Money on the Roundtable: Part I
How and Why the U.S. Should Embrace Stablecoins and Dollar Dominance on the Blockchain through the FDIC
This is Part I of a multi-part series that proposes a winning strategy for U.S. policymakers and the dollar-denominated global economy through the FDIC.
Comprehensive stablecoin regulation has eluded the members of the western world, and the multilateral, rules-based framework built over the past century was not designed to accommodate privately-issued money with a supply that changes in a constant, permissionless way. Instead of adopting a strong-arm containment strategy for stablecoins, the West should embrace these tokens to continue its international monetary dominance and counter attempts by the BRICS to undermine western influence through recent initiatives like Central Bank Digital Currencies (“CBDCs”) and digital cross-border payment solutions. These efforts by BRICS are underscored by an eroding petrodollar system as oil-exporting states like Saudi Arabia and the UAE begin accepting other currencies as payment for their chief export. The dollar will need to strategically diversify its trading pairs using digital assets like privately-issued stablecoins, which will become more relevant as economies move on-chain, the sovereign currencies of western allies become more volatile, and global green-energy initiatives decrease the influence of non-synthetic oil.
The proliferation of privately-issued stablecoins offer a way for the United States to lead the way in embracing the potential of blockchain technology, which can facilitate more efficient exchanges and payments, lower transaction fees, and more transparent monetary policy without unfairly compromising on western concepts like democratic governance, property rights, and privacy. Unfortunately, many attempts to clarify the regulatory status of privately-issued stablecoins have expressed annoyance that the standard global reserve currency, USD, is also considered the default settlement unit for decentralized finance applications, commonly referred to as “DeFi.” Although there are many examples of bad actors who have exploited this technology, the public ledgers used in blockchain can be used to prevent continued exploitation and allow crimes to be better understood through forensic technology pioneered by firms like Chainalysis. In time, these exploits will happen less often as bad actors realize it is harder to get away with crimes on the blockchain than when using untraced commodities or cash.
When it comes to bringing stablecoins to the table, the U.S. should take a leading role by offering Federal Deposit Insurance Corporation (“FDIC”) coverage to U.S.-based stablecoin issuers and their account holders. In exchange for coverage by one of the most reliable depositor insurance programs in the world, issuers would have to comply with simplified AML/KYC regulations tailored to the best traits of this new technology. Such a regulatory regime would show a good faith effort to come to the table with the young, promising cryptocurrency industry, prevent young talent from moving offshore to pursue new blockchain-based projects, and establish a path by which stablecoin issuers can reap the benefits of being legitimate participants in the western economy. It would also serve as a means of facilitating a reasonable differentiation between U.S.-based account-holders and participants of Eurodollar-type systems who would benefit from dollar stability and blockchain-based dollar efficiencies but cannot or should not be a direct participant in the U.S. banking system.
UNDERSTANDING NEARLY 100 YEARS OF THE FDIC
This potential use case for FDIC coverage bears a striking resemblance to the original circumstances that gave rise to it. The FDIC was established on June 16, 1933 through the Glass-Steagall Act as a coordinated policy response to the Great Depression and the widespread bank failures of that era. Certain people claim that we are living in an everything-but-official “silent depression,” and whether these observations are true it should be concerning to all that our private banking system, formerly the pride of the capitalist world order, is the most centralized it has ever been thanks to mergers and a concerning streak of bank failures over the past 20 years. The FDIC’s primary purpose then, as it is now, is to bolster confidence in the U.S. banking system by providing deposit insurance to bank customers in order to prevent bank runs and protects depositors’ funds. It can renew this purpose for the modern era by increasing the resiliency of dollar deposits for compliant stablecoin issuers that can replace the traditional banks of our formerly healthy and diversified banking system.
