Dual Perimeters: US Payments Policy Needs Federal and State Balance

Alex Barrage^[1] is a Partner at Troutman Pepper. Alex draws on her experience as a former FDIC executive and comprehensive knowledge of bank regulations to advise a wide array of banks and technology companies. She is a sought-after advisor on complex supervisory, regulatory, payments, and transactional issues.

US Treasury and OCC officials recently reasserted a full federal preemption model for a future regulatory framework governing domestic payments. The model focuses on perceived threats to the US financial system and monetary stability from a growing group of nonbanks that engage in payments–e.g., payment stablecoin issuers.^[2] Today, our federal regulatory framework does not have exclusive purview over stablecoin issuers, even though they engage in facilitating payments, a core banking activity that has historically lived within the federal regulatory perimeter.

The Biden Administration’s proposal for a full federal preemption model is a blunt force approach to resolving this tension, based on the idea that our state-based regulatory framework has “not kept pace with the growth in new kinds of money and payments, raising risks for the integrity of the payment systems and trust in money.”^[3] It asserts that our state-level framework has varying requirements that raise barriers to entry, limiting competition and innovation, and that states lack a “consistent standard,” resulting in a race to the bottom.^[4]

States disagree. They don’t see a regulatory gap requiring a federal regulator to oversee payments. For more than 100 years, states have “overseen a dynamic money transmission marketplace that promotes strong consumer protections, fosters innovation, and maintains access to popular and convenient financial services.”^[5] Within their perimeter, states argue they have kept pace with, and even facilitated, innovation. They license and supervise money transmitters and virtual currency businesses, taking enforcement actions when appropriate. In 2021, states created the CSBS Money Transmission Modernization Act (MTMA), which twenty-two states have adopted. Concerns about races to the bottom are belied by state cooperation, from engaging in multi-state examinations of money transmitters, to working with the federal government on enforcement actions.^[6]

Reducing the volume on the Hamilton soundtrack^[7]

Between the Feds and the states, who is right? Internecine federalism fights will not help create a better future for US payments regulation, protect consumers and businesses, or maintain the stability and dynamism that make the US financial system the perennial winner in global competition. Preemption battles are nothing new. Post-Cantero,^[8] we have seen increasing polarization between our states and federal government. 

These turf fights burn precious calories that could be put toward actual policy development. Bottom line: if the US hopes to make meaningful progress on payments regulation, our approach requires cooperation and flexibility.  We need to strike the appropriate balance between federal and state oversight of stablecoin issuers. 

Realizing this vision demands a model of federalism that recognizes the need for federal and state governments to share power as a means of solving hard problems together.

“Cooperative” or “marble cake” federalism^[9] refers to the idea that local, state, and national governments do not act in separate spheres, but instead have interrelated policy goals and administrative duties. This model analogizes the American form of government to one where colors are mixed like a “marble cake,” just like functions are mixed in the American federal system.^[10] 

Cooperative federalism can break through some of the limits inherent to a “one ring to rule them all” approach. If only one entity has oversight of stablecoins, we run into problems. The Federal Reserve, which might seem like an obvious choice, has been critiqued as the wrong regulator for stablecoins because of its “irremediable”^[11] structural conflict – it cannot both oversee and regulate private payment innovation while also running the existing payment rails and launching its own instant payments system, FedNow.^[12] 

A cooperative federalism approach to stablecoins could resolve the old Hamilton/Jefferson federal/state fight with an idea from Madison: checks and balances.

A Solution?

Starting with first principles, a new framework for stablecoin issuers should:

A discussion draft of stablecoin legislation released by Senator Hagerty (R-TN) on October 10, 2024 is a first step in achieving these ends, prompting deeper discussion.^[13]

Public trust and integrity

The Federal Reserve ensures monetary stability and promotes the safety and efficiency of payment and settlement systems, a role that must remain its exclusive domain if we want to maintain public trust. But we also need the integrity that comes from regulators knowing they do not have a monopoly on the market, regardless of whether they do their jobs well or poorly. A cooperative federalism approach would give stablecoin issuers a choice between a state and federal charter, the determination of which will depend on associated benefits and trade-offs. In our dual banking system, for example, flexibility in charter choice has allowed banks to balance trade-offs, including the ability to escape from arbitrary regulation or overly burdensome supervision.^[14]

While the Hagerty Draft preserves a federal vs. state chartering choice for stablecoin issuers, an issuer could only choose to be regulated at the state level if (i) its total market capitalization does not exceed $10 billion and the State-level regulatory regime is “substantially similar to the Federal regulatory framework”; or (ii) the stablecoin issuer has a total market capitalization of not more than $1 billion. While this proposal sounds like cooperative federalism, quantitative thresholds suffer from cliff effects,^[15] and it is not clear that market capitalization is an adequate proxy for risk.^[16] Allowing for substantive differences in how governments regulate stablecoins also cannot be a good outcome for consumers, businesses, and the broader financial system. 

