dollars, average citizens in many countries also used and still use dollars as an inflationary hedge. To put it into perspective, the number of eurodollars was estimated to be a staggering ~$14 trillion in 2016.
However, de-dollarization is happening, and it’s accelerating. Countries, especially those in the Global South, are decreasing their reserves of U.S. dollars, conducting cross-border transactions using currencies other than the U.S. dollar, and considering establishing new multilateral settlement systems. In fact, the dollar’s share in global foreign reserves has been declining by ~1% every year on average for the past 8 years.
For USD to remain competitive in the digital era, it needs to support the following:
- Open usage and integration as a native data type on the Internet that is programmable.
- Create a distinction between payment and lending instruments: mitigate the inherent risk of fractional reserve banking associated with bank money, which is currently used as payment instruments.
A major catalyst in this direction could be the ‘Stablecoin Bill,’ a pending legislative proposal in Congress aiming to regulate stablecoins. In this essay, we present our thoughts on the upcoming US stablecoin bill and its implications from the perspective of being stablecoin evangelists over the past two years.
For relevance, we will narrowly define stablecoins as on-chain tokens 100% backed by liquid assets like short-term treasuries and U.S. dollars.
Since the invention of credit cards in the 1960s, all payment innovations have been marginal improvements in debit and credit instructions. Payment stablecoins like USDC are critical improvements as they are internet-native and programmable with near-instant settlements. Stablecoins will soon rival transactions per second (TPS) of the world’s largest payments systems like Visa by running on high-performance blockchains such as Solana. They enable individuals and businesses to send, spend, save, and secure their money digitally to any device connected to the Internet.
The demand for digital dollars like USDC is highly global, particularly in emerging markets, where people want to hold digital dollars versus their local currencies in the banking system as an efficient medium of exchange for various types of international transactions. With over $8.6 trillion moved on-chain just in 2022, USDC is a proven “product,” representing the high velocity of money in a niche market.
However, a national regulatory framework is necessary for such internet-scale payments innovation to give legal certainty and holder protections, including bankruptcy-remote redemption rights at par. The only way to achieve this is for Congress to enact a comprehensive payment stablecoin legislation. Stablecoin regulation will enable the US to dollarize the Internet, and the Federal Reserve needs to implement the digital dollar into its “core systems” to capitalize on the high demand around the world.
What’s the Proposed Stablecoin Bill?
On April 15, a 73-page draft bill was announced as a product of bi-partisan efforts by Congress, which is said to be the first comprehensive proposed law for ‘Payment Stablecoins.’ The ‘McWaters Bill’ is the nickname given to the legislative brainchild of House Financial Services Chair ‘Patrick McHenry’ and Ranking Member ‘Maxine Waters,’ who spearheaded the efforts in 2022 to build a regulatory framework for payment stablecoins at the Federal level.
The purpose of this bill was to provide clarity to the industry by specifying the government entity responsible for overseeing stablecoin regulation, determining which private organizations would be permitted to issue stablecoins, and establishing guidelines for the storage of stablecoin reserves. In a Congress marked by the deadlock, particularly on matters related to cryptocurrencies, the McWaters bill stood out as a shining demonstration of bipartisan cooperation.
We won’t get into detailed specifics of the bill, but here’s a quick summary:
- The Federal Reserve would be the regulator for stablecoins by nonbank entities and issue operating licenses. Firms that fail to register with the authorities could be liable to a $1 million fine or five years imprisonment.
- Explicitly prohibits rehypothecation and commingling of funds with clear disclosure and attestation of stablecoin issuer’s reserves.
- A 2-year ban moratorium on creating, originating, and issuing ‘endogenously collateralized stablecoins’ like crypto-collateralized stablecoins or algorithmic stablecoins.
- Compliant stablecoins must be backed 1:1 with highly liquid, high-quality assets (such as fiat and T-bills). They would also have to meet strict liquidity and risk management requirements to ensure redeemability at any given time.
- Allows approved stablecoin providers to have a ‘master account’ at the Fed, which would enable them to directly deposit their funds with the Fed instead of relying on commercial banks like BNY Mellon or SVB.
Why Would A Master Account at the Fed be Critical?
While issuers like Circle currently hold a significant portion of their reserves in T-bills, which are debt obligations backed by The U.S. Department of the Treasury. However, ~8% of their cash reserves still remain in banks to facilitate USDC minting, redemptions, and USD <> USDC conversions. If Circle were to operate under the new Bill, it would have a master account with the Fed, establishing a direct obligation with them. This arrangement would completely safeguard Circle from the risks associated with fractional reserve banking and prevent stablecoin issuers from experiencing the implications of an SVB-like crisis.
When given access to direct Fed obligations, stablecoins would be what CBDCs could be in the most practical senses. Both will offer instant settlement across currency pairs, increased transparency, and increased automation. What differs will be who issues them and how they are operated, i.e., private financial institutions vs. central banks.
Latest Iteration of the Draft Bill
On 8th June 2023, The Republican chair of the House Financial Services Committee released a new draft, marking another potential move toward a bipartisan negotiation on the legislation. It specifies the stablecoins to be within the ‘Dual Banking System,’ where:
- A State payment stablecoin regulator shall have supervisory, examination, and enforcement authority over a State licensed payment stablecoin issuer.
- The Fed would have the power to intervene in emergency situations involving state-regulated issuers and allows states the option to delegate their supervision duties to the federal watchdog, further strengthening regulatory oversight.