The FDIC has been resilient and capable of adapting to change, providing changes to protect the resiliency of our monetary and banking system in the wake of the Great Inflation of the 1970’s with the Financial Institutions Reform, Recovery, and Enforcement Act (“FIRREA”) in 1980, which expanded the FDIC’s powers and increased the deposit insurance limit to $100,000 per account holder. Seven years later, FIRREA was expanded by the creation of the Savings Association Insurance Fund (“SAIF”), which insured deposits in savings and loan associations. Savings and loan organizations are particularly vulnerable to changes in interest rate policy and the real estate market. As a result, a crisis emerged which the FDIC dealt with in 1991 with the establishment of the Resolution Trust Corporation (“RTC”) to help manage and resolve failed thrift institutions.
During the 2008 Financial Crisis, one of the darkest periods in recent history for global financial stability, the FDIC yet again admirably and dutifully performed its role by managing and resolving the failed banks that littered the U.S. banking system. The FDIC also temporarily increased deposit insurance coverage limits and was given additional tools to stabilize the financial system. These efforts culminated in 2010 with the Dodd-Frank Wall Street Reform and Consumer Protection Act, which among other things strengthened the FDIC’s ability to resolve systematically important financial institutions (“SIFIs”) in an orderly manner.
The FDIC’s role is no less important today, examining banks and thrift institutions for compliance with banking laws and regulations and using its influence to maintain the stability and integrity of the U.S. banking system. It continues to offer insurance for deposits in banks and thrift institutions across the United States at $250,000 in coverage per account holder. This coverage is paid for by premiums collected from FDIC-insured banks in proportion to the size of their deposits and the level of risk associated with their activities, as well as interest earned on its portfolio of U.S. Treasury securities. The system is bolstered by a requirement that the agency keep at least 1.35% in reserves of the estimated insured deposits in the banks it insures, with an informal target of 2% to withstand serious economic downturns that can lead to higher levels of bank failures. Recently, the FDIC showed its quality by stating its intention to fully insure all customer deposits at Silicon Valley Bank, Signature Bank, and other recent bank failures as fears of contagion circulated. Since 1933, no depositor has lost a single cent of FDIC-insured money.
THE NEXT 100 YEARS: BRINGING STABLECOINS TO THE TABLE
Regulatory agencies have to come to terms with cryptocurrency technology, and the FDIC is no exception. This technology will continue to proliferate and function, in testament to its core ethos of unbiased, decentralized service. In its mission to maintain the stability of the U.S. financial and banking system, the FDIC will need to consider its interactions with the crypto ecosystem and seek compliance with the March 2022 executive order by President Biden, which tasked the agency with pursuing innovation and cost savings opportunities as well as developing and implementing strategies to manage risks regarding digital assets. Although an extension was granted in October, the Office of the Inspector General (“OIG”) considered FDIC’s assessment of the “significance and potential impact of the risks” effectively incomplete, resulting in confusion among FDIC-supervised institutions and a chilling of activity around digital assets in the U.S. If the FDIC wants to pursue meaningful progress and allow progress to continue in the institutions they regulate, they can rely on existing policy, provide updated guidance to institutions, and apply it to the parties championing this technology, who will be grateful for a rare example of clarity on crypto policy in the United States. The most immediate and proximate win the agency can pursue is a comprehensive path to compliance for privately-issued U.S. dollar stablecoins and their issuers.
When compared to cash, stablecoins are much better at preventing illicit transactions and preventing future crimes by bad actors. Privately-issued stablecoins like USDC and USDT rely on the same distributed ledger technology (“DLT”) used by decentralized cryptocurrency systems like Bitcoin, but can be hailed to account by established methods of legal process due to management by a centralized entity that is the sole source of new U.S. dollar-denominated tokens. This ability to trace token transactions by anyone with an internet browser, paired with the ability to directly contact the issuer of these tokens, has allowed forensic firms and enforcement agencies to work with stablecoin issuers like Circle and Tether (issuers of USDC and USDT, respectively) to identify and freeze on-chain accounts related to illicit activity.
