Guys I love @CryptoCred’s guides and highly recommend them but I’m looking more for something with a focus on the fundamentals in crypto. How to set up wallets, what is Bitcoin, how altcoins work. Crypto first, trading second.

Guys I love @CryptoCred’s guides and highly recommend them but I’m looking more for something with a focus on the fundamentals in crypto. How to set up wallets, what is Bitcoin, how altcoins work. Crypto first, trading second.


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Stable Coin Regulation, With A Focus On The STABLEAct

What are stablecoins? Of course the answer is that they are neither stable nor coins. A generic smart-alec answer to explain these compound words. For example: smart contracts are neither smart nor contracts.  A stable coin similar to USDC is meant to keep its value pegged to the US Dollar at 1:1. The only residual volatility in USDC is the volatility of USD. The user enters into a contract with Circle Financial Corp when they buy USDC which appears to guarantee that one USD is always convertible to one USDC and one USDC is convertible to one USD. The phrase “appears to” is in bold for reasons given later in the article. This applies to other USD based stablecoins like USDT (or Tether). USDC is used as an example in this article. Once the fiat currency in a deposit account or a credit-line is converted to a stablecoin, it is untethered from the fiat and can freely move around in the crypto-verse. In the case of USDC, it is supported on Ethereum, Solana and Algorand public chains.   

The amount of USDC issued has increased from around $1B at the beginning of the year to around $3B at the end of November. USDT has increased to around $20B. Why is so much money flowing into stablecoins? The cryptocurrency (CC) market is on a tear, the US Dollar is not directly available on CC marketa, but the USD pegged stablecoins are. In order to use USD to trade CC, there are two choices. Choice number one is to use an exchange to buy USD for a particular CC and hold on to it, either in a self-hosted wallet or in the exchange’s wallet, to sell the crypto-currency for USD, an off-ramp has to be used, usually an exchange. Choice number two is much better, convert the USD to a stablecoin like USDC which can be held in a USDC  wallet, use the USDC to buy CC. USDC is a native asset in the digital marketplace, the trades can happen independently and cheaply back and forth between USDC and the CC. Further, since CC trading happens 24/7/365. Holding volatile CCs make for sleepless nights and weekends. So during these times, when volatility is expected, the CC can be moved into a stablecoin, especially if the price of the CC is expected to fall rapidly. Of course any upside in the CC is also lost. There is an excellent analysis of the asymmetric demand for stablecoins in an article by Frances Coppola. She uses USDT as an example and ties it to the volatility of bitcoin.

Two significant risks are ever present in the stablecoin ecosystem of today. The first one is KYC/AML/CFT. The user has to be identified and should not belong to the proscribed set of users, this data is also used for reporting taxable events to the IRS.  The second risk is the surety of the peg: one USD for one USDC. In order assure the peg, the USD received from the user has to be stored in commercial bank accounts, a significant portion in low-duration instruments. The lowest duration instrument is a checking account. A checking account yields zero interest. This liquidity is needed to satisfy a run on the stablecoin. In other words, a surge in demand to convert USDC to USD needs to be covered. Guarantees tied to cash held in commercial banks on behalf of the users has attracted the attention of regulators and legislators. The STABLEAct proposed by some legislators should be seen in this light. The rest of the article is about the appropriateness of the proposals given below.  

  • Require any prospective issuer of a stablecoin to obtain a banking charter;
  • Require that any company offering stablecoin services must follow the appropriate banking regulations under the existing regulatory jurisdictions;
  • Require that any company or bank issuing a stablecoin to notify and obtain approval from the Fed, the FDIC, and the appropriate banking agency 6 months prior to its issuance and maintain an ongoing analysis of potential systemic impacts and risks;
  • And require that any stablecoin issuers obtain FDIC insurance or otherwise maintain reserves at the Federal Reserve to ensure that all stablecoins can be readily converted into United States dollars, on demand.

Basically, it says that all stablecoin issuers should get a banking charter, almost all the other proposals follow in its footsteps. Ostensibly, this is to protect Low and Middle Income (LMI) customers. There is an attempt to tar all of the stablecoin issuers with the shadow banking brush. More on that subject later.


Regulators regulate and legislators legislate. Legislation and regulations are often blunt instruments, they are not scalpels. Legislation is a reaction to the excesses of a particular scenario, in this case, the unrestrained growth of stablecoins. Broadly applied and interpreted by human beings, they almost always have unintended consequences. Further, there is a culture, knowledge and concern gap between the creators of cutting edge solutions and legislators. All entrepreneurs decry regulation, many of them are experts at abusing gaps in regulations and at leveraging regulations favoring their operations. They are endlessly crying about excessive regulation. There is truth to both sides. How can both sides of the divide be brought closer together? 

