Here's an interesting bit of stablecoin trivia. Half of all Paxos stablecoins are currently lying inert in MakerDAO, a decentralized finance protocol. Half!
Founded in 2018, Paxos Standard, or USDP, is one of the elder stablecoins. Overseen by the New York Department of Financial Services, and backed by dollars held in insured banks and Treasury bills, Paxos Trust has issued $1.03 billion worth of its USDP stablecoins into circulation (according to its last attestation report). Of that, $499,996,054 currently sits in MakerDAO (see below).
|$499 million USDP in MakerDAO|
This data point is useful for illustrating how stablecoin issuers like Paxos Trust should be regulated.
We should be regulating financial products on a functional basis. That is, if a financial instrument or financial venue functions in a certain way, we should have a regulatory framework that oversees that function, and everything that functions similarly should fall under that framework, and everything that doesn't should be caught by a more appropriate framework.
Common sense, right?
So how are stablecoins being regulated in the U.S? One of the many frameworks that has been adopted is existing state-based money transmitter law. The biggest stablecoin – USD Coin – is issued by Circle Internet, a company that is licensed by around 40 different states to transmit money. Oddly, this is the same regulatory framework that applies to old-school remittance companies like Western Union. If you've never made a remittance before, here's how it works. A retail customers temporarily hand over a small amount of money, say $200, to a Western Union agent. The agent contacts a foreign Western Union office and tells them to provide cash to the customer's friend or relative.
In the early 2000s this money transmitter framework was expanded to cover the likes of PayPal. Whereas Western Union keeps customer funds for an hour or two, tops overnight, customers of PayPal keep balances in their wallet for months, even years.
This storage function means that PayPal is doing something quite different than Western Union. And so the subsuming of PayPal (and other wallet providers like Venmo and Square Cash) under state money transmittal law in the early 2000s was probably a failure of functional regulation. A wallet business and a remittance business should be differently regulated.
This mistake was unfortunate. Zooming forward to the 2020s and the dawning era of stablecoins, one hopes the same mistake is not made again. What function is being performed by the $500 million Paxos stablecoins locked inside MakerDAO? Not Western Union-style remittances. Not PayPal-style personal wallet services. Paxos stablecoins are serving as the building blocks for core decentralized financial infrastructure. If Paxos fails, the entire MakerDAO edifice experiences a deep shock, this effect cascading to all the secondary tools based on MakerDAO and from there to all the tertiary tools based on those secondary tools.
In a sense, the role being played by Paxos stablecoins is the same role being performed by Treasury bills and other safe assets like commercial paper or money market funds, which are the foundational bedrock for all sorts of traditional financial services.
Now, there is another $500 million worth of Paxos stablecoin that is not frozen in MakerDAO. This block of stablecoin may very well be serving a different function than the half billion block locked in Maker. (For instance, I hold $100 in Paxos tokens, and I suppose they function very much like the $100 I hold at PayPal.) But the key point is that while there are times when stablecoins function like PayPal and Western Union, in other circumstances they are performing a role that PayPal and Western Union never do, which is to serve as the substructure for a set of financial utilities. Which suggests that stablecoins merit a different regulatory framework, one better fit for that function.
I don't know what framework that should be. Banking, securities law, a special stablecoin license? But the old school money transmitter framework – which has very lenient requirements governing things like the safety of the transmitters underlying assets – is probably the wrong framework. If you serve as financial bedrock, you merit more robust regulation than Western Union.
(And by the way, Paxos Trust is itself not regulated as a money transmitter. It operates under the NYDFS's stablecoin framework, which is stricter than money transmitter law, and may be sufficient).