- Finally, the bill proposes to amend the ‘Investment Advisers Act, the Investment Company Act, the Securities Act, the Securities Exchange Act, and the Securities Investor Protection Act’ by adding a clause that excludes payment stablecoins from classification as securities.
Interestingly, a sub-clause stating that it is ‘denominated in United States Dollars’ has been dropped, which can allow non-USD stablecoins to be issued in the US.
What Would be the Positive Implications of the Bill?
- Broader payment adoption: this would legitimize payment stablecoins like USDC and will lead to many FinTechs participating in the value chain, e.g., acting as merchant acquirers. We will also see web2 e-commerce websites like Amazon adding stablecoins as a payment option.
- Competitive stablecoin issuer market: legal clarity on “Payment Stablecoins ≠ Securities” will spur a number of new stablecoin issuers to emerge, leading to a competitive market.
- Industry credibility: cryptocurrencies are currently stereotyped as a casino for tokens and jpegs, but in truth, they could be used for real financial activities. Improving credibility as an industry in the political and financial spheres will be necessary for stablecoin mass adoption.
- Cross-board payments: efficient real-time cross-border payments powered by FinTechs using stablecoins as the settlement rails on highly performant blockchains like Solana as on/off-ramps would be much cheaper and faster due to supporting banking rails.
- Precursor for non-US regulations: other countries might follow and issue their own stablecoin regulations that would allow regulated financial activities on-chain.
However, keep in mind that a downside to having a regulatory framework is that it may hinder innovations in stablecoin designs, as players have to follow preconceived rules in order to play in this space.
The Future of Algorithmic and Crypto-Collateralized Stablecoins:
We believe that a blanket ban on non-fiat-backed tokens will limit creativity in the design of future currencies. Instead, those stablecoins should be allowed their own space to thrive but be known by other names such as “Equilibrium assets” or “Flat assets.” This category should include assets like:
- Flatcoins or inflation-resistant tokens backed by real-world assets.
- Crypto-collateralized tokens attempt to be pegged to a real-world asset or currency.
- Non-collateralized tokens are pegged algorithmically to any currency using different mechanisms.
Given their risky nature, these should be categorized separately from stablecoins and have guardrails to protect retail investors.
Recommendation to Regulators: Move Fast
Think of USDC as an export product, just like the USD, but with the scale of the Internet. In order to be adopted, there needs to be demand and network effects. Currencies are among the strongest network effect products. Suppose a user or business has to choose a stablecoin. In that case, they will choose one that is already widely used — a reason why dominant stablecoins like USDC and USDT control approximately 87% of the current market.
A number of regulators around the world have been actively working on regulating stablecoins and promoting their own currency-denominated stablecoins. The main ones are:
- Asian financial city-states (Hong Kong and Singapore): Singapore’s MAS and Hong Kong’s HKMA released discussion papers in October 2022 and January 2023, respectively. They are actively drafting stablecoin regulations to regulate fiat-backed stablecoins at the central bank level.
- Japan: The Financial Services Agency (FSA) is proposing to only allow banks, trusts, or licensed money transmitters to issue stablecoins and has already passed the bill in June 2022. The final legislation is yet to be enacted.
- European Union: MiCA (Markets in Crypto Assets) was unanimously approved on 16th May 2023 by the EU’s council, which includes stablecoin regulations. It will allow only regulated e-money institutions (EMIs) or credit institutions to issue stablecoins. It will have reserve management requirements (only high-quality liquid assets) and impose restrictions on interest-bearing mechanisms.
Other nations are enacting laws to regulate the use of the US dollar, which can drive away large stablecoin issuers from the US. The US needs to act fast in order to lead the development of the global stablecoin landscape that will determine the future of how US dollars (and perhaps an alternate future global reserve currency) move around the world.
From Eurodollars to Cryptodollars:
While Eurodollars aren’t directly subject to U.S. banking regulations, there is a unique opportunity to bring stablecoins or ‘Cryptodollars’ under US regulation. By promoting and regulating stablecoins, all US dollar reserves can be kept in the US financial system. If not regulated, all the US dollars backing stablecoins will be custodied in offshore jurisdictions like the British Virgin Islands, Cayman Islands, and so on. This implies that stablecoins will become Eurodollars 2.0!
Supporting the Bill
We believe that coordinated and united efforts are required from players such as blockchain associations and other blockchain foundations. All industry stakeholders need to rally together, along with dedicated media outreach. Payment founders should meet and educate congressional staff and a broader audience on the value of this revolutionary financial infrastructure that our industry has been building for the last decade. There will be several iterations of the Bill. Still, we are optimistic that if implemented correctly, it will lead to new forms of money with the superpowers of being global, instant, and programmable. The Stablecoin Bill is indeed a monumental moment for the future of the dollar.
- U.S. Congressional Committee Highlights the Importance of Payment Stablecoin Legislation by Circle
- Stablecoin Bill coverage by BeInCrypto
- Defending Dollar Competitiveness by Circle
- Thread on Payment Stablecoint Bill by Jeremy Allaire
- Beyond Speculation: Payment Stablecoins for Real-time Gross Settlements
- Stablecoin bill summary by Forbes
Disclaimer: This essay is our personal perspective and doesn’t represent any organization we might be associated with. None of this is financial advice or a recommendation