a16z partner discusses stablecoin regulation: Policymakers should consider these three core principles

Authors: Katie Haun (a16z Partner), Tomicah Tillemann (a16z Global Policy Lead), James Rathmell (a16z Legal Advisor)

Original Title: "Stablecoins, Stability, and Financial Inclusion"

Translation by: Chain Catcher

The commitment to provide financial services to underserved communities globally is a primary driver of our work, and we have long been concerned about an intuitive trend that has taken root in Western economies over the past few decades: the growing share of GDP flowing into the financial sector while millions remain excluded from basic financial services. From Senators Cynthia Lummis and Pat Toomey to Senators Elizabeth Warren and Kyrsten Sinema, an increasing number of voices acknowledge that digital currencies could be a powerful tool to "bring more people into the system."
As privately issued cryptocurrencies pegged to stable assets like the dollar, stablecoins play a crucial role in the next generation of democratized financial services. Over the past year, the total supply of stablecoins has increased from $2 billion to over $125 billion. Naturally, this astonishing growth has attracted the attention of lawmakers and regulators. The technological and financial advantages of the U.S. have historically relied on collaboration between business leaders and policymakers to ensure that the private sector can experiment and build, while an appropriate regulatory framework helps manage the real downside risks that could harm consumers.
Alongside stablecoin technology, smart and effective regulation of stablecoins is essential for protecting consumers, preventing financial crime, and maintaining the safety and stability of the financial system.
Stablecoin issuers typically use one of two mechanisms to maintain the value of stablecoins pegged to reference assets: policymakers should focus on three core principles when considering such regulation: (1) Promote equitable access; (2) Ensure the integrity of issuers and reserves; (3) Strengthen the technological and operational resilience of stablecoin networks.
There are already many different types of stablecoins, and the market is continuously innovating, so a one-size-fits-all regulatory approach is a poor choice if we want to harness this technology and mitigate its risks. We are still in the early stages of this race. Now is the time to establish the right framework for how we hope to use this technology for the benefit of society.
Today's Stablecoin Landscape
Before we delve deeper into these principles, we want to set the stage. The value of the three major stablecoins has increased about tenfold compared to a year ago.

Traditional companies, including Visa, Mastercard, JPMorgan Chase, and Wells Fargo, are piloting stablecoin integration to enhance the efficiency of their existing infrastructure. More importantly, stablecoins are also opening broader financial service channels by supporting new consumer finance products that disintermediate the traditional financial sector, with their application in decentralized finance (DeFi) being the most obvious example.
Stablecoins have been a core supporting technology behind the growth of DeFi, which requires low-volatility on-chain assets for everyday transactions. In fact, if stablecoins enable access to core financial services without any bank involvement, the concept of "banking the unbanked" may become a thing of the past.
Stablecoin issuers typically use one of two mechanisms to maintain the value of stablecoins pegged to reference assets:

• Asset-backed stablecoins, which maintain asset reserves backed by fiat or cryptocurrencies, allowing demand-side price arbitrage to keep prices stable.
• Algorithmic stablecoins, which use self-executing smart contracts to maintain price stability.

One issue with asset-backed stablecoins is whether the underlying assets are secure and whether they have established touchpoints with the traditional financial system that could lead to systemic risks. For algorithmic stablecoins, the primary risks today are technological and operational—whether smart contracts execute as intended, whether they are susceptible to malicious actors, and whether the economic and incentive structures of the protocols could produce unintended consequences that can be easily identified and appropriately mitigated.
This is important as we enter policy discussions, as a one-size-fits-all solution does not address these very different issues.
Stablecoin Regulatory Principles

We believe policymakers should embrace and responsibly regulate stablecoins. Leveraging the thriving ecosystem of private stablecoins can help the U.S. act swiftly to win in the emerging geopolitical arms race of financial innovation. This is an extremely important consideration. Looking ahead, a country's choices regarding digital infrastructure may have implications for its geopolitical direction as significant as those of previous generations joining NATO or the Warsaw Pact. Dollar-denominated stablecoins help ensure the continued dominance of the dollar and the central role of the U.S. financial system in the global economy.

These views are not universally understood among lawmakers and regulators. Recent legislative proposals would grant the Treasury Secretary the discretion to completely ban fiat-backed stablecoins. Others have suggested that the Glass-Steagall Act has already conferred relevant powers to the Justice Department to impose criminal sanctions on issuers. These approaches fail to capitalize on the opportunities presented by dollar-based stablecoins and instead undermine the nation's core interests—highlighting the need for careful regulation.

Good regulation can not only deter bad actors and control depreciation risks but also establish a framework and vision for how technology can positively benefit humanity. With this in mind, we responsibly propose three principles for stablecoin regulation: it should promote equitable access; ensure the integrity of stablecoin issuers and reserves; and strengthen the technological and operational resilience of stablecoin networks.

1) Promote Equitable Access

The regulatory framework for stablecoins should first ensure that all consumers have equal access and can overcome existing barriers to access. As Senator Robert Menendez (D-NJ) pointed out in a recent hearing, Americans who do not enjoy financial services, particularly those who cannot access credit cards at any time, find it difficult to fully participate in the economy.