This level of control over dollar-denominated transactions is unprecedented when considering the disparity between the amount of money laundered globally using traditional cash as opposed to cryptocurrency. In fact, notwithstanding the use of double-encrypted cryptocurrencies like Monero by ransomware attackers, many illicit organizations have explicitly denounced the use of crypto due to its ability to be traced by forensic tools, firms, and services like Chainalysis. Despite the fact that the current generation of stablecoins are revocably permissionless, illicit activity only accounts for less than 1% of cryptocurrency transactions (compared to 2–3% of illicit activity in the traditional banking system), and of those the majority come from scams rather than terrorism, funding sanctioned actors, or other major forms of international criminal violations.
Given the lack of illicit activity in crypto compared to the traditional banking system, the on-chain value proposition for the U.S. monetary system cannot be ignored — Chainalysis data shows that more than half of all on-chain transaction volume to or from centralized services between June 2023 and July 2022 took place in stablecoins, with more than 90% of stablecoin activity takes place in stablecoins pegged to the U.S. dollar. A 2020 Rand Corporation report estimated that “99% of cryptocurrency transactions are performed through centralized exchanges, which can be subject to AML/CFT regulation similar to traditional banks or exhanges.” Unfortunately, the current trend shows that over half of these transactions are being directed to non-U.S. licensed exchanges as a result of the unclear domestic regulatory landscape and fearmongering by legislators supported by the traditional banking system.
As a form of cash, stablecoins are superior both for consumers due to their low cost and latency and for enforcement agencies due to their traceability and ability to be frozen, but current regulations are so unclear that they are almost a deterrent for proactive compliance by token issuers. In the 2023 Geography of Cryptocurrency Report by Chainalysis, Jason Somensatto, Head of North America Public Policy at Chainalysis, discussed a clear advantage that stablecoins — and all cryptocurrencies — provide when compared with fiat currency. “The inherent transparency of blockchain technology empowers global regulators, including those in the U.S., to investigate and combat illicit activities efficiently,” he said. “This North America 15 transparency can also enhance the enforcement of sanctions, allowing participants throughout the crypto ecosystem to screen for and detect activities involving sanctioned entities.”
In terms of compliance, the FDIC should provide a viable path toward FDIC coverage for issuers and token-holders by requiring that issuers hold a minimum amount of auditable reserves held in U.S. dollars and/or Treasuries as a ratio of the total amount of issued stablecoins, which themselves can be audited by the public using on-chain forensics tools. Stablecoin holders based in the U.S. can make claims for coverage directly through the issuer or alternately through the FDIC if attempts via the direct method have been exhausted. Under this proposed regime, stablecoin issuers would still be free to offer non-KYC/AML blockchain products, but they would presumably be valued less without the substantive protections of the FDIC and the benefit of being part of the U.S. banking system. By offering a voluntary path to compliance, the U.S. would show its commitment to principles of free trade and international cooperation, and promoting economic partners like the U.K. in the process, which has decided to not prohibit overseas stablecoins to be used for domestic payments since enabling this type of competition “may bring benefits of greater consumer choice.”
Compliant stablecoin issuers could also presumably be first in line to offer direct on-chain access to a tokenized Treasury Bond product to their customers, which would also increase global marketability for US T-Bills. These could easily be built on the same rails being used in SWIFT’s partnership with Chainlink. This technology could also be used to allow for more direct relationships between stablecoin account holders and FDIC, either relying on stablecoin issuers to pay premiums on their behalf or removing the need for a middleman altogether.
Naturally, the Federal Reserve will want to maintain a healthy amount of control over the money supply, but their interests of maintaining the health of the economy would be served by making the banking system more decentralized without compromising on depositor protections. Rather than putting all our eggs in one basket, the dollar could be buoyed by multiple secure systems and diverse standards for institutional risk tolerance.
In the meantime, several proposed stablecoin bills have been introduced, including the Clarity for Payment Stablecoins Act and the Responsible Financial Innovation Act. It is unclear whether either of these bills will gain traction or whether a new contender will rise from the congressional lawmaking process, but timely action is imperative to prevent further offshoring of the dollar while the on-chain economy grows and develops new systems for a new, technocratic system of free trade.
Stay tuned for Part II — Eurodollar 2.0: Exporting Dollar Stability Beyond the West
