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Warren Calls for Clampdown on DeFi and Stablecoins ‘Before It is Too Late’

Scammers, cheats and swindlers. That’s how Sen. Elizabeth Warren (D-Mass.) described the denizens of DeFi in an anxiously anticipated U.S. Senate hearing on stablecoins on Dec. 15. She said stablecoins must be regulated to safeguard the financial system.

“Stablecoins provide the lifeblood of the DeFi ecosystem,” Warren said. “In DeFi, people need stablecoins to trade between different coins, to trade derivatives, to lend, to borrow money — all outside of the regulated banking system. Without stablecoins, DeFi comes to a halt.”

Decrying DeFi as “one of the shadiest parts of the crypto world,”the influential lawmaker called for a crackdown on the sector during a hearing of the Senate Committee on Banking, Housing and Urban Affairs.

Smoke and Mirrors

Warren, a former law professor at Harvard, warned that the reserve assets supporting the peg for top centralized stablecoins could be smoke and mirrors. She said she fears systemic consequences for the financal system if there is a run on stable tokens, and demanded regulators “get serious about clamping down before it is too late.”

Warren took explicit aim at an open decentralized finance sector.“ DeFi is where the regulation is effectively absent […] it’s where the scammers and the cheats and the swindlers mix among part-time investors and first-time crypto investors,” she said “Shoot, in DeFi, someone can’t even tell if they’re dealing with a terrorist.”

Warren was not alone in offering a scathing appraisal of decentralized finance and stablecoins. Hilary Allen, Professor of Law, American University Washington College of Law, likened DeFi to a “shadow banking system” threatening systemic risks should its growth be allowed to continue.”

“I don’t think DeFi can grow without stablecoins,” Allen said. “It’s critical that stablecoins not be allowed to fuel that growth,” she added.

“In DeFi, people need stablecoins to trade between different coins, to trade derivatives, to lend, to borrow money — all outside of the regulated banking system. Without stablecoins, DeFi comes to a halt.”

Sen. Elizabeth Warren

Allen’s comments echoed concerns made earlier this month by the Bank of International Settlements, the powerful standards-setting body in Basel, Switzerland. It urged central banks around the world to implement “systemic regulation” to rein in DeFi.

Allen also challenged the President’s Working Group on Financial Markets (PWG)’s recommendation that stablecoin issuers be required to be insured depository institutions, claiming such a move could provide legitimacy to the sector.

Jai Massari of law firm Davis Polk & Wardwell also pushed back against the PWG’s recommendation during the hearing.  Yet Massari argued the mandate would be “unnecessary because stablecoins can be structured and regulated to avoid the risks that require deposit insurance and the application of traditional banking oversight in the first place.”

Warren challenged the integrity of the reserve assets backing the dollar-peg for leading stable tokens Tether (USDT) and USD Coin (USDC).

“Stablecoins are supposedly pegged to the dollar […] to reassure users that stablecoins are as stable as using the dollars you have in your wallet or your checking account,” she said.

“If Tether’s assets were actually backed one-to-one, it would be one of the 50 largest banks in the country. But we know that it is not, and that’s because according to Tether’s own report, only about 10% are real dollars in the bank — 90% is something else, it’s not real dollars.”

Peg Could Collapse

Warren added that Tether’s report has not been verified by a “comprehensive financial statement” or government regulator.”

The senator asked whether a stablecoin investor holding 10 USDC or USDT is “guaranteed” to get $10 back. Alexis Goldstein, director of financial policy at Open Markets Institute, replied: “No senator, you’re sort of dependent on the exchange where you’re trading it.”

Goldstein noted the terms of USD Coin and Tether prohibit U.S. customers from redeeming the tokens for US dollars, adding that USDT and USDC typically trade within relatively close proximity to the greenback.

“Sometimes it’s a little above the dollar, sometimes it’s a little below — but if there were a run, the peg could collapse,” she warned.

Goldstein recommended that lawmakers “monitor stablecoins and ensure compliance with existing laws,” adding that Congress should “examine if there are regulatory gaps that require new legislation to ensure consumer and investor protection.”

Read the original post on The Defiant.