The Biden administration is recommending cryptocurrency companies that issue stablecoins be regulated as banks, according to a long-awaited report spearheaded by the Treasury Department.

The President’s Working Group on Financial Markets on Monday recommended that Congress take action as soon as possible to come up with a new framework to regulate stablecoin issuers, tailored according to the amount of risk they pose to users and the financial system.

Stablecoins are digital currencies with values tied to fiat currencies like the U.S. dollar, or short-term securities, and are used by traders to get in and out of trades. Increasingly, they’re being used for lending or borrowing in other digital assets on cryptocurrency exchanges.

The recommendations are intended to curtail risks posed to the financial system, regulators worry. The presidential group urged Congress to mandate that stablecoin issuers become banks subject to oversight by the Federal Reserve and the Comptroller of the Currency.

In a statement, Senate Banking Committee Ranking Member Pat Toomey said "While Congress works on thoughtful legislation, I hope the administration will resist the urge to stretch existing laws in an effort to expand its regulatory authority."

In the midst of an unfolding debate about how the federal government should regulate the booming cryptocurrency industry, the Pennsylvania Republican added that "digital assets have the potential to be as revolutionary as the internet. It’s important lawmakers and regulators alike work to continue America’s longstanding tradition of fostering technological innovation—not stifling it.”

Becoming a bank could include obtaining a national charter, state charter or thrifts – all of which are subject to banking regulations and have a layer of federal oversight and underscores that stablecoins may only be issued by an insured depository institution.

The thinking on using these rules is that a bank deposit product – like a stablecoin — offers the promise of redemption – that you expect to get your money back when you ask for it.

The FDIC may insure stablecoins, but not all stablecoin users or activities would necessarily be insured. The report notes if the stablecoin issuer deposits fiat currency reserves at an FDIC-insured bank that meets all the requirements for deposit insurance coverage, the deposit would be insured to each stablecoin holder individually for up to $250,000.

Without required coverage, the deposit at the bank would be insured only to the stablecoin issuer itself, regulators suggest.

Issuers will be required to meet capital and liquidity requirements. The level of risk posed to users or the financial system by each stablecoin issuer may determine the level of oversight and capital requirements required.

The largest, systemic stablecoin issuers will also be required to come up with a resolution plan – known in the banking industry as “living wills” — so that in the event of failure, the firm knows how to wind down its operations without injuring the financial system.

The problem with stablecoins

Now a rapidly growing market that sits at over $130 billion worldwide, officials are worried about runs on stablecoins, even as some market participants have argued that scenario does not pose a major risk.

Issuers hold massive amounts of commercial paper or other short-term securities like Treasuries or certificates of deposit (CDs); if investors choose to pull their money out suddenly if cryptocurrencies plunge, that could lead to losses for investors, or potential runs on the financial system.

The PWG recommends the Financial Stability Oversight Council (FSOC), a regulatory group created after the financial crisis to monitor risks banks and financial firms pose to the overall economy and financial system, and consider steps to address risks of stablecoins. That includes designating certain stablecoin activities as systemically important, or putting issuers on a watch list for engaging in activities that are likely to become systemically important.

It’s how the stablecoin is being used, not the individual issuer itself that would trigger oversight from FSOC. Treasury is leaving it up to the FSOC to identify what would trigger the threshold to become systemically important, for instance a certain amount of transaction volume.

The Digital Chamber of Commerce – one of the crypto industry’s biggest lobbying groups – told Yahoo Finance last week that stablecoins don’t pose a systemic risk to the financial system. The group argues that U.S.-based stablecoin issuers– unlike banks – are not leveraged, and largely hold reserves in cash.

Right now, the organization doesn’t think any U.S.-based stablecoin issuer has reached a significant size that would warrant extra oversight.

The administration also recommends digital wallets — such as Meta Platform/Facebook’s (FB) Novi, which is still in development — be subject to oversight. That includes restricting digital wallet companies from lending stablecoins, and requiring them to meet capital requirements.

The report says Congress should consider limits on use of users’ transaction data and limiting digital wallets’ relationships with major companies — inline with banking laws that prohibit major corporations like Walmart (WMT) from also housing a bank. The risk is that competitors could be disadvantaged or certain partners may receive special treatment, distorting the allocation of credit in the economy.

According to officials, Congress should also provide the regulator of a stablecoin issuer with the authority to require any company that’s critical to the functioning of the stablecoin to also take measures to guard against risks they may pose to the financial system.

Since stablecoins are evolving quickly, officials note legislation should offer flexibility to adapt.

Agencies, including the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) will retain existing authorities to oversee stablecoins, but will not be given new authorities. As Congressional action is awaited, the agencies will act within their existing authorities to oversee stablecoins.

But a stablecoin could be classified as a security or a commodity giving the SEC and CFTC jurisdiction, according to the PWG guidelines. SEC Chair Gary Gensler has likened stablecoins to poker chips used at casinos and said they should be classified as securities.

The various financial regulatory agencies are working together to guard against the risk that stablecoins oversight could fall through the cracks, or be subjected to inter-agency turf wars.

Meanwhile, the SEC and CFTC are actively considering regulation for cryptocurrency exchanges. The trading platforms and decentralized finance depend on stablecoins to facilitate borrowing, lending, and trading.

The report adds the Department of Justice could consider applying the Glass-Steagall Act to certain stablecoin arrangements, which requires that a bank’s trading operations be separated from bank deposits, and that trading cannot put bank deposits at risk.

Still, the Digital Chamber of Commerce opposes mandating stablecoin issuers get national bank charters and classifying stablecoins as securities. The Chamber recommended that stablecoins be regulated as digital payment systems and not investments or a security, since they settle transactions instantaneously using blockchain technology.

The next step is having discussions with Congress over these recommendations. In the coming days and weeks, the Treasury will be engaging with partners on Capitol Hill.

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