US Fed’s New Crypto Team is after Unregulated Stablecoins

The Federal Reserve is planning to set a special team to oversee the regulation of cryptocurrencies.

Stablecoins are cryptocurrencies that maintain a constant value over a long period.

The Stablecoins face liquidity risk, market volatility risk, reputational risk, operational risks, and asset contagion risks.

The governments can create central bank digital currencies that compete with Stablecoins.

Keywords: Crypto regulation, cryptocurrency regulation, crypto regulators, cryptocurrency law, Federal Reserve cryptocurrency, CBDC, Liquidity risk, Market volatility risk, Reputational risk , Operational risks, Asset contagion risks

Introduction

Several governments including the United States are stepping up efforts to regulate cryptocurrencies in a bid to protect the consumers from risks affecting the sector. In this blog post we focus on the Fed’s possible oversight role on stablecoins and the major risks it aims to safeguard the crypto sector from.

Fed’s chairman calls for Stablecoin regulation

The United States is stepping up its effort to deal with the risks that exist in the cryptocurrency sector which can have a negative impact on the traditional financial as well. The risks inherent in cryptocurrencies and other digital assets can lead to financial loss on the part of the United States consumers.

In this context, the US Federal Reserve is exercising its oversight role on cryptocurrencies to reduce the effects of risks that may affect its citizens. Recently, the Central Bank announced that it is going to establish a “special team of experts” which will monitor the various developments taking place in the crypto sector.

This is because the US Federal Reserve is concerned about the risks which Stablecoins pose to its population. Nevertheless, the United States is cognisant of the economic transformational role which cryptocurrencies and other digital assets have on its economy.

US Federal Reserve to introduce a team of experts - Federal Reserve

When speaking at the Peterson Institute for International Economics in Washington on March 9, Michael Barr, Vice Chair for Supervision, said that the nation can realize the benefits of cryptocurrencies only if they operate within a crypto regulation framework.

According to Barr, the country should avoid “overregulating” the crypto sector which forestalls innovation. On the other hand, it should avoid “underegulation” which will “allow for substantial harm to households and the financial .” The current focus of the Federal Reserve is to provide financial stability as well as instill public confidence in the economy.

Read also: What Is The Impact On The Market, As The Federal Reserve Continues To Raise Interest Rates

The central bank is particularly concerned about Stablecoins which face various risks that can destabilize the financial sector. It contends that if Stablecoins go unregulated they will increase the risks that the public, businesses and the entire economy face.

Barr said, “Stablecoins, like other unregulated private money, could pose financial stability risks… In the absence of appropriate regulation, private money is subject to destabilizing runs, financial instability, and the potential for widespread economic harm.”

Basically, the Fed classifies Stablecoins as private money which pose financial risks. This is the reason why Barr said “I believe Congress should work expeditiously to pass much-needed legislation to bring Stablecoins, particularly those designed to serve as a means of payment, inside the prudential regulatory perimeter.”

For a long time, the Federal Reserve has shown its eagerness to protect the public from risks associated with cryptocurrencies and other digital assets. Nonetheless, by forming and supporting a special team that supervises the central bank it has shown its seriousness in curbing the risks that exist in the sector.

Meanwhile the central bank has promised to release more guidelines on the cryptocurrency regulation the country will craft and adopt.

Understanding Stablecoins

We have already talked about stablecoins, but what are they? A Stablecoin is a cryptocurrency that maintains a constant value over a long period. This is because most Stablecoins are backed by other assets such as precious minerals or fiat money. There are, however, other Stablecoins which are backed by cryptocurrencies.

Stablecoins - Developersk

Most Stablecoins on the market are backed by the United States dollar, meaning that they maintain a value of $1. It is important to note that we also have algorithmic Stablecoins whose values are determined by changes in their supply and demand.

Nonetheless, the underlying principle is that Stablecoins should have a constant price or value. As a result, people can use them to make payments. Tether USD (USDT) Binance USD, BUSD and True USD (TUSD) are examples of Stablecoins.

Insecurity with Stablecoins

Many people wonder how risky Stablecoins are since they maintain a certain value. Nevertheless, in reality Stablecoins face various risks which include asset contagion risk, financial stability and ic risks.

Read also: What Are Algorithmic Stablecoins?

