Exploring Stablecoins: Why Congress Considers Regulating Them

Members of Congress are working to legislate guardrails for stablecoins, a unique form of cryptocurrency.

While a relatively new concept, stablecoins have exploded in popularity, leading lawmakers to seek regulation. Here’s what to know.

What stablecoins are

Stablecoins, while a form of cryptocurrency, differ in some major respects from traditional crypto assets, such as bitcoin and ether. The biggest difference is that while traditional cryptocurrencies can fluctuate wildly in price, that is not supposed to be the case with stablecoins.

For instance, in the past month, the value of one bitcoin has fluctuated between below $62,000 and as high as $73,000 — a difference of nearly 18%. On the other hand, stablecoins, such as Tether, USDC, and Dai, the three largest stablecoins by market capitalization, remain pegged at $1.

Stablecoins, which now make up a multibillion-dollar market, tie their value to an underlying asset, such as gold or fiat currency. The backing of assets is meant to ensure they don’t wildly fluctuate in value.

To maintain a stable value against the underlying asset, stablecoins are meant to be backed by reserves. So, if a stablecoin were to be tied one-to-one with the dollar, the entity behind that stablecoin should have $10 million in cash reserves in a bank as backing for 10 million stablecoins.

Other assets, such as precious metals, can also be used to back stablecoins. For instance, PAX Gold tokens, which were running at about $2,330 a piece on Tuesday, are backed one-to-one by fine troy ounces of gold, stored in LBMA vaults in London, according to the company.

“If you own PAXG, you own the underlying physical gold, held in custody by Paxos Trust Company,” PAX Gold said.

The popularity of stablecoins has exploded, leading to lawmakers wanting to establish legislative guardrails. Tether, for example, is now the third-largest cryptocurrency by market capitalization.

How they are used

Stablecoins are frequently used to buy or sell cryptocurrencies and other digital assets.

They are also used in more traditional exchange. For instance, while apps such as Venmo might work in the United States and the West, in developing countries, stablecoins could be seen as a viable way to exchange goods and services. Additionally, stablecoins can be used in cross-border payments.

Why they are being targeted

Recent years have seen huge failures of stablecoins and massive losses to investors holding the cryptocurrencies. Most notable was the 2022 collapse of stablecoin TerraUSD, which caused a chain reaction that wiped out $40 billion in crypto market value.

A major fear for stablecoins is that they might not have the reserves they claim to have. If that were to be the case, it could cause the value of the coin to untether from its target, for instance, $1, causing the entire issuer to melt down.

Members of both parties have responded by seeking legislation.

Legislative priorities

Rep. Patrick McHenry (R-NC), chairman of the House Financial Services Committee, said this week at the Bitcoin Policy Institute’s annual summit that stablecoin legislation he has been working on could pass in the coming months with bipartisan support.

“I think we can get our stablecoin policy set through and signed into law,” McHenry said on Tuesday at the event in Washington. “That will be the first sign that there is hope and that there is bipartisanship when it comes to this world of digital assets.”

A version of McHenry’s legislation debated last year in committee would set up a federal regulatory structure while still assigning a role to individual states. The legislation applies to payment stablecoins and would define what assets can be used to back stablecoins — for instance, U.S. dollars.

The McHenry legislation would limit permissible reserves for issuers to coins and currency, insured funds held at banks and credit unions, short-dated Treasury bills and repurchase agreements backed by Treasury bills, or central bank reserve deposits, according to the Congressional Research Service.

This would better allow the government to limit how stablecoins are backed, with the goal of preventing issuers from deceiving investors or the government about what the stablecoin is tethered to.

It also requires that stablecoin issuers submit certificates to either state or federal regulators with information about their coins, sets parameters for banks issuing stablecoins, and establishes capital requirements for stablecoin issuers.

The bill would require an issuer to hold at least a dollar of permitted reserves for every dollar worth of stablecoins that are issued or outstanding.

The legislation also clarifies that payment stablecoins are neither securities nor commodities and, thus, aren’t subject to the jurisdiction of the Securities and Exchange Commission and the Commodity Futures Trading Commission.

McHenry said his legislation would provide clarity on what exactly a stablecoin is under a federal regime. During his remarks, McHenry noted he has worked closely with his counterpart on the committee, Rep. Maxine Waters (D-CA), in crafting the stablecoin legislation. He thinks that before the end of the year, the stablecoin legislation could be passed and signed into law.

“I think there is an opportunity for us to have a good legislative outcome there, a solid product that could stand the test of time,” he said.

More broadly, McHenry pointed out just how little concrete guidance there is in the digital asset space.

“We have the IRS putting out rulings on the tax consequences of owning bitcoin, we don’t have in federal law a definition of a digital asset, we don’t have in federal law a means of exchange for a digital asset — we have to provide that clarity,” McHenry said.

In an op-ed in CoinDesk, Heath Tarbert, former chairman of the Commodity Futures Trading Commission, said stablecoin legislation must establish redemption and custody requirements that protect consumers; robust transparency, audit, and reporting requirements; and strong supervision over stablecoin issuers.

“By prioritizing stablecoin legislation, Congress can establish clear, coherent standards to protect consumers, improve financial stability, and advance the dollar as the internet’s preeminent currency,” Tarbert wrote. “This critical piece of financial plumbing is needed first to ensure that America’s digital asset markets become the envy of the world.”

Also on Tuesday, during the Bitcoin Policy Institute summit, Sen. Kirsten Gillibrand (D-NY) said she and Sen. Cynthia Lummis (R-WY) intend to introduce stablecoin legislation soon, perhaps in the next week or two.

She said they worked with the Federal Reserve, New York State Department of Financial Services, and the Treasury “to allow nondepository institutions to issue stablecoins while promoting safety and soundness within the industry.”

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Gillibrand and Lummis introduced legislation last year to create a comprehensive regulatory framework for crypto assets, including stablecoins.

Cryptocurrency guidelines have also come under more scrutiny in the wake of FTX’s dramatic collapse in 2022. This year, disgraced founder Sam Bankman-Fried was sentenced to 24 years in prison for his role in the collapse, which upended the entire crypto sphere and caused the prices of digital assets to crater temporarily.