DeFi: Fed's novel activities supervision program targets stablecoins, neobanks, crypto clients; risks of PayPal's PYUSD approach
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Today we highlight the following:
DEFI & DIGITAL ASSETS: PayPal Launches US Dollar Stablecoin (link here)
FINANCIAL INSTITUTIONS: The Fed’s Stablecoin Note Takes Aim at Bank Runs, Reversible Transactions (link here)
CURATED UPDATES
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DEFI & DIGITAL ASSETS: PayPal Launches US Dollar Stablecoin (link here)
PayPal, the payments app with 430MM active accounts, has launched its stablecoin, PayPal USD (PYUSD), issued by Paxos Trust. Stablecoins represent digital cash equivalents tied to fiat currencies — PYUSD is fully backed by US dollar deposits and short-term Treasuries. Centralised stablecoins (e.g. USDT and PYUSD) are issued by private firms, which are responsible for safeguarding the underlying assets backing the token and ensuring a stable 1:1 peg.
In February, Paxos stopped issuing new Binance USD (BUSD) tokens following guidance from the New York Department of Financial Services (NYDFS). The launch of PYUSD was initially postponed due to the the Paxos investigation. Now, given increased scrutiny, PYUSD is poised to be closely watched. PayPal intends to release monthly asset reports confirming PYUSD's backing. PYUSD will also adopt an attestation model, similar to USDT, in place of security audits. More specifically, Paxos will provide third-party attestation from an accounting firm regarding the reserve assets of PYUSD.
PYUSD users will be able to transfer funds across PayPal accounts and integrated wallets. This feature will soon extend to PayPal's Venmo, broadening its reach by a further 78MM+ users. Another interesting feature is that PYUSD facilitates conversions with PayPal's supported cryptocurrencies, including Bitcoin, Bitcoin Cash, Ethereum, and Litecoin. And note that PYUSD operates as an ERC-20 token; it is a smart contract within the Ethereum network, so all transfers are traceable on the blockchain. The ERC-20 design permits movement beyond PayPal, allowing users to interact with dApps on blockchains.
PayPal's move to create its own coin makes sense — it began offering services in 2020, allowing users to trade a range of crypto assets. The acquisition of a New York BitLicense last year further reinforced this notion. Among centralised stablecoins, the most prominent are USDT and USDC, with Tether's USDT having a 67% market share.
Despite a contraction in the stablecoin market from $180B in early 2022 to $125B, recent progress includes the House Financial Services Committee's approval of the Clarity for Payment Stablecoins Act of 2023. If enacted, this legislation would establish a regulatory framework for issuing and overseeing payment stablecoins — a development that grants stablecoins federal recognition and aligns them with their intended purpose: secure blockchain-based representations of dollars.
The downside of assets like this is control by the issuer, in this case Paxos. The code allows them to freeze assets, or wipe them out. However as noted by the discussion here and above, USDC has similar functions that have been deployed over the years — around $70MM and 170 addresses have been banned. That’s about 25 basis points of the total supply, so not a catastrophic share by any means. Still, it is “risk”.
Strategically, we think this is great for the American consumer — check out our long take below on the topic.
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FINANCIAL INSTITUTIONS: The Fed’s Stablecoin Note Takes Aim at Bank Runs, Reversible Transactions (link here)
Continuing the stablecoin topic, The Federal Reserve is expanding how it oversees the crypto activities of all US-regulated banks, including those under $10 billion in assets. Supervision Letter 23-7: Creation of Novel Activities Supervision Program specifically calls out stablecoin / dollar token issuance or distribution, crypto-collateralised lending, crypto trading, and crypto custody.
The program will have regulators more closely supervise crypto-related activities at banks, pairing “external experts from academia and the banking, finance, and technology industries” with its own supervisory teams “to better understand novel activities, the novel manifestations of risks of such activities, and appropriate controls to manage such risks.” A key focus area outlined in the Fed program is tokenization, like what non-bank projects like Backed Finance have been building.
As a part of the regulations, state member banks will be required to obtain written approval from the Fed before engaging with distributed ledger technologies, or similar technologies relating to stablecoins. This applies to all banks supervised by the Fed, even those with less than $10B in consolidated assets, likely incorporating regional financial operators as well.
While we have been expecting more concrete action from the Fed, the program remains light on details despite encompassing a large portion of financial services. On Tuesday, the UK Treasury also released a proposal for how to regulate systemic stablecoins, opting for a similar supervisory approach. This came shortly after the UK passed the Financial Services and Markets Act 2023. The Act provides the Bank of England with powers to develop a systemic stablecoin regime, with plans to publish its rules later this year.
At one point we would have argued that too much regulation would stifle innovation in the blockchain and DeFi sectors. However, given the SEC’s track record of destructive regulation by draconian enforcement, at this point we welcome any steps towards regulatory clarity for operators. These moves by the Fed and BOE indicate that paths to a collaborative approach are possible.
If you want access to the Fed and its money mana, then Fed officials will have veto power over your engagement with embedded finance, neobanks, and crypto assets. At this point, the incumbents at least acknowledge the existence of novel technology in finance that isn’t going away. This Fed program attempts to get an advance warning to the system administrators before the same risks shock the economy, but it is unlikely that the problems of the past are exactly the problems of the future. We also hope to see carve-outs for smaller players to experiment and learn before having to invoke the central bank.
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Curated Updates
Here are the rest of the updates hitting our radar.
Financial Institutions and Adoption
⭐ SEC Will Appeal XRP Ruling In Case Against Ripple, Regulator Says - CoinDesk
⭐ Binance Secures Crypto Exchange License In El Salvador - Decrypt
⭐ Almost 100 Crypto Funds Have Closed This Year: Report - The Block
Revolut To Halt US Crypto Services Next Month - Blockworks
Maple Opens Cash Management Pools To Accredited US Investors - The Defiant
Supreme Court Says Apple App Store Rules Can Stand—For Now - Decrypt
Fed Looks To Increase Oversight Of Banks’ Crypto Activities - The Defiant
DeFi and Digital Assets
Crypto Investor Hashkey Aims To Raise $100MM For New Digital Assets Fund - CoinDesk
Frax Founder Proposes Expansion Into Real-World Assets - The Defiant
How DeFi Users Are Navigating Post-Curve Exploit Landscape - Blockworks
Blockchain Protocols
⭐ Base Opens Mainnet To All Users - The Defiant
Cube3.AI Secures $8.2MM To Launch AI-Powered Blockchain Security App - Decrypt
Polygon Zero And Matter Labs Square Off Over Open-Source Norms - Blockworks
NFTs, DAOs and the Metaverse
⭐ DeGods Ditch Polygon, Moving y00ts To Ethereum And Returning $3MM Grant - Decrypt
Metamask Enables Staking Feature In Portfolio App - The Defiant
How Decentraland Is Using AI To Make The Metaverse Feel More Alive - Decrypt
Zero10 And JD Sports Offer Virtual Try-On Of Nike Apparel At IRL Stores - Decrypt
Palm Network To Launch NFT Creators' Platform On Polygon Supernet - Decrypt
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