The week of the terraUSD (UST) collapse was among the most painful weeks in crypto history – and one we’ll reckon with for a long time. It wrought havoc on the crypto market, resulting in billions of dollars in lost value. And while those in Washington, D.C., rightly debate next steps, a smart, thoughtful conversation around potential regulation is critical.
Stablecoins are a vital innovation, providing many benefits for users and a competitive advantage for the United States. Stablecoins improve efficiency in payments and transfers, reducing costs and accelerating settlement for businesses and consumers. They make the financial system more inclusive by offering open access to anyone, anywhere, regardless of their background or economic status. They can also advance U.S. geopolitical interests, strengthening global dollar dominance in the face of attempts by our adversaries – such as China and Russia – to undermine U.S. leadership in the financial system.
Jake Chervinsky is head of policy at the Blockchain Association.
As the name suggests, stablecoins are intended to be stable and reliable. In general, there are two broad categories of stablecoins: custodial and decentralized.
Custodial stablecoins are issued by a central administrator and backed by collateral held in a bank or other institution. They are usually fully collateralized: The issuer holds one dollar in the bank for every one dollar of stablecoins it issues. Custodial stablecoins represent the vast majority of total stablecoin volume and are very stable and reliable, provided the issuer is trustworthy and transparent.
Decentralized stablecoins are designed to address the fact that not all issuers are trustworthy or transparent. Their goal – much like the public blockchains that enable them – is to eliminate dependence on trusted intermediaries in the financial system, who often do more harm than good. They achieve that goal by producing stablecoins that seek to maintain their peg to the dollar through the operation of autonomous code rather than reliance on a central issuer. Instead of being backed by dollars in a bank, decentralized stablecoins are typically backed by other digital assets held programmatically as collateral on the blockchain.
Importantly, although custodial and decentralized stablecoins use different models, neither is fundamentally better or worse than the other. Each has unique properties – both benefits and risks – that combine to form a robust, competitive market characterized by consumer choice. We should support responsible innovation in both categories.
Unfortunately, UST was in a category of its own, relying solely on an algorithmic mechanism to maintain price stability with no collateral whatsoever, a risky model that many predicted might fail.
So, following this month’s events, how should policymakers respond?
First, as U.S. Treasury Secretary Janet Yellen indicated in congressional testimony on May 12, policymakers should follow the process set forth by President Joe Biden’s executive order (EO) earlier this year. The EO – directing federal agencies to study crypto and report on regulatory priorities and solutions – provides clear guidance on how to thoughtfully proceed on stablecoin regulation. That work is important and ongoing. With the help of input from industry stakeholders and trade groups like my employer, the Blockchain Association, policymakers should develop a strong understanding of the stablecoin space and the essential differences between various stablecoin designs. This is a necessary first step before effective regulation can be formulated.
Second, a bipartisan consensus should be developed in Congress. Immediately following UST’s collapse, Congress became entrenched on either side of the aisle over the issue. But as my colleague Kristin Smith recently wrote, crypto is too big for partisan politics. We need leaders on both sides of the aisle to come together and determine the best regulatory approach for crypto. As the President's Working Group on Financial Markets (PWG) recommended in its report on stablecoins last year, a regulatory solution must come from Congress – not from the regulatory agencies.
Third, new regulations should be adopted that are fit for the purpose. These policies must be balanced and consider the essential nature of dollar-dominated stablecoins to U.S. financial security in the coming decades. We need tailored regulatory frameworks that address the specific benefits and risks of stablecoins. For custodial stablecoins, Sen. Pat Toomey (R-Pa.) and Rep. Josh Gottheimer (D-N.J.) separately proposed tailored frameworks – great examples of smart regulatory approaches from both sides of the aisle in the Senate and House of Representatives. With time, we can develop similarly well-tailored frameworks for decentralized stablecoins, too.
Stablecoins present too big an opportunity for us to risk getting them wrong as a matter of policy. The U.S. is in a competitive international race to be the home of Web 3. It’s time for strategic thought and deliberate action. The future of the U.S. as a hub of global crypto innovation hangs in the balance.