Stablecoins were constructed to dampen volatility of crypto-currencies. Companies that issue one type of stablecoin do this by creating a reserve of fiat currency, a 1:1 peg to the underlying fiat. In this type of stablecoin, the volatility that should remain is the volatility of the fiat itself. The market cap for stablecoins as of a few days ago was $20 billion. This is a three-fold increase from the start of the year.
OCC building
From OCC website
Why Stablecoins
Why should anyone put any money into stablecoins when they can hold dollars or euros or pounds? There are two reasons, one is that the stablecoins are native on public blockchains; crypto-currency traders can easily move BTC, ETH, or any other kind of crypto-currency into a stablecoin shelter during periods of high volatility in cryptocurrency. The second reason involves lower KYC burdens during these conversions which allow the holding of a stablecoin easier for non-sovereign actors. That is, if you are in Hong Kong, Taiwan or any other non-US jurisdiction, you could buy a USD pegged stablecoin easier and faster than you could USD. A huge volume of trades in BTC and ETH are related to the on and off ramp trades into stablecoins.
Challenges Of Stablecoins
The main problem with stablecoins is the custody and the certification of reserves held by the issuer. For example, the reserves backing USDC, the stablecoin issued by Circle, is audited every month. A snapshot does not prove that the reserve is always adequate to back the stablecoin 1:1, even if it is done by the most trustworthy auditor on earth. Stablecoins are not backed by FDIC or any other forms of insurance.
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During a run, that is an event where a huge percentage of stablecoin holders wish to cash out into fiat, the only protection is to have stablecoin reserves that can match that demand for fiat. If the issuer does not have this fiat available in a liquid form, the stablecoin and hence the backer of the stablecoin would crash.
USDT or Tether, whose market cap is $15 Billion or about 75% of the total of $20 Billion came under investigation when questions of the adequacy and liquidity of the reserve were raised in 2018-2019. This was due to the fact that the reserves were not completely transparent, and probably not 100%, and probably not as liquid as they claimed them to be. The utility of stablecoins for the crypto-currency traders was so great that such questions did not matter. Maybe the fact that Tether was under scrutiny even increased its cachet, following the perverse logic of the cryptoverse.
Promise Of Stablecoins
The total market cap of stablecoins is small potatoes in the world of equities. It is not even the market-cap of a single reasonably large unicorn. The fact that the market-cap and utility of stablecoins have grown rapidly and has a lot more room to grow, is a fact. If digital finance grows such that many more assets are available to trade, a stable stablecoin(sic) would naturally power a payment rail. The utility and appeal of a stablecoin would increase tremendously as digital finance takes off, especially in the absence of a Central Bank Digital Currency.
The Interpretive Letter #1172
The interpretive letter from the OCC applies only to stablecoins backed by fiat. The promise of stablecoins to function as general payment rails is stated up front. The giudance on deposits from stablecoin issuers only apply to hosted wallets. Hosted wallets are controlled by an identifiable third party, not the account holders themselves. The key word here is identifiable, which implies passing BSA (Banking Secrecy Act) controls, AML KYC and other regulations, including beneficial ownership checks.
This OCC letter opens up regulated banks and thrifts to cater to stablecoin issuers as long as they follow regulations. There are two points of importance, one says that banks need to monitor liquidity risks for their deposit holders. This means that the bank has to have agreements in place with the issuer that allows the monitoring on a daily basis that the issuer has adequate fiat deposits that are greater than or equal to the stablecoins issued. How this requirement will ever be fulfilled is anyone’s guess. At the very least, this will mean the bank participating in the stablecoin issuance as an observer. What if there are multiple depositary institutions holding reserves for a single issuer? They need to co-ordinate their oversight of the total stablecoin issuance.
The second piece is the provision of deposit insurance as a pass-through beneficiary. Seeing that the amounts protected by FDIC insurance are limited, how can such a provision protect issuers of a stablecoin like USDT which have a market cap of $15 billion? There is another intriguing sentence in there, which talks about individual account holders pass-through insurance, which seems completely at odds with the guidance for issuers and for omnibus wallets.
Libra
What effect does this letter have on Libra, which is a stablecoin to be? A very large portion of Libra will be backed by USD, which is the subject of this interpretive letter. This letter seems to allow regulated banks to hold reserves in USD for Libra. On the whole, a net positive for the prospect of Libra and for major regulated banks to hold USD reserves for Libra.
This guidance from OCC is positive for stablecoins. It strengthens the reserve requirements for fiat backed stablecoins. The letter allows banks to welcome stablecoin issuers as clients, and makes clear the requirements to administer such reserve accounts.