FSOC Warns Stablecoins Pose a Risk to Financial Stability, Calls for Regulatory Framework

Highlights:

• FSOC warns that insufficient regulation and high market concentration in stablecoins threaten financial stability.
• FSOC calls for a federal framework to address stablecoin risks, including reserve management and transparency.
• Yellen cautions that digital assets and AI pose significant risks to financial stability.

The United States Financial Services Oversight Council (FSOC) expressed concerns that stablecoins, due to insufficient regulation and high market concentration, could threaten financial stability. In its annual report, released on December 6, the council stressed the urgent need for legislative action to establish a comprehensive federal framework for stablecoin issuers. The framework will reduce risks from the fast growth and lack of transparency in stablecoins.

FSOC Getting Wrecked Over Crypto FUD: Caitlin Long Claps Back

Caitlin Long, Custodia Bank’s boss, is calling out the FSOC for its weak takes on stablecoins.

They’re crying “concentration risk” because one stablecoin dominates 70% of the market, but let’s be real – banks… pic.twitter.com/iK2RlJhjAf

— Mario Nawfal’s Roundtable (@RoundtableSpace) December 6, 2024

FSOC Highlights Major Risks in the Stablecoin Market

The FSOC highlighted that stablecoins, marketed as reliable digital alternatives to traditional currencies, are highly susceptible to runs. It also pointed out that the opacity surrounding issuers’ reserves and operations weakens market discipline. This increases the risk of fraud.

The report argued that the lack of transparency about issuers’ reserves and operations harms market discipline and raises the risk of fraud. It also noted that one issuer controls about 70% of the market. This increases the risk of disruptions if the issuer fails. However, the report did not mention the name of the issuer. 

Currently, the stablecoin market is worth $206.57 billion, with significant concentration. Tether (USDT) controls approximately 67.5% of the market, boasting a market cap of $137.8 billion, according to CoinMarketCap. Tether’s absence of third-party audits has sparked concerns about a potential liquidity crisis like FTX.

FSOC Calls for Federal Framework for Stablecoin Regulation

The council urged Congress to create a federal framework for stablecoin issuers. Recommended actions include requiring strong reserve management, setting minimum capital and liquidity standards, and implementing regular reporting. The report stressed that a framework would reduce risks from payment disruptions. It would also improve protections for investors and consumers. FSOC members pointed out that stablecoins are becoming more integrated with traditional financial systems. This is a growing concern.

The report noted:

“The Council recommends that Congress pass legislation creating a comprehensive federal prudential framework for stablecoin issuers to address run risk, payment system risks, market integrity, and investor and consumer protections.”

The report warned that without proper risk management, problems in the stablecoin market could affect broader financial markets. The council suggested that federal agencies explore other regulatory options under current laws if Congress does not act.

US Treasury Secretary Yellen Cautions on Crypto

Speaking on Friday, US Treasury Secretary Janet Yellen highlighted the risks posed by crypto assets and digital innovations to the US financial system. Yellen warned that while the financial landscape offers potential, it also has vulnerabilities that could threaten stability. The US economy seems stable this year, with low inflation and unemployment. However, she warned of two major threats. These include crypto and a fragile commercial real estate sector.

Yellen said that while crypto assets have grown into billion-dollar markets, they still pose risks. Digital assets like stablecoins offer faster payments but could destabilize traditional financial systems. Without clear regulation, stablecoins could create cracks in the global system.

Caitlin Long, CEO of Custodia Bank, flagged the FSOC’s new position on crypto. She said regulators’ anti-crypto stance has led many banks to quietly stop serving crypto issuers. This has pushed some stablecoin issuers and crypto firms out of the US. Caitlin Long criticized the FSOC for calling out fewer banks serving crypto, calling it hypocrisy. She also pointed out the FSOC’s disregard for state regulation of stablecoin issuers. The Custodia Bank CEO pointed out the discrepancies and said she looks forward to the first report from the FSOC under Donald Trump.

Here's a good example of FSOC's seething contempt for state regulators👇. (Don't forget all 3 federal bank regulators had multiple opportunities during the Biden/Warren period to bring #crypto into the regulatory perimeter but blocked every one of them. This is their own fault!) pic.twitter.com/CVQMhaBK6C

— Caitlin Long 🔑⚡️🟠 (@CaitlinLong_) December 6, 2024