Liquidity risk

There are times that Stablecoins may lose their pegs when investors sell them in large amounts. This may take place if the assets that back a certain cryptocurrency are illiquid such as treasury bonds. According to the Fed, “This mismatch in price and liquidity is a recipe for a classic bank run.”

Market volatility risk

Stablecoins can also face serious price volatility. For example, when a Stablecoin depegs, many investors may want to redeem it leading to high price fluctuations. Such a scenario may result in market uncertainty and financial losses.

Reputational risk

The depegging of a Stablecoin often results in a bad reputation for the entire market. In the end, Stablecoin issuers will fail to get new users leading to a low total market value.

Operational risks

Stablecoins, like any other cryptocurrencies, are susceptible to operational risks which include hacking and frauds. In most cases, there is no way the users can recover cryptocurrencies they lose through that. Sadly, crypto exchanges, digital wallets and other DeFi platforms cannot compensate the people who lose their cryptocurrencies.

Asset contagion risks

When there is liquidation of other cryptocurrencies most Stablecoins are affected in one way or the other. For example, when the value of a cryptocurrency that backs a certain Stablecoin decreases significantly that may lead to depegging or even an implosion of the related Stablecoin.

Do Stablecoins face the same risks?

Many crypto fans want to know if all Stablecoins face the same risks and impact. The truth is the risks the different Stablecoins face depend on various factors such as their designs and the assets that back them. For instance, the assets backed by less illiquid assets face different uncertainties than the ones that are supported by more liquid assets.

On the other hand, algorithmic Stablecoins face greater risks than those backed by liquid assets like fiat currencies. It is important to note that Stablecoins are truly stable if they are backed by fiat currency such as the United States dollar. Secondly, the stability of the Stablecoins depends on how the issuers manage their reserves. As an instance, most crypto backed Stablecoins maintain higher quantities of the base cryptocurrency than the set amount.

What should regulators do?

Crypto regulators can deal with Stablecoins in several ways depending on how they view them. National laws of different countries may put Stablecoins in various categories. For example, governments may treat Stablecoins as securities, banks or as mutual funds. Let’s consider these different scenarios.

Designating them as atically risky

Governments can classify Stablecoins as a atically risk payment . In this case, governments can take stricter oversight roles on them as they view them as a potential source of financial market turbulence. Nevertheless, governments can only categorize them as atically risky if they anticipate greater market threats than now. Of course, greater adoption of Stablecoins may increase the risks involved.

Treating Stablecoins as securities

Any government that treats Stablecoins as securities will call for disclosure of their activities. For example, that will require the issuers to provide annual financial reports and proofs of reserve.

Treating the Stablecoins as market mutual funds

Some experts believe that Stablecoins behave in the same manner as mutual funds that act as short term savings. Classifying them this way is reasonable as it is possible to redeem them in a short period.

Treating Stablecoins like banks

Due to their price stability some regulators view them like bank deposits. In that case, it becomes the responsibility of bank regulators to have oversight on them. That also means that deposit insurance will apply to them.

Creating competition between Stablecoins and central bank digital currency (CBDC)

Stablecoins can compete with central bank digital currencies (CBDC). If there are secure CBDC on the market consumers may prefer them over Stablecoins. Nonetheless, for CBDCs to compete with Stablecoins they should be free from tight government control and maintain high privacy in a way similar to what cryptocurrencies do.

Central Bank Digital currency - Fintecnews

What is the governments’ focus when overseeing Stablecoins?

Many experts believe that regulating cryptocurrency like Stablecoins will become successful if there is international cooperation. This may involve using similar or the same cryptocurrency law. Sadly, if there is oversight in a few countries, Stablecoins will move to regions where there is no crypto legislation.

Is crypto regulation bad?

There is no doubt that crypto regulation is good for the sector. They protect the investors as well as preventing fraudulent activities. Regulatory authorities can oversee crypto activities if there is suitable regulation.

Second, crypto regulation will reduce speculation in the market which leads to higher investor confidence. As a result, more long term investors will bring their financial resources in the sector.

Conclusion

The United States government, through the Federal Reserve, is catching up in crypto regulation through establishing a special team that will oversee cryptocurrency activities in the country. Currently, the United States’ special focus is on regulating Stablecoins.