Author: Brendan Malone, paradigm; Translation: Golden Finance 0xxz

1. Summary

Stablecoins present an opportunity to upgrade and meaningfully expand payment systems for the digital age. However, despite technological advancements around the world and the continued demands of clients in today's digital economy, several recent regulatory actions and aspects of current legislative proposals have shoehorned crypto payment instruments into existing banking and securities frameworks , which would be a step backwards.

Instead, if legislative efforts in this area move forward, they should track three key goals:

To address the risks faced by users of USD-pegged stablecoins, legislation may require centralized issuers of USD-pegged stablecoins to meet appropriate risk management standards. For fiat-backed stablecoins, the issuer of such a stablecoin advocates guaranteed redemption at face value, which may include holding reserve assets attesting that they match 1:1 with outstanding stablecoin balances, consisting of central bank liabilities or short-term treasury bills , segregated from the issuer's own assets, immune to creditor proceedings, and subject to appraisal or audit. Importantly, these issuers do not need to be banks or be fully regulated like banks.

To foster growth and competitiveness, legislation could prioritize orderly and efficient competition among stablecoins and related services, and with incumbent banks. This includes setting clear guardrails to ensure objective, risk-based, and publicly disclosed licensing eligibility for stablecoin regulatory frameworks, as well as traditional payment infrastructure regulations, allowing banks and regulated non-bank entities to operate fairly and openly in the state. and federal licensing. Access should also be open for end users (whether corporate or personal).

To encourage responsible stablecoin innovation, legislation could provide consumers and businesses with a wide range of payments and related services while meeting baseline security requirements. Regulation should not mandate that all stablecoins must be pegged to the U.S. dollar, should not broadly ban algorithmic stablecoins or stablecoins that are overcollateralized with on-chain collateral, but should explicitly allow Experiment and innovate, within additional rules commensurate with scale.

2 Background

While the recent U.S. Congressional proposal on stablecoins allows stablecoins to be issued outside of banks, ongoing policy discussions around appropriate regulation tend to focus primarily on traditional safety and soundness principles of banking regulation, such as capital requirements or securities-related risk management framework, for example as a money market fund (MMF).

But given the unique risks and current use cases of stablecoins, the traditional banking and securities law framework is a poor model for the regulation of stablecoins. If policymakers are to seize the opportunity to craft regulation appropriate to current conditions, they should do so by promoting openness and competition more than current banking or securities frameworks do.

Specifically, while ensuring that prudential and market risks are addressed is critical, we believe that the regulatory framework must also allow stablecoin payments to function and thrive. Regulatory guardrails can help maintain confidence in stablecoins as a form of money and ensure that the power to determine our monetary system does not fall into the hands of a few market participants.

**3. What is a stablecoin? **

Stablecoins are digital dollars issued on public, permissionless blockchains. Due to specific characteristics of blockchains, they are able to significantly improve the digital payment ecosystem.

Reliable, shared infrastructure. Public blockchains are data and network infrastructure with more open access and high uptime, requiring very limited upfront capital expenditures for payments and tokenization.

Programmability. Thanks to smart contracts, most public chains are programmable, transparently executing complex codes based on arbitrary conditions set by users, and customized to their liking.

composability. Applications and protocols built on public chains can be combined and used interoperably to create new capabilities.

These capabilities make it possible to design electronic payment systems that significantly reduce intermediation of bank balance sheets and create new paths for the efficient flow of payments. Stablecoins that use different mechanisms to maintain stability (e.g. on-chain collateral) are characterized by less reliance on banking systems and balance sheet intermediaries.

At the same time, trust and confidence are fundamental characteristics of money. For these reasons, a regulatory infrastructure that ensures trust and confidence in stablecoins can help them thrive. However, if stablecoins are shoehorned into the regulatory framework of unsuitable banks or money market funds, they will end up looking like banks or money market funds, and by extension, they will be as inefficient as existing financial services .

4. From a risk perspective, stablecoins are not bank deposits

Banks play a central role in the financial system and the wider economy: They hold the savings of households and businesses across the country on their books. In addition to taking deposits, they also make loans to individuals, businesses, government entities and a range of other clients. If businesses can only raise their own funds, or individuals can only use cash on hand to buy things like a house or a car, then business activity will be very limited.

Banking can also be highly risky. Banks take deposits from customers, customers can withdraw deposits at any time, banks make loans or invest in bonds or other assets that are often long-term (performing what is called maturity transformation), and can be vulnerable to losses due to poor judgment. If all of the bank's customers were trying to withdraw their deposits at once, the bank might not have enough assets on hand. This could lead to panics, bank runs and fire sales. If a bank is mismanaged and suffers losses due to bad loans or poor investment choices, this can also affect its ability to repay customers when they all try to withdraw their deposits. Even the perception of these carries risks.

Stablecoins inherently do not carry these same risks. Issuers of dollar-pegged stablecoins, subject to their terms, that can be redeemed at par on demand, may hold a reserve of assets to back their redemption commitments. These reserve assets, which may be matched one-to-one with outstanding stablecoins, consist of central bank liabilities or short-term treasury bills, are segregated from the issuer's own assets, are not subject to creditor procedures, and are subject to evaluation or audit. Federal regulations implemented under new legislation may require specific safeguards. If so, then unlike bank deposits, there is no maturity mismatch between short-term liabilities (which stablecoin holders can redeem at face value at any time) and long-term or risky assets.

