Maker vs Redemption-Based Stablecoins Under Glass-Steagall

Much discussion has occurred informally and occasionally formally about the various legitimate reach and impact of US-based financial regulation on the crypto economy. While it is unlikely to be exciting reading, I think it’s important for members who are able to continue to build out the theoretical framework around the Maker protocol, since it is so distinctly different from other sources of stablecoins.

A few months ago, I posted some discussion about a paper making the rounds in policy and media circles, “Taming Wildcat Stablecoins” by Gorton and Zhang. My main conclusion at the time was that policy is being directed at DAI’s competitors and not DAI itself.

One possible mechanism for regulating stablecoins under current US law is again being whispered about as a low-effort way for the Financial Stability Oversight Council (FSOC) to recommend regulatory action. Let’s run through this specific mechanism, and why it would probably be a positive for Maker.

As we all know, the US financial laws are a legal thicket that are complex to navigate. This is a problem not just for market participants, but for regulators and lawmakers. So deciding that an existing legal framework already exists often elicits a sigh of relief from those looking to patrol the regulatory perimeter.

Gaining favor in some circles is the notion that an unrepealed section of the 1933 Glass-Steagall Act – a Great Depression-era banking law – provides fairly clear prohibition against the acceptance of deposits by non-bank institutions.

The text of the relevant portion, Section 21(a)(2):

“For any person, firm, corporation, association, business trust, or other similar organization to engage, to any extent whatever with others than his or its officers, agents or employees, in the business of receiving deposits subject to check or to repayment upon presentation of a pass book, certificate of deposit, or other evidence of debt, or upon request of the depositor, unless such person, firm, corporation, association, business trust, or other similar organization (A) shall be incorporated under, and authorized to engage in such business by, the laws of the United States or of any State, Territory, or District, and subjected, by the laws of the United States, or of the State, Territory, or District wherein located, to examination and regulation, or (B) shall be permitted by the United States, any State, territory, or district to engage in such business and shall be subjected by the laws of the United States, or such State, territory, or district to examination and regulations or, (C) shall submit to periodic examination by the banking authority of the State, Territory, or District where such business is carried on and shall make and publish periodic reports of its condition, exhibiting in detail its resources and liabilities, such examination and reports to be made and published at the same times and in the same manner and under the same conditions as required by the law of such State, Territory, or District in the case of incorporated banking institutions engaged in such business in the same locality.”

Note the unlawfulness of "receiving deposits subject…to repayment…upon the request of the depositor."

This, of course, can through the eyes of US regulators, appear to fit fairly nicely on top of Tether, USDC, BUSD, USDP, GUSD, et al. Violations of this provision result in:

(b)
“Whoever shall willfully violate any of the provisions of this section shall upon conviction be fined not more than $5,000 or imprisoned not more than five years, or both, and any officer, director, employee, or agent of any person, firm, corporation, association, business trust, or other similar organization who knowingly participates in any such violation shall be punished by a like fine or imprisonment or both.”

It is important to note that there are three exemptions to the illegality of taking demand deposits, all of which can be summarized as being subject to federal, state, territory, or district laws and regulations regarding the product. Right now, there is considerable lack of clarity at any level about how digital assets should be considered, but it likely means organizational headaches for the likes of USDC and Tether. Other stablecoins may or may not suffer less disruption, depending upon their structure and if they are already under specific regulations at the federal or state/territory/district level.

As far as DAI is concerned, there are no deposits held by Maker that are subject to redemption promises. A user of the Maker protocol’s software retains custody of their own collateral and any DAI is user-generated. This is naturally quite different from how fiat-backed stablecoins operate, and represent an example of how Maker both deserves a different regulatory touch, and in some circumstances may be likely to receive that.

That difference supports my own assertion that Maker is not a lending protocol (leaving aside RWA for the moment), but a loan-guarantee protocol. Any claim the Maker protocol has on a user’s collateral is more akin to a lien than anything else, with liquidation triggered by collateralization falling to unacceptable levels, but otherwise not interacting with the user’s collateral at all.

If Section 21 of the 1933 Glass-Steagall legislation does indeed become the primary method of regulating stablecoins in US markets, Maker could be well positioned to benefit. This is only one possible road that US regulation of the stablecoin space may take, but is a reassuring example of how DAI might emerge with a lasting competitive advantage under some regulatory outcomes.

