PayPal recently announced that it will issue a new stablecoin, PayPal USD, in partnership with Paxos Trust. PayPal is a state-licensed money transmitter, while Paxos Trust is a New York crypto trust company. PayPal and Paxos are not FDIC-insured institutions, and they are not examined or supervised by any federal banking agency. To preserve the stability and integrity of our banking and payments systems, Congress must stop PayPal, Paxos and other nonbanks from issuing stablecoins.
Stablecoins are digital tokens that promise to maintain a stable value, typically based on the U.S. dollar. PayPal states that its stablecoins will be "redeemable 1:1 for U.S. dollars," based on reserves that will include "U.S. dollar [bank] deposits, U.S. Treasuries and similar cash equivalents." PayPal
Stablecoins are highly vulnerable to runs by investors whenever there are doubts about the adequacy of their reserves. More than 20 stablecoins have failed since 2016. In May 2022, the collapse of the TerraUSD stablecoin inflicted tens of billions of dollars of losses on investors. TerraUSD's failure triggered a widespread crisis in crypto markets, resulting in the demise of numerous leading crypto firms such as FTX and Alameda.
Circle USD, the largest U.S.-based stablecoin, lost its $1 peg in March 2023 after Silicon Valley Bank (SVB) failed. Circle held $3.3 billion of its reserves at SVB and was SVB's largest uninsured depositor. Circle USD's value dropped to 90 cents after Circle publicly disclosed that its deposits were frozen at SVB. A potential crypto meltdown was narrowly avoided when federal regulators decided to protect uninsured depositors at SVB and Signature Bank, another failed bank that was deeply involved with crypto.
PayPal's stablecoin is functionally equivalent to a bank deposit because it is redeemable on demand and can be used for payments to third parties. PayPal's stablecoin also resembles a money market fund because its promised value of $1 per coin depends on the current market value of its reserves.
PayPal's stablecoin will greatly increase the dangers that are already present in PayPal's operations. PayPal has more than 400 million customers, and PayPal holds about $35 billion of its customers' funds. Those customer funds are uninsured liabilities that PayPal must repay on demand.
PayPal's issuance of stablecoins will create additional uninsured and payable-on-demand liabilities. A default by PayPal on those liabilities would be likely to disrupt our payments system and could trigger a broader financial crisis. The Fed and the Treasury might well decide to bail out PayPal's uninsured customer liabilities, just as they decided to bail out money market funds in 2008 and 2020 and to rescue uninsured depositors of SVB, Signature and First Republic in 2023.
The small bank in eastern Washington State violated its commitment to regulators by helping the crypto company issue stablecoins. Earlier this year, the bank opted to dissolve itself.
The House Financial Services Committee recently passed a stablecoin bill sponsored by Chairman Patrick McHenry (R-NC). McHenry's bill would allow uninsured state-licensed nonbanks — like PayPal and Paxos Trust — to issue stablecoins that would not be regulated by either federal banking agencies or the Securities and Exchange Commission. McHenry's bill would not allow the Fed to examine or supervise state-licensed stablecoin providers unless the relevant state agency invited the Fed to do so. State officials would be very unlikely to ask the Fed to oversee their stablecoin providers until a crisis erupts, at which point it would be far too late for the Fed to take effective preventative measures.
During the banking crises of the 1930s and 1980s, state-regulated and state-insured depository institutions collapsed across the country. The catastrophic effects of those failures convinced all 50 states to pass laws requiring depository institutions to obtain federal deposit insurance and accept federal oversight. Those laws remained in effect in every state until Wyoming and Nebraska passed laws in 2019 and 2020 that authorized uninsured crypto banks.
Like Wyoming's and Nebraska's laws, McHenry's bill ignores the hard lessons we should have learned from past financial crises. States must balance their budgets, and they cannot print money. As a result, they cannot authorize sufficient emergency funding to protect depositors when a systemic crisis occurs. As we saw this year, only the federal government has the capacity to protect depositors and maintain financial stability during a severe crisis. Federal banking agencies cannot fulfill those crucial responsibilities unless they have robust regulatory and supervisory authority over all depository institutions.
Congress should reject McHenry's bill and pass legislation requiring all issuers and distributors of stablecoins to be FDIC-insured banks. Such legislation would ensure that all stablecoin providers must obtain federal deposit insurance and comply with the other federal safeguards governing FDIC-insured banks. Such legislation is mandated by the widely accepted principle of "same activity, same risk, same regulation," an essential cornerstone for any effective financial regulatory system.
Requiring all stablecoin providers to be FDIC-insured banks would also prevent Big Tech firms and other commercial enterprises from using stablecoins to become de facto banks. Federal laws generally prohibit commercial companies from controlling (or being controlled by) FDIC-insured banks. As shown by Facebook's embryonic stablecoin project, Big Tech firms will almost certainly launch their own stablecoins if PayPal succeeds with its plan. Allowing Big Tech firms to issue stablecoins would undermine our national policy of separating banking and commerce and would greatly increase the ability of Big Tech firms to control, monitor and monetize consumer financial transactions.
Congress must prevent PayPal and other nonbanks from issuing stablecoins that could destroy the stability and integrity of our banking and payments systems. As PayPal's announcement makes clear, the time for Congress to act is now.
