Cypherpunks don’t have to love centralized, censorable dollar tokens. But make no mistake—trusted stablecoins would be incredibly bullish for real crypto.
Posted April 18, 2024 at 2:43 pm EST.
A new stablecoin bill proposed in the U.S. Senate embodies the duality of regulation: though its immediate purpose is to put up guardrails around one segment of the blockchain-based financial system, the bill’s ultimate effect would be to legitimize and even “supercharge” the crypto world as a whole.
The new Lummis-Gillibrand bill would establish basic definitions, custody and redemption requirements, and regulatory responsibilities for perhaps the least controversial or innovative branch of crypto: deposit-backed USD stablecoins like Tether’s USDT and Circle’s USDC. Hardcore cypherpunks and Bitcoin maximalists have been broadly dismissive of the fully centralized, bank-dependent, and centralized nature of these instruments.
But the same features that make stablecoins boring for crypto natives make them comprehensible, and even appealing, to lawmakers. Unlike for bitcoin, there’s actually someone to prosecute if something goes wrong with a stablecoin. It’s very easy for OFAC or other entities to get a stablecoin issuer to cut bad actors out of the system. Additionally, it may finally be getting through to lawmakers that stablecoins are a powerful way to expand global demand for U.S. dollars, a key (if rarely openly acknowledged) American strategic goal.
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Of course, on its face, all of these features go against crypto-native priorities like self-custody, getting rid of financial intermediaries, and letting individuals transact freely across borders. If cryptocurrency wound up being about nothing but fiat-based stablecoins, it would be a disappointing outcome for the decades-long quest for decentralized digital money.
But that’s not what stablecoin regulation would actually lead to. Instead, it’s a huge boon for the crypto world, and that’s according to one of its most strident critics: Elizabeth Warren predicted in a recent letter to Treasury Secretary Janet Yellen that formalizing stablecoin oversight would “supercharge” crypto activity – although Warren of course sees this as a negative, pointing to increasing the opportunities for terrorists to evade sanctions and receive untraceable income.
Dollars Working Overtime
On the most basic level, a regulated stablecoin regime would mean holders worldwide could enjoy U.S.-quality regulation for self-custodied dollars. It’s hard to overstate just how enticing this would be, particularly for those in the developing world or conflict areas. The added trust could trigger a global surge in everyday people holding digital dollars, and a rapid improvement in UX and other aspects of crypto-oriented software and products.
We’re not talking about just any old digital dollars: formal regulation could take a huge bite out of Tether, the offshore dollar stablecoin issuer. Rightly or wrongly, many both within and outside of crypto have major misgivings about Tether’s stability and activities. While some of Tether’s backing is held by American firm Cantor Fitzgerald, the issuer itself – which still doesn’t even have a clearly-defined regulatory domicile—would face major headwinds in passing the regulatory hurdles to operate under a bill like Lummis-Gillibrand. If Tether couldn’t qualify, U.S. based custodial crypto exchanges and services would no longer be able to touch it, marginalizing the USDT stablecoin.
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More demand for digital dollars would in turn create more demand for native crypto assets in several ways. Most obviously, stablecoins are heavily used by crypto traders, so regulation would actually create a more solid backstop for even the most degen of the crypto degens. Even more fundamentally, these stablecoins will still move on decentralized, public-blockchain rails, and the fees for those transactions are ultimately paid for in native assets like ETH, AVAX, or SOL, not in dollars.
That might not be a huge new source of chain revenue, but it would create a direct tie from U.S. Treasury demand to the health of public blockchains. It’s Elizabeth Warren’s worst nightmare: once custodians start making money from managing dollars that move on blockchains, they’re going to be more invested in sensible regulation of the crypto assets that secure them. To put it another way, it’s hard to envision a future where Congress passes regulation for stablecoins on Ethereum, but the main venue for buying ETH – Coinbase – remains in a quasi-legal gray area, under the baleful gaze of the SEC.
For users, the inherent appeal of regulated U.S. stablecoins could also be the on-ramp to other blockchain-native services. For example, USDC holders abroad might just keep their stablecoins in a simple wallet for savings and payments – but they’d also have near-frictionless access to lending protocols and other advanced smart-contract services. Some of these, of course, will be fragile or fraudulent, and at that point regulators around the world will likely face pressure to better oversee those products, too – again, legitimizing “DeFi” as much as hemming it in.
‘They Hit The Right Macro Notes’
As for the details of the Lummis-Gillibrand bill, reactions have been mixed to positive.
“They hit some of the right macro notes, but the bill has a lot of technical implementation issues to work through,” says Austin Campbell, formerly an asset and risk manager for stablecoin issuer Paxos. “It also makes a big judgment call on non-fiat backed stablecoins that might be unnecessary, or at least unnecessary to the extent they’ve gone after them.”
Campbell is referring to the bill’s ban on the issuance of “algorithmic payment stablecoins,” which it defines in part as “[using] an algorithm that adjusts the supply of the crypto asset in response to changes in market demand for the crypto asset.”
Read more: As Ethena’s USDe Quickly Reaches $2 Billion in Market Cap, Some Wonder If It’s as Risky as Terra’s UST
This provision is a specific reaction to the collapse of Luna’s UST stablecoin in 2022. However, some worry that the language could impact instruments like DAI or Ethena that don’t use 1:1 dollar backing, but also aren’t nearly as risky as Luna’s Rube Goldberg nightmare. Personally, I can’t say I object to the caution—there are risks even in DAI and Ethena, and making it harder to confuse those tokens with actual dollars doesn’t seem so bad.
The other provision of the Lummis-Gillibrand bill that’s getting the most attention is a limit of $10 billion on the amount of stables that can be issued by “non-depository trust institutions.” Some see this as aimed at keeping tech companies from issuing stablecoins, which seems correct—remember the universal fury when Facebook started talking about issuing its own stablecoin in 2019. But the provision would be a headache for Circle, currently the largest U.S.-based issuer at $33 billion, and not a depository bank.
Those and other wrinkles certainly deserve debate. But more importantly, serious progress towards broadly acceptable stablecoin regulation is already a big legitimizing moment for crypto. When it passes, it will be the thin end of a wedge that opens the door to much, much bigger things.
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