Between the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), the Financial Crimes Enforcement Network (FinCEN), the Internal Revenue Service (IRS), the Department of the Treasury, the Federal Trade Commission (FTC) and the Office of the Comptroller of the Currency (OCC), the United States has a gigantic tangle of regulators each presiding over portions of the financial markets, banking, currencies, taxation and investor protection. 

Marshalling this network of national regulators to come to firm decisions on cryptocurrency over the years has been as difficult as herding cats. 

And so it is with no little trepidation that crypto market watchers see the Biden administration pushing ahead, with stablecoins first in the spotlight for regulation. 

As the Wall Street Journal reported on 25 September 2021, regulators see potential systemic financial risks from stablecoins like Tether (USDT), Pax Dollar (USDP) and Circle’s USD Coin (USDC). 

“I have seen one fool’s gold rush from up close in the lead-up to the 2008 financial crisis,” said Michael Hsu, acting comptroller of the currency at the OCC. “It feels like we may be on the cusp of another with cryptocurrencies.”

Hsu, of course, is referring to the way that money market mutual funds were overwhelmed by outflows as investors fled for the exits, in a frightening time when the banking system seemed on the verge of collapse. 13 years ago this month, in September 2008, the Reserve Primary Fund — which held $750m in commercial paper issued by Lehman Brothers — told markets its peg to the dollar had failed. Drawdowns from the biggest money market funds totalled $300bn in a matter of days. 

If the same were to happen with stablecoins, regulators argue, and investors start pulling money out of the market in such numbers, the fallout could infect markets in the same way as that crisis of investor confidence. 

The US government was forced to prop up these funds, both in 2008 and in 2020 in response to Covid-19: would it do the same and back Tether, or Circle?

Flight to safety

Stablecoins tend to be backed by ‘safe’ assets like US Treasuries (government debt). Hence they maintain a strong peg to the dollar and should be easily redeemable for the same. But the equivalent of a crypto-era bank run, where large numbers of investors suddenly rush to redeem USDT or USDC for US dollars, would force issuers like Tether to sell underlying assets at bargain basement prices. 

If something investors tend to trade that is considered as ‘safe’ as cash in the bank, like money market mutual funds, can fail — as they did in 2008 and 2020 — what future does this pose for stablecoins?

Tether’s woes and the obfuscation around its reserves that has earned it the ire of regulators have been well-covered both in the crypto press and more traditional papers. But something more concrete appears to be on the horizon. In recent days, the SEC has hinted at a large-scale probe of Tether by denying a Freedom of Information Act request for information, citing a law enforcement exemption, Coindesk’s Nikilish De reported.

At $2 trillion dollars, the total crypto market cap is approximately the same as the value of all US dollars in circulation. 

At the same time, stablecoin usage has surged: in 2021 alone, dollar-pegged stablecoins like Tether, USD Coin and Pax Dollar have jumped from $30bn in circulation to around $125bn.   

Regulators fear that they are not particularly stable despite the name, and a run on these digital currencies could cause a contagious collapse that would threaten the economic stability of the United States, and world economies more broadly. 

Factor it in

There are a huge number of complicating factors in how the US regulates cryptocurrencies, cryptoassets, and stablecoins. Firstly, we have central bank digital currencies coming to prominence. Secondly, America now has neighbours to the south trying to decouple the US dollar from their economy in favour of Bitcoin, namely El Salvador. 

For nearly six decades, the US has imposed a trade embargo on Cuba, hugely restricting the goods that can be exported to the island. In September 2021, perhaps emboldened by Salvadoran President Nayib Bukele, the Cuban central bank recognised cryptocurrencies; a landmark move which will have vast geopolitical implications. 

It is true that Bitcoin has had destabilising effects on the world economy. How could it not? 

It has a still-unknown cryptography genius, Satoshi Nakamoto, as its creator.

It has enriched a small group of early adopters and made them billionaires. It has turned programmers into business leaders and folk heroes: see Vitalik Buterin on TIME magazine’s list of the Most Influential People of 2021, for example. 

And then there’s the China angle.

East vs West

The US has one main superpower rival in China. And Xi Jinping’s government has shocked markets, firstly by instituting a summer 2021 crackdown on Bitcoin mining, and now by banning all cryptocurrency transactions declaring digital currencies effectively illegal. 

Wider tensions remain: US allies in the UK and Australia that have signed up to a trilateral security agreement - Aukus — in order to combat China’s military might with nuclear submarines. The Guardian wrote of the September 2021 arrangement: “There was no doubt that the initiative was a response to China’s expansionist drive in the South China Sea and increasing belligerence towards Taiwan.”

China is the US’s second-largest foreign creditor, having spent decades buying up $1.1 trillion of government debt. Having a rival nation owning around 4% of the $28 trillion US national debt is a clear and present security risk. 

Could, then, aligning the US as the home of cryptocurrency and all the future wealth that such a position portends, offer the States an economic advantage against the Eastern superpower?

Regulators roll out

National-level US cryptocurrency laws have been a long time coming. But at a state level, regulators have moved remarkably quickly. In 2015, New York became the first state to regulate digital currency companies with the BitLicense. 

With a GDP of approximately $1.75 trillion, if the state of New York were an independent nation, it would rank the 8th largest in the world. That’s larger than Canada, South Korea, Russia or Australia. That means its financial decisions echo throughout the world. 

Other states have followed with their own methods of attracting crypto businesses: specifically Wyoming, which was the first to license crypto banking facilities. 

At the same time, many agencies have cautioned against overzealous regulation, which would naturally dampen investor enthusiasm at home, and drive capital and technological developments overseas.

What is clear is this: we have long passed the point of no return. Bitcoin and cryptocurrencies are inextricably tied up with traditional financial markets, whether late-adopters or regulators like it or not.