More generally, even for stablecoins that are not pegged to the U.S. dollar or promise redemption at par, issuers are inherently less involved in maturity transformation than banks are. Here, safeguards can also be put in place to ensure that consumers are protected and financial stability is maintained. These guardrails could include required disclosures, third-party audits, and even baseline consumer protection rules for accountability and educational resources for centralized service providers who choose to offer or promote such stablecoins to clients.

Essentially, a risk management framework applicable to stablecoins should aim to manage the unique risks associated with stablecoins that are different from those that arise in traditional banking.

5. Stablecoins are not the same as MMFs in practice

Certain regulators, including representatives of the SEC, have said that certain stablecoins are similar to money market funds (MMFs), especially when they hold various assets such as government securities, cash and other investments as reserves to back their stable value , and should therefore be regulated as a money market fund. We do not believe this is an appropriate form of regulation as it is inconsistent with the actual market use of stablecoins.

MMF is an openly managed investment company subject to securities laws. They invest in high-quality, short-term debt instruments such as commercial paper, U.S. Treasuries, and repurchase agreements. They pay dividends that reflect current short-term interest rates, are redeemable on demand, and are required to maintain a constant net asset value (or "NAV") per share, typically $1.00 per share, per SEC rules. Like other mutual funds, they are registered with the SEC and regulated by the Investment Company Act of 1940. MMF interests are publicly listed investments that are bought and traded through a securities intermediary, such as a broker or bank that enters an exchange.

Over the years, various types of money market funds have been launched to meet the different needs of investors with different investment purposes and risk tolerance. As classified by the SEC nearly a decade ago, most investors invest in high-quality money market funds, which typically hold a variety of short-term debt issued by corporations and banks, as well as repurchase agreements and asset-backed commercial paper. By contrast, government money market funds primarily hold U.S. government bonds, including U.S. Treasury bonds, and repurchase agreements backed by government securities. Government money market funds generally offer greater security of principal than premium funds, but have historically delivered lower yields.

The combination of principal stability, liquidity and short-term yield offered by money market funds shares some similarities with dollar-pegged stablecoins. But importantly, stablecoins have a very different practical use than money market funds, and most stablecoins will lose their utility if they are regulated as money market funds.

In practice, stablecoins are primarily used as a means of payment in crypto transactions as dollars, rather than as investment options or cash management tools. For the largest dollar-pegged stablecoin, holders receive no rewards based on reserves. Instead, stablecoins are used as the equivalent of cash itself. Holders of dollar-pegged stablecoins typically do not seek to redeem the value of their stablecoin holdings from the issuer and then use the proceeds in cryptocurrency transactions. They simply pay for cryptocurrency transactions in the stablecoin itself as U.S. dollars. This is not possible or practical if the stablecoin is regulated as a money market fund (MMF) and holders are required to sell through a broker or bank.

We believe it would be wrong to mandate the inclusion of stablecoins in the MMF regulatory framework, especially as legislation has the opportunity to create a framework that is more attuned to the risks posed by stablecoins and the actual market behavior around them. In fact, the Supreme Court has declined to extend the SEC's authority to such instruments when comprehensive legal frameworks are already in place to govern the use of arrangements such as bank deposits or pension plans.

In other words, just as money market funds are regulated differently from other investment firms because of their structure and purpose, stablecoins should be regulated in a manner consistent with their unique structure and purpose.

6 Conclusion

We believe that over-imposition of existing banking and securities law frameworks on stablecoins would also ignore key payment system principles, particularly those related to fairness and open access. What is unique about payment systems is the dynamic nature of network effects, where the benefit a user derives from the system increases with the number of other users on the system. Combined with barriers to entry, including overly onerous and strict bank-style regulation of stablecoin issuers, these factors tend to limit competition and concentrate market power in a few dominant parties. If left unchecked, this could lead to lower levels of customer service, higher prices, or underinvestment in risk management systems.

This concentration of power would also be a curse to the freedom and decentralization of cryptocurrencies. A stablecoin issuer or service provider with centralized market power may make governance decisions for the public chain and also have discretion to influence the competitive balance among other participants. It may choose to disadvantage certain participants (and their customers) by restricting or otherwise restricting access to its services, and reward other favored crypto service providers with preferential treatment, thereby enhancing its market power.

For these reasons, we urge Congress to act now to enact legislation that addresses the risks posed by stablecoins while still allowing stablecoin payments to function and continue to innovate. Based on these principles, such legislation would address key issues while still allowing for the operability of stablecoins:

• Protect stablecoin users by setting reasonable risk management requirements for centralized providers;
• Prioritize competition by ensuring that non-bank issuers at the federal and state levels have viable avenues;
• Multiple forms of stablecoins can be adopted as long as consumer protection benchmarks are met and risks are managed appropriately, thereby fostering innovation.