WASHINGTON, DC – The crypto sector and some of Wall Street’s financial giants are sprinting to put stablecoin infrastructure in place well before U.S. watchdogs set their rules, and Federal Reserve Governor Michael Barr took a moment Thursday to remind industry legal experts of the dangers posed by nominally safe assets.
“Issuing liquid liabilities that are redeemable at par but backed by assets, even high-quality ones, that creditors may have questions about, leaves private money vulnerable to risk,” Barr said at a DC Fintech Week event in Washington, pointing out that permitted reserves such as uninsured deposits can pose dangers.
He was the Fed’s top official in financial supervision as the board’s former vice president in that role, but he stepped down when President Donald Trump’s administration arrived. The digital assets sector saw Barr as part of the “debanking” trend, with industry insiders accusing banking regulators of encouraging banks to walk away from their businesses, and the Fed and other US regulators recently reversing the more restrictive crypto policy stance they had taken during his tenure.
But Barr remains on the seven-member Fed board and warned the agencies writing stablecoin rules — including his own — about “the long and painful history of private money created with inadequate safeguards.”
Barr offered the US experience with money market funds as an example, noting that the Reserve Primary Fund “broke money” – falling from its value of $1 per share. share – in 2008, when the global financial crisis started, and how the more recent covid pandemic put pressure on such funds again.
Despite the passage of the Guiding and Establishing National Innovation for US Stablecoins (GENIUS) Act, banking regulators have yet to write the rules they need to implement it, leaving the industry in something of an unregulated gray area. While this continues, the world’s leading stablecoin, Tether’s USDT, is being run offshore and under a reserve approach that would not qualify against the pending US standard (although Tether is also planning full access to US markets).
“Stablecoin issuers traditionally retain profits from investing reserve assets and therefore have a high incentive to maximize the return on their reserve assets by extending the risk spectrum as far as possible,” noted Barr. “Stretching the limits of allowable reserve assets can boost profits in good times, but risks a dent in confidence during inevitable bouts of market stress.”
“For the most part, I agree with everything he says,” said Corey Then, vice president and vice director of global policy at Circle, the issuer of USDC, the leading US-based stablecoin.
“There’s a lot of work to be done in the rulemaking process,” the Circle executive said at the same Washington event, taking the stage right after Barr. “The last thing we want at Circle is a permissive environment.”
Barr highlighted the inclusion of uninsured deposits as potential reserves for issuers under GENIUS, noting that they were “a key risk factor during the March 2023 banking stress.” He also pointed to the so-called “overnight repo” as a reserve component that “could include potentially volatile assets.”
During the 2023 crisis among tech-centric US banks, Circle held as much as 8% of its reserves at failing Silicon Valley Bank, worth more than $3 billion, causing a rush to redeem USDC, pushing it temporarily out of its dollar peg. Other high-profile stablecoins have also strayed from the peg, including in the 2022 implosion of Terra’s UST.
Barr offered a GENIUS Act hypothetical, suggesting that because bitcoin has been legal tender in El Salvador, a case could be made for bitcoin repo as a legitimate reserve asset.
Federal and state regulators need to write “a comprehensive set of rules that can fill important gaps and ensure that robust guardrails are in place to protect users of stablecoins and mitigate broader risks to the financial system,” Barr said.
Still, because issuers may be regulated across a spectrum of government agencies at both the federal and state levels, he warned of the risk of arbitrage, where issuers trade for the easiest watchdog, despite the GENIUS Act’s intent that they are substantially the same.
In the 2008 meltdown, American International Group’s risky financial products arm was famously overseen by a weaker federal regulator—the Office of Thrift Supervision—and much of its other operations by a variety of state regulators, resulting in undetected dangers that eventually threatened the broader financial system. (OTS was subsequently disbanded.)
Read more: Tether CEO says he’ll comply with GENIUS to come to US, Circle says it’s set now
