The Federal Reserve Board’s most recent semi-annual Financial Stability Report, issued November 15, 2019, includes a lengthy discussion of potential systemic risks posed by stablecoins. In the report, the Fed observed that innovations fostering faster, cheaper and more inclusive payments could complement existing payment systems and improve consumer welfare if appropriately designed and regulated. But the Fed also warned that the emergence of global stablecoin payment networks introduces important challenges and risks related to financial stability, monetary policy, money laundering and terrorist financing, and consumer and investor protection.
For purposes of the report, the Fed defined stablecoins as a form of cryptocurrency whose value is supposed to be tied to an underlying asset or basket of assets. Noncollateralized stablecoins, such as those that are algorithmic, are outside the scope of the Fed’s discussion. From the Fed’s perspective, stablecoins attempt to address volatility in other cryptocurrencies (such as bitcoin) by seeking to tie their value to an asset (for example, domestic currency) or a basket of assets (for example, a portfolio of sovereign currencies). The Fed also noted that stablecoin initiatives that are built on existing large and cross-border customer networks, such as Libra, have the potential to rapidly achieve widespread adoption.
Stablecoins could become a new medium of exchange, but, if poorly designed and unregulated, the Fed believes they could also negatively affect financial stability. For example, the inability to convert stablecoins into domestic currency on demand or to settle payments on time could create credit and liquidity dislocations in the economy. If a stablecoin’s credit, liquidity, market or operational risks are managed ineffectively, it could face a loss of confidence, which could in turn lead to a run, where many holders attempt to liquidate their stablecoins at the same time. In an extreme scenario, the Fed posits that holders may be unable to liquidate, with potentially severe consequences for domestic or international economic activity, asset prices and financial stability.
The Fed also expressed concern about the anonymity often found in stablecoins and its potential to obscure financial transparency or facilitate money laundering, terrorist financing and other financial crimes. Financial institutions are subject to customer due diligence and other anti-money-laundering regulations intended to help detect and disrupt illicit activity. According to the Fed, addressing such vulnerabilities is likewise critical for any stablecoin.
The Fed stated that as with any financial product, it is of utmost importance that consumers and investors understand how stablecoins work and are aware of the product’s relevant costs and fees, terms and conditions, and risks. According to the Fed, stablecoin issuers, operators and intermediaries should fully disclose the terms of their services. These disclosures should clearly detail consumer and investor rights and protections, including whether the holder of the stablecoin has any rights to the underlying asset. Similarly, the Fed believes issuers should be transparent as to how the stablecoin is tied to the underlying asset. The Fed believes holders must also be protected against erroneous and fraudulent transactions and receive recourse in the event of any unauthorized use. Additionally, holders’ data privacy must be appropriately protected.
Given the array of risks and unaddressed issues to date, the Fed concluded by noting that it and other regulators are cooperating closely to ensure that any stablecoin system with global scale and scope must address a core set of legal and regulatory challenges before it can operate. Citing a recent Group of Seven report on stablecoins, the Fed reiterated that “no global stablecoin project should begin operation until the legal, regulatory and oversight challenges and risks outlined [in this report] are adequately addressed, through appropriate designs and by adhering to regulation that is clear and proportionate to the risks.”