USDC's 'Black Swan' Depegging Could Have Been Avoided With Proper Regulatory Framework

The collapse of Silicon Valley Bank ricocheted through the crypto ecosystem, even causing Circle’s USDC stablecoin to depeg from the dollar this weekend. The momentary fall, which has since been reversing, was symptomatic of a black swan event, as Circle noted, but also of a larger truth: Stablecoins exist in a dangerous state due to the lack of a regulatory framework.

John Rizzo is senior vice president for public affairs at Clyde Group, and a former senior spokesperson at the U.S. Department of the Treasury.

It would be understandable if America’s failure to implement a regulatory framework for stablecoins were due to the topic's sheer complexity. Unfortunately, that’s not the case, and you don’t have to take my word for it.

Nations and governing bodies worldwide are moving forward with crypto regulation, including regulation related to stablecoins. Europe has managed to weigh the risks and benefits of crypto assets and establish a European Union-wide framework. France’s National Assembly is already implementing it. The United Arab Emirates recently put its crypto framework in place, with Hong Kong proceeding with its regulatory framework. Japan, which was early to crypto regulations, is tweaking and refining its own laws.

See also: Silvergate’s Struggles Will Likely Boost Stablecoins’ Role in Crypto Trading: Kaiko

It would be less understandable but more rational if the lack of a regulatory framework for stablecoins were due to a government's failure to prioritize the topic. However, that’s not the case either.

In November 2021, the President’s Working Group on Financial Markets (PWG) produced a comprehensive report outlining a regulatory framework for stablecoins. The report, led by the U.S. Treasury Department and drafted while I served as Treasury’s senior spokesperson, included signatories including the U.S. Securities and Exchange Commission (SEC), Federal Deposit Insurance Corporation (FDIC), the Commodity Futures Trade Commission (CFTC), the Federal Reserve and the Office of the Comptroller of the Currency (OCC). The signatories recommended bank-like regulation of stablecoins to prevent runs, federal oversight of custodial wallet providers and other measures, like 1:1 backing of stablecoins and prohibitions on commingling customer funds.

The need to fully implement the report’s recommendations was evident when the PWG report was released in November 2021 and reinforced during critical events, such as the failure of algorithmic stablecoins and the FTX crypto exchange’s collapse.

In both instances the U.S. financial system merely dodged a bullet. In the case of the algorithmic stablecoins, their market was too niche and new to cause broader ecosystem disruption. Moreover, during FTX’s fall crypto was not yet sufficiently intertwined with the traditional financial system to cause contagion.

Despite these two near-misses and a searing reminder of the risks this weekend as Circle depegged from the dollar, the prospects for the kind of legislation outlined in PWG’s report remain uncertain. The impasse is not an issue of complexity, simple government inertia or Republican opposition.

Instead, as someone who has spent his career working to elect Democrats, it pains me to note fissures on the politicalbleft – between those who believe stablecoins pose risks, possess potential and require regulation, and those who think crypto should be outlawed completely – are primarily responsible for the lack of progress.

Those on the left who wish to banish crypto into the dustbin of history are acting out of a genuine belief in what’s best for the economy and the American people. However, I believe this perspective is risky and wrong in three critical ways.

First, this thinking misunderstands how assets acquire legitimacy. Many on the progressive left believe that government regulation of stablecoins and crypto more broadly would provide undue legitimacy. In contrast, I assert it is crypto’s market cap, which indicates its use, that gives it legitimacy. It’s the people who get to decide, not the government.

Second, the effort to outlaw crypto or regulate it into a nonfunctional space overestimates the government's capacity to implement such actions effectively. As a result, it’s more likely that crypto would move overseas into opaque jurisdictions with fewer controls, thereby raising the risks to the financial system if contagion occurs.

See also: Stablecoins Are Not Worth the Risk | Opinion

Finally, the progressive left’s perspective ignores the innovative potential of stablecoins and crypto. The crypto ecosystem, part of a broader trend of digitization in finance, simply has too much unrealized promise – to improve the payment system, foster financial inclusion and give everyday people more power over their economic lives – to ban it.

There’s no political or practical pathway to a ban on crypto or stablecoins. From Mt. Gox to FTX, crypto has proved more resilient than the proverbial cat with nine lives. So instead of pursuing bans we should foster crypto’s innovative potential and mitigate risks, beginning with stablecoins.

As we hold our breath during this time of upheaval, the solutions we need are already in front of us. It’s time for action before it’s too late.