US Federal Reserve issues stablecoin warning to banks

The U.S. Federal Reserve, the central bank of the United States and the country’s chief banking sector regulator, has issued an announcement warning any state banks dealing with digital asset “Dollar Tokens,” or stablecoins, to obtain a written “supervisory nonobjection” from the Federal Reserve (Fed) before issuing, holding or transacting in them.

“A state member bank seeking to engage in such dollar token activities, including for the purpose of testing, must notify its lead supervisory point of contact at the Federal Reserve of the bank’s intention to engage in the proposed activity and should include a description of the proposed activity,” the Fed’s letter read.

As well as asking for permission from the Fed, banks engaging in such Dollar Token activities must identify, measure, monitor, and control the risks, including those related to money laundering, cybersecurity, and compliance.

Customer runs were also a concern, with the Fed noting that it intended to examine banks’ capacity to handle “substantial redemptions in a short period of time.”

While the notice didn’t mention Paypal (NASDAQ: PYPL) by name, it’s almost certainly no coincidence that it was posted a day after the company announced the launch of its U.S. dollar-pegged stablecoin on Monday.

Banking Regulators Issue a Stern Warning to Any Bank Doing Business with PayPal, Continuing An Unprecedented Financial Regulatory Onslaught Against All Things Crypto.

The Federal Reserve just issued yet another announcement relating to any bank that has anything to do with the… pic.twitter.com/twfrsTBhi5

— John Reed Stark (@JohnReedStark) August 10, 2023

“Fully-backed, regulated stablecoins have the potential to transform payments in web3 and digitally native environments. To address that emerging potential, PayPal today announced the launch of a U.S. dollar-denominated stablecoin, PayPal USD (PYUSD),” said the payment giant on August 7.

The company said that Paypal USD would be 100% backed by U.S. dollar deposits, short-term U.S Treasuries, and similar cash equivalents, and redeemable 1:1 for U.S. dollars. Rollout would begin as of Monday and increase over the course of the next few weeks, to be issued by Paxos Trust Company.

This move caused immediate concern amongst some lawmakers and regulators that the Paypal USD could slip into a regulatory grey area, with stablecoins still largely unregulated in the United States.

Rep. Maxine Waters (D-CA), ranking member of the House Financial Services Committee, released a statement on August 9 saying she was “deeply concerned that PayPal has chosen to launch its own stablecoin while there is still no federal framework for regulation, oversight, and enforcement of these assets.”

Waters pointed to Paypal’s 435 million customers globally as a reason for the urgency of stablecoin regulation.

“Given PayPal’s size and reach, Federal oversight and enforcement of its stablecoin operations is essential in order to guarantee consumer protections and alleviate financial stability concerns,” Waters urged.

January statement

The latest Federal Reserve announcement builds on a January 27 policy statement issued by the Board of Governors of the Federal Reserve System, which clarified that under the Federal Reserve Act, the Board would limit the activities of state member banks and their subsidiaries to those permissible for national banks.

National banks are authorized, by the Office of the Comptroller of the Currency, to use blockchain technology or similar technologies to conduct payment activities, including issuing, holding, or transacting in stablecoins.

Therefore, under the January policy statement, state banks would also be authorized to engage in the same blockchain and stablecoin activities, which is likely why the Federal Reserve felt the need to issue Tuesday’s warning letter to state banks.

Watch: U.S. Congressman Patrick McHenry on Blockchain Policy Matters