Testimony of Hilary J. Allen, U.S. Senate Committee on Banking, Housing, and Urban Affairs Hearing on 'Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks?'
18 Pages Posted: 27 Dec 2021
Date Written: December 14, 2021
The rise of crypto poses very real risks for financial stability, which I have explored at length in research that I would be happy to share with the Committee. In considering its response to crypto, I submit that Congress’s most important goal should be to ensure that crypto does not cause a financial crisis. Proponents of crypto often cite the industry’s potential to create jobs and improve financial inclusion, but financial crises destroy jobs and exacerbate inequality – including for people who never invested in crypto in the first place.
A “stablecoin” is a relatively new form of crypto asset. Stablecoins try to avoid the volatility associated with cryptocurrencies like Bitcoin by pegging their value to the US Dollar (or some other fiat currency). In November of this year, the President’s Working Group on Financial Markets released a report on stablecoins (the “PWG Report”) that identified a number of risks associated with stablecoins, and made three recommendations for addressing those risks. The PWG Report’s first recommendation reads as follows:
To address risks to stablecoin users and guard against stablecoin runs, legislation should require stablecoin issuers to be insured depository institutions, which are subject to appropriate supervision and regulation, at the depository institution and the holding company level.
In this statement, I will set out why I share the PWG’s general concerns about crypto and financial stability, but disagree with this specific recommendation. In short, stablecoins are not really being used to make payments for real-world goods and services. Instead, the primary use of stablecoins is to support the DeFi ecosystem. DeFi is a type of shadow banking system with fragilities that could – if DeFi reaches significant scale – disrupt our real economy. If lawmakers and regulators treat stablecoins as regulated banking products, that will lend legitimacy to and inspire confidence in stablecoins in a way that is likely to turbocharge the growth of DeFi. While stablecoins do have structural fragilities that may make them vulnerable to runs, the incidence and costs of stablecoin runs can be addressed by other policies that are less likely to encourage the growth of DeFi.
At the conclusion of this statement, I will summarize some of the policy options available to Congress in responding to stablecoins. These policy options range from an outright ban on stablecoins, through a licensing regime for stablecoins, to a multifaceted approach that uses aspects of securities law, antitrust, financial stability regulation, and banking law to respond to stablecoins’ risks. While any regulation will inevitably create some barriers to innovation, this is a necessary trade-off when dealing with money and finance. Use cases for stablecoins and DeFi are often explained with analogies to other digital services – “send money as easily as sending a photograph”, or “send money just like sending an email” – but these analogies underestimate the stakes involved. Because money and finance are the lifeblood of our economy, finance has always been highly regulated in a way that Kodak’s provision of photographs, and FedEx’s delivery of couriered letters, never were.
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