Treasury officials believe congressional action is “highly appropriate” this year to address the risks that the latest financial stability report underscores.

By Alan W. Avery, Pia Naib, and Deric Behar

On May 9, 2022, the Board of Governors of the Federal Reserve System (FRB) published its semi-annual Financial Stability Report (Report). The Report, which covers a variety of topics, briefly repeated some familiar warnings regarding digital assets and potential risks to the wider financial system. In particular, the FRB expressed concern about funding risks posed by stablecoins.

Some of the notable points on stablecoins include:

  • The stablecoin sector remains highly concentrated, with the three largest stablecoin issuers constituting more than 80% of the total market value.
  • The stablecoin sector remains exposed to liquidity risks and is vulnerable to runs.
  • Vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins.
  • The increasing use of stablecoins to meet margin requirements for levered trading in other cryptocurrencies may amplify volatility in demand for stablecoins and heighten redemption risks.

President’s Working Group Report on Stablecoins

The sentiments expressed in the Report reiterate the themes in the November 1, 2021, President’s Working Group on Financial Markets Report on Stablecoins, published in conjunction with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency (Stablecoin Report). The Stablecoin Report highlighted the various risks that stablecoins pose to better ascertain when agencies such as the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Financial Action Task Force have a handle on those risks, and when further action is needed by legislative means or regulatory authorities. At the top of the list of recommendations was the need for Congress to “act promptly to enact legislation to ensure that payment stablecoins and payment stablecoin arrangements are subject to a federal framework on a consistent and comprehensive basis.” As we noted in our blog on the Stablecoin Report, there is a risk that in the absence of any congressional action, the disparate patchwork of regulatory oversight leaves markets vulnerable to the numerous risks and regulatory gaps delineated in the Stablecoin Report.

Treasury Officials Speak Up

Nellie Liang, the US Treasury Department’s Under Secretary for Domestic Finance, spoke about the risks that stablecoins pose at an event hosted by the Federal Reserve Bank of Atlanta on the day the Report was released. She noted that stablecoins have the “potential to generate destabilizing runs” and introduce payment system risk into the financial system.

A day later, on May 10, 2022, Treasury Secretary Janet Yellen testified before the Senate Banking Committee to review the Report. On the topic of stablecoins, Secretary Yellen once again called on Congress to develop a “federal prudential framework on a consistent and comprehensive basis” and noted that the goal of passing stablecoin legislation in 2022 would be “highly appropriate.”