Regulating Stablecoins as Glass-Steagall Deposits and Consequences for Money Market Funds

In November 2021, the President’s Working Group on Financial Markets, in partnership with the Comptroller of the Currency and the Federal Deposit Insurance Corporation, released its long-awaited report on stablecoins attempting to outline the risks posed by these digital assets and propose next steps for financial regulators. Although its main recommendation called for new legislation to restrict the issuance of stablecoins to insured depository institutions, the report also determined that action could be taken within current statutory authorities. Among those existing authorities is Section 21 of the Glass-Steagall Act, which the report mentions but nevertheless does not explore.

Section 21 is a powerful tool which could bring stablecoins unambiguously within the authority of the financial regulators. The statute, jointly enforced by the Department of Justice (DOJ) and regulators, provides that only certain types of entities—those “subjected … to examination and regulation” or which otherwise “submit to periodic examination by the banking authority” of the state of its incorporation—may issue deposits, and traditional statutory interpretation, legislative history, and case law support the conclusion that § 21 deposits are liabilities which are available at par and on demand. Drafters of the Banking Act decried the mismatch between unregulated and uninsured demand deposits and loans on bank balance sheets, which gave rise to prolific bank runs. They also understood that the money supply, which was and remains primarily constituted by bank deposits, was a public good and therefore justified a robust public role in its administration.

Stablecoins, as currently constituted, are deposits within the meaning of § 21. Even though the drafters of the Banking Act could not have imagined digital assets, stablecoins nevertheless align with the Act’s motivations and sit well within its policy framework. Stablecoins are liabilities issued with a promise to redeem them for dollars (or other fiat) at users’ request, and that liability is promised to be nominally fixed. DOJ and relevant regulators could therefore apply § 21 to stablecoin issuers, requiring them to comply with one of its exemptions.

Regulators nevertheless face a problem. When money market funds (MMFs) arose in the late 1970s as a way for investors to circumvent limitations on banks’ abilities to pay higher interest rates, banks argued that these new instruments violated § 21 as prohibited deposits. In response, the DOJ in 1979 issued an opinion distinguishing bank deposits and MMF shares on highly formalistic grounds: because shares are equity claims and deposits are debt claims, the former are not deposits within the meaning of Glass-Steagall.

Consider therefore the likely sequence of events if DOJ and civil authorities sought to apply § 21 to a stablecoin issuer. The issuer could simply interpret its user agreements as equity claims, using the 1979 guidance as a shield from the application of § 21 notwithstanding the economic similarity of unregulated bank deposits before the Great Depression and stablecoins today.

In order to effectively apply § 21 to stablecoins, then, DOJ would need to review its past interpretation of § 21 as it applies to equity claims. But MMFs have relied on this understanding of § 21 for decades, and the industry now comprises over $4.5 trillion in assets. MMF clients, from retirees to financial behemoths, unknowingly benefit from the non-application of the Banking Act to their shares. Regardless of the initial wisdom of distinguishing MMF shares from bank deposits for the purposes of § 21, DOJ must obviously tread lightly to prevent financial upheaval and turmoil in stablecoins, MMFs, and underlying asset markets. The application of § 21 to stablecoins is a prudent alternative to new legislation, but careful review of prior interpretations and the implications of rescinding them is critical. To that end, this history suggests two paths forward: rescinding and reissuing guidance on why § 21 may apply to stablecoins but not MMFs, or the uniform application of § 21 to bank deposits, MMFs, and stablecoins alike.

One, mechanically simpler approach would simply issue new interpretative guidance, which cabins the non-application of § 21 to MMFs. It would require distinguishing between the equity claims of shares issued by MMFs and those which might be issued as stablecoins. It’s not entirely clear, though, what features would distinguish these two types of claims in ways that would be legally relevant for § 21—for instance, both MMFs shares and stablecoins float their values such that they are not universally and constantly available at par. Such an interpretation might therefore risk running afoul of the Administrative Procedure Act’s requirements that agencies not act arbitrarily or capriciously, exposing them to legal challenges.

Another approach would apply § 21 to all of these instruments. The application of § 21, though, might not require the conversion of MMFs and stablecoins to banks. Recall that deposit-taking under Glass-Steagall is generally prohibited, subject to three exceptions. The first exception fairly plainly applies to banks, but interpretations of the second two are sparse and therefore present an opportunity for regulators to develop a more complete framework of § 21. One of these exceptions requires that the entity is “permitted . . . to engage in such business and shall be subjected . . . to examination and regulations.” Some congressional hearings discussing the rise of MMFs suggest that they may readily fall into the second exception as subjected to examination by the Securities and Exchange Commission and regulations as provided for by the Commission and statute. Because these examinations and regulations under federal securities laws and Rule 2a-7 aim at the same financial stability concerns which motivated § 21, it seems fairly possible that MMFs would fall into the second exception of § 21. In that case, they would be taking deposits for the purposes of the Act, but nevertheless continue operating as they do now through that exception. Stablecoins could therefore likewise comply with § 21 through either registration as banks or MMFs.

The President’s Working Group has correctly identified the scope of the risks of stablecoins. In March 2022, the report was followed by an executive order from President Biden, which called for coordination among banking and securities officials, likewise acknowledges the promise and pitfalls of stablecoins’ rise. Despite these considerable and growing threats, banking regulators seem mostly content to wait for new congressional authorization, notwithstanding their awareness of § 21. Regulators should instead view what remains of Glass-Steagall as the tool that it can be, and taking care to consider the implications of its use.