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Part of Glass Steagal is to seperate deposit-taking businesses from investment dealers.

That is precisely why I held off on proposing a CU for fixed rates.

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There’s been so many changes and repeals since 1933, I’m not entirely sure what parts aside from this one are still on the books. I mostly learned about it in economic history class. For all I know, Section 21 may be one of the last remnants of the law.

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It was repealed in the Citi Travellers merger.

However it remains in the forefront of regulators views of markets considering the repeal was widely viewed as a precursor to the financial crisis.

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And perhaps why integrating ANY fixed rate protocol into Maker is a bad idea (cough cough, Deco).

I am confused, if fixed rates are such a large regulatory concern, why did Maker holders already vote to offer fixed rate vaults as a product to institutions?

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It’s the yield-bearing side. Mechanisms to create a fixed rate by swapping or selling a yield-bearing product are what might cause problems.

Note that exchanges and yield-bearing instruments have been the main focus of regulatory action in the US. That is no guarantee that lack of yield-bearing product is a shield (there are just so, so many laws and regulations!) but BlockFi, Coinbase Lend, etc all attracted attention because they offer yield.

I am not aware of any major US enforcement yet around the taking of yield (rather than offering it). But I could be mistaken.

Thanks for clarifying. This all seems rather speculative and maybe not the right venue or time for these discussions. In the past (2018 onward) Maker offered the DSR. The DSR is still a core feature on the SE roadmap recently offered to the community for consideration.

We can cross that bridge when we come to it. Right now it is not widely used or marketed.

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Glad to see you sharing the thinking coming from your meetings @PaperImperium

I agree in many ways DAI is not a redemption on anything except as a lein on collateral for a borrower. Where this breaks down is in Emergency Shutdown but even then this ‘lein’ is satisfied by collateral, at least at the locked collateral price. This could become an issue if backing collateral value changes - but there is no issue of the locked collateral not being available for redemption only that the value of it can change up or down relative to the expected value of the DAI. This is a very different mechanic than any other product btw.

A lot of other protocols are going to have issues here and the idea we could lose the DSR as a DAI sop up mechanism is interesting in the face of Impossible Trinity but not the end of the world for Maker. Single Collateral DAI did fine without the DSR though SF did move from 0 to 20% in like 12-16 months…

As to fixed rates. We do not need any other protocol changes for governance to make an agreement for fixed rate vaults.

Maker can take on ‘reasonably termed’ fixed rate risk (12months pretty easily I think). Anything beyond 3 years I think is hazardous to the protocol. All this does is reduce potential income…

Because of the multiple issues here I am really turning to a no vote on anything related to fixed rate protocol changes. Warming up my no vote on Deco btw. We don’t need to do one single thing here except for governance to commit to terms on these IV vaults and basically stick with them. Which is why the details and time frame as (term) are so important.

The current IV solution using custom collateral types is not scalable. It is a stopgap solution by PE in the interim. Deterministic smart contract behavior exists to enable scalability and trustlessness. The way we are implementing IV at present cuts out significant market segments (IV vaults must presently exceed 200mm Dai) and relies on a social promise from Maker and governance not to move rates. There is a real need for a scalable fixed rate solution that fulfills Maker’s specific needs in the space.

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I surmise that Maker holders did not consider the issue (through no fault of their own) and, if they did, the justification was that this was a limited offering to a select group of institutions, and not a general offering to “normal” (that is, retail) users.

Unfortunately, this is not speculation at all. In fact, if you listen to Chairman Gensler’s speeches the past months about the need to regulate “borrowing and lending platforms,” the SEC’s sweep of DeFi protocols and the agency’s position on Coinbase’s proposed yield product, Earn, it’s clear that a fixed rate offering to all Maker users will flash red lights with US regulators. Now I understand the points about “well, if this is an issue, what about [Sagittarius Engine or whatever else people are coming up with]?” but I’ll just say that as far as fixed income products where Maker Governance is expected to operate the issuance of clear securities (Vamsi’s posts about Deco expressly says this), we should avoid engagements that lead us to regulated waters. Let other free-floating protocols offer Dai with fixed rate products (Yield, Element, etc.), while MakerDAO continues to protect the regulatory moat around the Maker Protocol.

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