The Fed says it can regulate stablecoins. So why doesn't it?

Bloomberg News

The Federal Reserve wants oversight of stablecoins, but some lawyers and policy analysts say the only things keeping the central bank from exerting that authority are its own words and actions. 

Earlier this month, Fed Vice Chair for Supervision Michael Barr said he is "deeply concerned" about unregulated stablecoins, stressing that their proliferation could "pose significant risks to financial stability, monetary policy, and the U.S. payments system." The comments echoed previous comments by other officials, including Fed Chair Jerome Powell, who called for Fed oversight of dollar-backed digital assets a year ago. 

Yet, some say the Fed's official position that stablecoins should be within its regulatory perimeter is undermined by supervisory guidance on the matter, its denial of membership to state-chartered banks that transact with stablecoins, and the agency's overall tone of commentary about the risks posed by the asset class.

"It sometimes feels like it's a little bit of a tug of war," said Joseph Silvia, partner at the law firm Dickinson Wright and a former counsel at the Federal Reserve Bank of Chicago. "There's guidance on how to do it, but it's very clear that the Fed still doesn't like it. They see too much risk or volatility."

In his first remarks on crypto assets last October, Barr urged banks to be cautious when engaging with the novel technologies. The comments came just weeks before the collapse of the crypto exchange FTX in November. A rash of guidance from the Fed, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency in the months that followed emphasized stern warnings about volatility and run risks in the stablecoin sector.

Barr, like other Fed officials, wants Congress to codify a regulatory framework for stablecoins, but such efforts have repeatedly stalled in the House and have gained virtually no traction in the Senate. He has also argued that stablecoins constitute private money, a designation that would give the Fed jurisdiction over digital assets pegged to the value of the U.S. dollar.

"Stablecoins are a form of money, and the ultimate source of credibility in money is the central bank," Barr said last week. "If non-federally regulated stablecoins were to become a widespread means of payment and store of value, they could pose significant risks to financial stability, monetary policy, and the U.S. payments system."

Lawyers familiar with the matter say there is no specific statute in the Federal Reserve Act that directs the central bank to regulate private money, but there is a consensus that payments-related issues are firmly within the Fed's remit.

"The history and origin of the Fed was to provide a central clearing mechanism for what was essentially private money for a long time and normalize our money around the U.S. dollar," said Cliff Stanford, a partner at the law firm Alston & Bird and a former assistant general counsel at the Federal Reserve Bank of Atlanta. "That has long been their historic role and they've done a good job with it."

As the hope for a legislative solution for stablecoin oversight wanes, Clifford said regulators have other avenues they could explore that would not be reliant on a bitterly divided Congress. This includes going through Financial Stability Oversight Council to designate individual stablecoin issuers as financial market utilities or having stablecoin issuance broadly deemed a systemically important activity. Though, he notes, FSOC is not known for acting swiftly. 

Silva said the most direct way for the Fed to bring stablecoins into its orbit is by providing banks clear guidelines on how to engage with them, and pairing that guidance with "consistent support around those practices."

Fed's Barr 'deeply concerned' about unregulated stablecoins

Another option, Stanford said, is for the Fed to allow state-chartered banks that are already engaged in issuing, holding or transacting with stablecoins into the federal banking system as state member banks. He noted that the Fed has broad authority to grant master accounts, which serve as a single point of access for the Fed's various financial services — including its payments systems — for member banks.

"That's another lever in the existing authority of the Fed," he said. "If there was to be a new charter type that was stood up just to hold deposits to back stablecoins or that sort of thing, the Fed could use its operational authority over granting or not granting — under its scheme of hierarchy and tiers — master accounts."

Norbert Michel, director of the conservative Cato Institute's Center for Monetary and Financial Alternatives, said recent Fed actions around master accounts have demonstrated that it has broad discretion over the types of institutions and activities it allows into the regulated banking system. 

"That gets to an even bigger question for me, which is: Should the Fed have so much control over the payment system?" Michel said. "Why should we be in a world where the Fed gets to decide Circle gets to have a master account but Custodia does not?"

Custodia Bank is a Cheyenne, Wyoming-based digital asset bank that had its applications for membership in the Federal Reserve System and a master account through the Federal Reserve Bank of Kansas City denied in January. 

Custodia founder and CEO Caitlin Long has said her bank — which is chartered through Wyoming's crypto-focused Special Purpose Depository Institutions regime — sought to be a regulated bridge between the traditional banking sector and the world of digital assets. After Barr's speech earlier this month, Long argued that the Fed squandered an opportunity to address its oversight problem when it denied Custodia's applications.

"[W]hy did Barr block the path for state-chartered payment banks to become Fed member banks in January, which would have solved that very problem," Long wrote on X, formerly known as Twitter. "Does it wish it could have its vote back?"

Custodia is suing the Federal Reserve Board and the Kansas City Fed in federal court, claiming they unlawfully denied the firm a master account. The bank argues that all state-chartered banks are entitled to access the Fed's payment systems. 

The Fed, meanwhile, has maintained that it has discretion over which institutions are suitable for master accounts, and Custodia did not meet that standard. In a published version of their denial decision, Fed officials wrote that Custodia had insufficient risk controls in place and inexperienced executive leadership. The Fed also noted that the bank was too reliant on highly volatile and unproven business models, including its dealings with stablecoins. 

Silva said the Custodia ordeal embodies the paradox of the Fed's approach to stablecoins. While it is open to banks engaging in the activity in theory, in practice, he said, the Fed expects banks to meet an unobtainable standard to do so.

"It seems like they would be looking for a bank that is devoid of other risks so that it could focus on the risks with respect to banking in the stablecoin industry. That just doesn't exist. Banks are risk management entities," Silva said. "The Fed was looking for a cleaner option to start engaging with stablecoins, and I don't know that they'll get that. I don't know that they'll get their pristine, white unicorn of a neobank to really engage with."