December 14, 2021

At Hearing, Warren Calls on Regulators to “Clamp Down” on Stablecoins and DeFi Platforms “Before It Is Too Late”

Stablecoins fuel unregulated, shady DeFi platforms - posing a risk to our economy and consumers

Video of Hearing Exchange

Washington, D.C. — Today, during a hearing of the Senate Banking, Housing, and Urban Affairs Committee, United States Senator Elizabeth Warren (D-Mass.) raised concerns over the growing risks presented by stablecoins. Stablecoins, such as Tether and U.S. Dollar Coin, are a type of digital asset designed to maintain stable value by being pegged to the value of a fixed asset, like the U.S. dollar. However, stablecoins are often backed by risky assets and have fueled decentralized finance (DeFi) platforms, a fast-growing and highly opaque corner of the cryptocurrency market where users can lend, borrow, and trade stablecoins without any protections. 

In response to Senator Warren, Alexis Goldstein, Director Of Financial Policy at Open Markets Institute, confirmed that stablecoins may not always be backed one-to-one, meaning that a consumer who owns $10 worth of stablecoins is not guaranteed to get $10 back, as the assets backing those tokens are often not real dollars. Additionally, Hilary Allen, Professor at the American University College of Law, told Senator Warren that stablecoins pose risks to the stability of our financial system because of their vulnerability to runs – in which investors rush to redeem their tokens amid a market panic or loss of confidence  – and their role in propping up the DeFi sector, which may become intertwined with our traditional financial system.

Transcript: Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks?
U.S. Senate Committee on Banking, Housing, and Urban Affairs
Tuesday, December 14, 2021

Senator Warren: So, unlike other cryptocurrencies like Bitcoin, stablecoins – like Tether and USDC – are supposedly pegged to the dollar.  

And the reason for this is to reassure people that stablecoins are as stable as using the dollars you have in your wallet or in your checking account: a stablecoin dollar, in other words, will supposedly be worth a real dollar. Now that would make it a lot easier and a lot safer to trade among different tokens, to put up collateral for a risky bet, or even to pay for a cup of coffee at your local bodega.

But I want to examine whether or not the stablecoin talk matches the stablecoin reality. 

Ms. Goldstein, let’s say that I own $10 worth of Tether or USDC. If I wanted to trade my $10 worth of these tokens, am I guaranteed to get 10 dollars back?

Ms. Goldstein: No, Senator. You’re sort of dependent on the exchange where you’re trading it. Because as a U.S. retail customer, I cannot go to Circle and say, please redeem my USDC. And Tether explicitly says, no U.S. customer can redeem Tether, so I have to trade it on an exchange. Sometimes it fluctuates. Sometimes it's a little above the dollar. Sometimes it's a little below. But if there were a run, the peg could collapse. And we also don't really know necessarily what's backing all of these stablecoins, right. Tether is--

Senator Warren: Hold on a sec. I want to get into that. Okay. I promise. Because I want to just underscore this point that if Tether’s tokens were actually backed one-to-one, it would be one of the 50 largest banks in the country. But we know that it is not. And that’s because according to Tether’s own report, only about 10% of the assets backing its stablecoin are real dollars in the bank. 90% is something else—not real dollars.  

And if that worries you, there is a little more news on this one: The report that 10% of Tether’s stablecoins are backed up by dollars is not actually verified by a comprehensive audited financial statement or verified by any government regulator.    

So, Professor Allen, let me ask you. Let’s say I’m not the only one who wants to redeem my $10 worth of Tether or USDC for dollars. And maybe there’s bad news in the market, and people rush to cash in their stablecoins. What would a run on the stablecoin market look like? Could it endanger our financial system?

Professor Allen: Thank you for that question, Senator. So a number of the witnesses today have said that stablecoins don’t engage in maturity transformation and therefore don't suffer the same fragilities as bank deposits and runs. And that’s probably true to some degree, but a run on the stablecoin would look a lot like the runs we've seen on money market mutual funds in 2008 and again in 2020. And it could also share dynamics with the foreign exchange crisis we've seen in the past, like the Mexican peso crisis. So if holders of the stablecoin suddenly lose confidence in either the ability of the assurer of the stablecoin or the reserve of assets backing it to maintain a stable value, they could seek to redeem or exchange their stablecoin en masse. And if they have direct redemption rights, that would force the assurer to liquidate its reserve of assets. And right now, I don't think that would have systemic consequences, but if stablecoin holders are only using them to speculate, they're not really going to expect stability and so runs will be less likely. But if a run did occur right now, I think the impact would probably be felt in the DeFi ecosystem. And that's why it's critical that we not provide this government support to the DeFi ecosystem. And expect to pay it out--

Senator Warren: Okay. So let me go there. Sorry to interrupt, but let me go there. We know that stablecoins are not always stable. In fact, it’s worse than that. In troubled economic times people are most likely to cash out of risky financial products and move into real dollars. Stablecoins will take a nosedive precisely when people most need stability, and that run-on-the-bank mentality could ultimately crash our whole economy.  

But there’s another piece of the risk here, and you headed in that direction, Professor Allen. DeFi is the most dangerous part of the crypto world. This is where the regulation is effectively absent and—no surprise—it’s where the scammers, the cheats and the swindlers mix among the part-time investors and first-time cryptotraders. Shoot, in DeFi someone can’t even tell if they are dealing with a terrorist.  

Stablecoins provide the lifeblood of the DeFi ecosystem. In DeFi, people need stablecoins to trade between different coins, to trade derivatives, to lend and borrow money – all outside the regulated banking system. Without stablecoins, DeFi comes to a halt.  

So, Professor Allen, does DeFi threaten our financial stability? And can DeFi continue to grow without stablecoins?

Professor Allen: I don’t think DeFi can grow without stablecoins. I think it would struggle. Right now, I think DeFi is contained to the point where it won’t impact financial stability, but if it grows, I think there's a real threat there. Particularly if it becomes intertwined with our traditional financial system, and there is industry interest in pursuing this integration on both the traditional finance and the crypto side. So, I think it's critical that stablecoins not be allowed to fuel that growth.

Senator Warren: Well, I appreciate it. You know, this is risk to traders. Risk to our economy. The time to act is before it all blows up.  

Stablecoins have no regulators, no independent auditors, no guarantors, nothing. And they are propping up one of the shadiest parts of the crypto world—the place where consumers are least protected from getting scammed. 

Our regulators need to get serious about clamping down on these risks before it is too late.

Thank you, Mr. Chairman.