This is largely due to the high costs, inefficiencies, and other barriers posed by the traditional financial system. Policymakers should not replicate the mistakes and limitations of the current financial system but should view stablecoins as a fundamental component to transform our foundational financial infrastructure, laying new tracks to enhance efficiency and competition, allowing society to begin to reduce or eliminate these barriers.

Raising public awareness and understanding of stablecoins is essential to ensure that consumers can reliably benefit from financial innovations. The private sector, government, and civil society all have a responsibility to enhance transparency and educate consumers, ensuring they are fully aware of the risks and opportunities associated with new products and services. The result of blockchain-based infrastructure is that consumers can benefit from audits and disclosures that are far stronger than anything we have today in the consumer finance space. Traditional disclosure-based systems can and should be modernized to leverage the benefits of this technology, ensuring that disclosure standards focus on consumers' understanding of the products and services available to them.

2) Ensure the Integrity of Stablecoin Issuers and Reserves

Provide a clear and predictable pathway for issuers to enter the market and meet regulatory expectations. So far, states rather than the federal government have dominated the process of granting licenses to stablecoin issuers as money transmitters. The federal government should also seriously consider the feasibility of authorizing stablecoin issuers under federal law. The OCC has taken steps in this process, issuing conditional national trust bank charters to Paxos, Anchorage, and Protego, while also releasing a number of guidance documents related to stablecoins,

including guidance on the powers of national banks to custody stablecoin reserves and to use stablecoins as a means of payment. While the Biden administration is reviewing this activity, regulators should seriously consider creating options for new stablecoin issuers to enter the market based on their specific circumstances. For example, some stablecoin issuers may seek bank charters (which could accelerate some reserve-backed stablecoin banking operations) or narrow bank licenses (if they are willing to hold only central bank reserves and U.S. Treasury securities).

At the same time, some stablecoins are governed by highly auditable smart contract protocols that maintain price stability through algorithms without any human intervention. For these protocols, a bank charter is neither coordinated nor necessary. Given this diversity, policymakers should propose a tailored option set for stablecoin regulation. Ongoing regulatory ambiguity can have significant real-world consequences. Two years ago, regulatory uncertainty led to the shutdown of a promising project in this space, and a lack of clarity will continue to stifle innovation and drive talent offshore.

Create a clear framework for how asset-backed stablecoin issuers must audit and disclose their reserves. Since 2018, Circle and the Center Consortium have published attestations from Grant Thornton LLP regarding the reserves backing USDC. Regulators should work with issuers and auditors to adopt specific standards for managing, for example, what periodic attestations regarding asset-backed stablecoin reserves must be provided.

Moreover, regulators should ensure that, like the Grant Thornton report, disclosures are concise and understandable to the average consumer. For their part, stablecoin issuers need to be proactive in ensuring transparency. For protocols based on decentralized assets (crypto collateral), data exists on-chain, making collateral verification relatively easy; for issuers with off-chain assets, disclosures should include periodic public audit reports from recognized accounting firms.

Fully leverage the compliance advantages of stablecoins. Given their auditability, blockchain provides national security and law enforcement agencies with new ways to detect illegal activities and enforce sanctions. Rapid technological innovation also holds the promise of embedding regulatory compliance into smart contracts, reducing or eliminating operational flaws that plague traditional compliance programs. With an appropriate privacy-first architecture, public-private partnerships in the stablecoin space, such as creating shared analytical tools and data repositories, can significantly improve the status quo. Contrary to popular belief, existing systems do not do enough to detect or prevent such behavior.

3) Strengthen Technological and Operational Resilience

Collaborate with market participants to develop specific guidance on the verification and governance of crypto-collateralized and algorithmic stablecoins. Algorithmic stablecoins have the potential to unlock tremendous economic potential by creating a stable and decentralized medium of exchange. Many projects in this space are governed by DAOs, which presents a challenge for regulators.

Therefore, policymakers should first focus on collaborating with established participants to develop appropriate standard guidelines for the verification of their foundational financial models and the governance of their protocols. There has been considerable thought given to the commitments of projects like DAO-governed stablecoins and the methods to remediate the accompanying risks. Policymakers and regulators have the opportunity to accelerate progress and actively engage in this dialogue. Additionally, a significant number of crypto-native stablecoin projects are transparent and auditable in their stabilization mechanisms, which can naturally align with a disclosure-based framework to adapt to the realities of the 21st century.

Support resilience and redundancy. The dialogue around stablecoins is closely related to the conversation about CBDCs (Central Bank Digital Currencies), which are government-issued cryptocurrencies representing sovereign obligations. However, CBDCs also face a range of challenges—particularly regarding privacy and security. When these issues fall into the hands of authoritarian regimes, the problems become even more severe.

These privacy and security risks can and should be addressed, but CBDCs and stablecoins can coexist. The most important goal should be to ensure that U.S. developers do not fall behind and that the dollar remains the foundational currency of this emerging industry. Fostering a range of dollar-backed stablecoin projects will support these goals and enhance the resilience of our financial infrastructure by avoiding single points of failure.