Let us look at how the shadow bank moniker applies to stablecoins. All shadow banks in the article referenced in the STABLEAct preview generate secured or unsecured loans. Shadow banks issue loans using their balance sheet directly (in other words they do not function like chartered banks in this regard). They have a pipeline which securitizes these loans and sells them off to others, freeing their balance sheet to make more loans. The main difference between shadow banks and stablecoin issuers is the generation of loans; no loans are generated by stablecoin issuers, neither directly in the form of USD nor indirectly in stablecoins. Just calling them shadow banks does not make them so.  

KYC/AML checks of customers by stablecoin operators probably use NIST approved remote identity proofing methods. The custody side of the equation, the adequacy and liquidity of the USD reserves in commercial accounts to satisfy the USDC to USD conversion deserves more examination. Egregious violations of the adequacy of USD accounts backing Tether were reported widely; only 70% of the USD was found to be in accounts, 30% was lent out to “affiliates”. As long as the demand for Tether continues to rise, this asymmetry will never materially affect the value or demand for Tether. 

USDC is better governed than USDT. Yet, text from the customer agreement which is the contract  between USDC and its users should give one pause, section 14 states under No guarantee of price stability:… “For each USDC that is issued by Circle and remains in circulation, Circle will maintain the equivalent of one U.S. Dollar ($1) with its banking partners in Segregated Accounts….However, this does not guarantee that the value of one (1) USDC will always equal one U.S. Dollar ($1). ” What is the “equivalent” of one U.S. Dollar? On closer reading this means that a portion of the reserves are locked in approved investments

In the monthly auditor’s report from Grant Thornton LLC to reassure users, similar language is pervasive. They also tell us that they have verified the material evidence, presumably by going directly to the source, the commercial banks for the account details. However this presumption is not stated clearly, they dance around this in the auditor’s report. The audit is also delayed, the November 30th report was issued on December 16th. These arms-length audits are snapshots of a fast moving space, delivered with a significant delay. If you look at the USDC issued in the November report it is around $3Billion. The market cap of USDC on coinmarketcap on December 18th is $3.3B, a 10% increase in 15 days. 

Other People’s Money

Whenever any enterprise takes other people’s money; the regulators’ Spidey senses should start tingling. Especially if the money is sloshing around in omnibus segregated accounts controlled solely by the enterprise. These accounts are not protected by FDIC insurance. Since they are probably very large accounts, even if they are distributed, they are subject to the risk that the commercial bank may not be able to honor rapid withdrawal requests. This raises the question whether such issuance constitutes a shadow bank, as the STABLEAct contends. There is one major difference, stablecoin issuers cannot create loans in USD like commercial banks, creating money out of thin air. Hence the requirement that stablecoin issuers need a banking charter is probably overreach. 

When regulations established about two hundred years ago are used to control emergent behavior in the name of protecting customers, there are missteps. The provision of FDIC insurance to protect customers seems sane. This insurance cannot be provided for omnibus accounts, held in the name of the stablecoin issuer. FDIC Insurance cannot be provided without the banking charter, regulation by the FDIC, the FED and regulatory agencies and a reserve account at the Fed. This regulatory system grew organically over the years and contains contradictions. Chartered commercial banks are comfortable existing in this universe where they have grown and existed. Under the STABLEAct, all existing chartered banks can issue stablecoins with adequate time and preparation. 

The STABLEAct, similar to the initial bitlicense guarantees the status quo. This cannot be the intention of the most progressive members who have introduced this legislation. There has to be a way to pass through FDIC insurance to the beneficial owners of these USD deposits. Which are the customers who provided the initial funds, the provenance of whose USDC can be traced to the redeemers, since only approved USDC wallets can be used for these transfers. This will provide for a form of proto-reserve account held at a commercial bank. However, this requires a rethink of regulation, not the blanket reanimation of the banking act from before the Civil War.  The administrative burden can be eased by integrating technology into regulation, more to do with the spirit and not the letter of the law. More technologists need to be engaged, not just lawyers in the creation of sane regulation, not regulation that is too late and not fit for purpose. 

Stablecoin issuers are aware that more transparency and rational engagement with regulators are needed. Witness the latest action by the Centre consortium who oversee USDC, Centre is a joint creation of Coinbase and Circle. Both deep-pocketed startups. Centre hired David Pugh, lately of an enterprise which was regulated by more than 27 central banks, an experienced communicator. This signals that is ready to engage with regulators.

In 2021, unfettered technological growth and leverage is going to come under greater scrutiny. From the definition of platforms and price based Anti-Trust laws for the biggest enterprises in the world like Facebook, Amazon AMZN , Google GOOG and Apple AAPL to the much smaller crypto-currency universe, legislators, regulators and the public are circling. The question will be how to create a more level playing field and protect consumers. Proposals for the breakup of behemoths echo the actions against Standard Oil more than a century ago. In 2021, actions against fintech innovation will involve moderating the advantages enjoyed by unregulated entities without killing innovation and new ideas dead. It will be better for the public, if regulators and technologists and entrepreneurs engaged in a rational conversation, but if prior events are a guide, this might be hoping for too much.


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