It’s Time to Regulate Stablecoins as Deposits and Require Their Issuers to Be FDIC-Insured Banks

By | January 10, 2022

 In November 2021, the President’s Working Group on Financial Markets (PWG) issued a report analyzing the rapid expansion and growing risks of the stablecoin market.[1]  Stablecoins are digital assets that claim to maintain a “stable” value with reference to a designated currency (typically the U.S. dollar) or some other asset, index, or formula.  PWG’s report concluded that stablecoins pose a wide range of potential dangers, including inflicting large losses on investors, destabilizing financial markets and the payments system, supporting money laundering, tax evasion, and other forms of illicit finance, and promoting dangerous concentrations of economic and financial power.  

PWG’s report called on Congress to pass legislation that would (i) require issuers of payment stablecoins to be banks insured by the Federal Deposit Insurance Corporation (FDIC), and (ii) “ensure that payment stablecoins are subject to appropriate federal prudential oversight on a consistent and comprehensive basis.”  PWG also recommended that federal agencies and the Financial Stability Oversight Council should use their “existing authorities” to “address risks associated with payment stablecoin arrangements . . . to the extent possible.”[2]

The volume of outstanding stablecoins has mushroomed during the past two years, growing from less than $6 billion in January 2020 to more than $150 billion in December 2021.  The rapid expansion of the stablecoin market has mirrored the explosive growth of all cryptocurrencies.  The total market capitalization of cryptocurrencies increased almost nine-fold – from $350 billion to $3 trillion – between September 2020 and November 2021.

At present, stablecoins are mainly used to make payments for trades in cryptocurrencies and to provide collateral for derivatives and lending transactions involving cryptocurrencies (including so-called DeFi transactions) .  However, technology companies are exploring a much broader range of potential uses for stablecoins, including their use as digital currencies for making purchases and sales of goods and services as well as other person-to-person payments.  In October, Facebook launched a “pilot” of its Novi digital currency wallet, which uses the Pax Dollar stablecoin as its first digital currency.  Novi enables customers to make person-to-person payments within and across national borders and is part of Facebook’s ambitious plan to become a major player in the global payments system.  Facebook intends to offer its proposed Diem stablecoin in Novi’s digital wallet as soon as Facebook receives regulatory approvals for Diem. 

Issuers and distributors of stablecoins are quickly becoming a new category of systemically important “shadow banks.”  Shadow banks provide functional substitutes for deposits (“shadow deposits”) and offer other financial services that mimic the activities of banks while avoiding compliance with federal laws that protect consumers and establish essential safeguards for the safety, soundness, and stability of our banking system.  The systemic significance of stablecoin issuers would increase exponentially if stablecoins became a widely-accepted medium of payment in consumer and commercial transactions.  Under those circumstances, stablecoins would become a systemically important form of “private money” comparable to money market funds, which do not have explicit government backing but rely on general expectations of government support during severe economic downturns or financial crises.

Federal agencies have not yet issued rules governing the creation and distribution of stablecoins.  PWG’s report calls on federal agencies and Congress to take immediate steps to establish a federal oversight regime that could respond effectively to the dangers created by stablecoins.  In my recent paper,[3] I strongly support three regulatory approaches that are recommended or suggested in PWG’s report.  

First, the Securities and Exchange Commission (SEC) should use its available powers to regulate stablecoins as “securities” in order to protect investors and securities markets.  However, the scope of the SEC’s authority to regulate stablecoins is not entirely clear.  In addition, federal securities laws do not provide adequate safeguards to control the systemic threats that stablecoins pose to financial stability and the payments system. 

Second, the Department of Justice (DOJ) should designate stablecoins as “deposits” and bring enforcement actions to prevent issuers and distributors of stablecoins from unlawfully receiving “deposits” in violation of Section 21(a) of the Glass-Steagall Act, 12 U.S.C. § 378(a).  Section 21(a) offers a promising avenue for regulatory action, but its provisions contain uncertainties and gaps and do not provide a complete remedy for the hazards created by stablecoins.  The most significant gap in Section 21(a) allows state (and possibly federal) banking authorities to charter special-purpose depository institutions that could issue and distribute stablecoins without obtaining deposit insurance from the FDIC.  

Third, Congress should adopt legislation mandating that all issuers and distributors of stablecoins must be FDIC-insured banks.  That requirement would compel stablecoin issuers and distributors and their parent companies to comply with federal laws that protect the safety, soundness, and stability of our banking system and obligate banks to operate in a manner consistent with the public interest.  Requiring stablecoin issuers and distributors to be FDIC-insured banks would also maintain the longstanding U.S. policy of separating banking and commerce, embodied in the Bank Holding Company Act (BHC Act).  Upholding that policy would prevent Facebook and other Big Tech firms from using stablecoin ventures as cornerstones for building huge shadow banking empires. 

The entry of Big Tech firms into the banking business would create a wide range of potential threats, including unfair competition, market dominance, predatory lending, abusive sharing of customer data and other violations of customer privacy rights, as well as the likelihood of systemic contagion across financial and nonfinancial sectors of our economy during financial crises and severe economic downturns.  The PWG Report correctly determined that “the combination of a stablecoin issuer or [digital] wallet provider and a commercial firm could lead to an excessive concentration of economic power,” which could “restrict access” to credit and other financial services and have “detrimental effects on competition.”[4]  

Our nation stands at a crossroads.  We can maintain the BHC Act’s policy of separating banking and commerce, thereby preserving (1) a financial sector that is not compromised by toxic conflicts of interest and (2) an economy and society that are not dominated and exploited by the overwhelming market power and political influence of giant banking-and-commercial conglomerates.  Or we can allow Facebook and other Big Tech firms to enter the banking business and leverage their stablecoin ventures to create massive shadow banking kingdoms.  In that event, Big Tech firms might well gain dominance over our banking industry and perpetrate the very evils that the BHC Act is designed to prevent.

The PWG’s report provides a welcome blueprint for urgently-needed actions by regulatory agencies and Congress.  The SEC should use its existing powers to regulate stablecoins as “securities” in order to protect investors and securities markets.  DOJ should designate stablecoins as “deposits” and bring enforcement actions to prevent issuers and distributors of stablecoins from violating Section 21(a) of the Glass-Steagall Act.  To overcome uncertainties and gaps in the authorities available to the SEC and DOJ, Congress should pass legislation requiring all issuers and distributors of stablecoins to be FDIC-insured banks.  The foregoing measures must be adopted to counteract the grave dangers that stablecoins pose to our society, financial system, and economy.

Arthur E. Wilmarth, Jr. is Professor Emeritus of Law at George Washington University Law School

This post is adapted from his recent paper with the same title, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4000795.

The views expressed in this post are those of the author and do not represent the views of the Global Financial Markets Center or Duke Law.


[1] President’s Working Group on Financial Markets et al., Report on Stablecoins (Nov. 2021), https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf.  

[2] Id. at 16, 18.

[3] Arthur E. Wilmarth, Jr., “It’s Time to Regulate Stablecoins as Deposits and Require Their Issuers to Be FDIC-Insured Banks” (Geo. Wash. Univ. Law Sch. Legal Stud. Working Paper No. 2022-01, Dec. 16, 2021), available at https://ssrn.com/abstract=4000795.   

[4] PWG Stablecoin Report, supra note 1, at 14.

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