A more practical approach would be to eschew all quantitative thresholds in favor of a benefits-and-trade-offs approach.  A state-regulated stablecoin issuer that is a virtual currency licensee or state-chartered trust company may be focused on serving their state community, and may be uninterested (or unable) to secure a Fed master account. So long as the states’ regulatory regime substantially tracks to the Federal regulatory framework (e.g., as determined uniformly all states),^[17] then it should maintain the ability to be regulated at the state level, including by multiple states.   

One benefit with this approach is that it is designed to ensure state regulation is not automatically or arbitrarily subordinated to federal control. Another benefit is that it minimizes regulatory arbitrage between state and federal regimes because rules are substantially similar, promoting certainty. The primary trade-off with this option is that it would limit state-regulated stablecoin issuers from scaling and competing with others who gain access to a Fed master account, and therefore the ability to offer customers a broader and more attractive range of financial services. But that would be the issuer’s choice to make.

With federal privileges come federal obligations. For the stablecoin issuers that prioritize scale and competitive advantage (domestically and globally), the Hagerty Draft proposes an OCC-issued federal charter. The OCC would approve charter applications, issue regulations, and examine approved stablecoin issuers.^[18] These issuers would de facto include the largest stablecoin issuers who are seeking (and should be required to secure) a federal payments charter as a condition to obtaining a master account. Again, the issuer’s choice to make.

The principal benefit of obtaining a master account is that it provides a stablecoin issuer a single point of access to the Federal Reserve’s payment rails, and therefore the ability to settle transactions in central bank money. Additional benefits include the ability for issuers to park reserves at the Fed (instead of at banks), along with direct access to clearing and settlement systems (instead of through correspondent bank relationships), resulting in lower overall costs and broader product offerings to a wider segment.^[19] The associated trade-offs are the unknown costs associated with federal agency examination and supervision, not to mention the potential impacts of yet-to-be-seen implementing regulation (e.g., capital, liquidity, and risk management requirements). This trade-off is balanced against the fact that such regulation is imposed on all depository institution master account holders, and would be required to keep the payments system safe and trusted by consumers.^[20]

A new payments framework should incorporate both a federal and state chartering option, allowing for dual federal and state supervision.^[21] In the example above, the Fed would monitor a stablecoin issuer if it is successful in obtaining a master account (as it does for eligible institutions), the OCC would be the primary federal regulator over that issuer, and the state licensing entity would remain primarily responsible for delineated functions, like consumer protection. 

Clarity and consistency

Payments regulation and policy must be clear and consistent across federal and state frameworks. Implementation of the rules governing either a federal payments or state charter should be specific and appropriately tailored to the relatively narrow business models of stablecoin issuers. Bank-like regulations (designed for a fractional reserve business model) will not work to effectively regulate stablecoin issuers. 

Regulatory clarity begins by defining what types of stablecoin issuers would be eligible to apply for and obtain for a federal payments charter. Ideally most issuers should be eligible for either charter, as there should be little (if any) substantive daylight between regulation across state vs. federally-chartered entities. Next, we need clarity on qualifications for a Fed master account. Implementation of capital, liquidity, and risk management rules should be carefully calibrated to their business models, but also coordinated across state and federal regulators. The devil lives in the details, and those details should be consistent. Overly burdensome capital requirements, for example, could easily crush stablecoin issuers’ ability to compete. Risk management requirements should be thoughtfully tailored to the business models and risk profiles of stablecoin issuers, incorporating bank-like elements like recovery and resolution planning. 

Under a cooperative federalism model, stablecoin issuers should have a choice: (i) stay regulated by the states (i.e., issuer does not seek a Fed master account); or (ii) also be regulated by the federal government (the OCC, with monitoring by the Federal Reserve) through a federal charter. If an issuer elects the second option, the issuer remains regulated at the state level, but the state plays a more limited/backup function (e.g., focusing on delineated powers, like consumer protection). For either option, there should be no substantive difference between what is required of issuers, and any future regulation at the federal level could be informed by existing state regimes, such as the virtual currency guidance issued by the NY Department of Financial Services.

Responsible innovation and furthering competition

Principle #3 goes beyond chartering considerations to consider marble cake-like regulatory engagement. Regulators need to engage meaningfully on risks and industry trends. This dialogue could take various different forms, e.g., (i) staff-level office hours focused on current developments; (ii) memoranda of understanding between state and federal regulators designed to promote timely and comprehensive identification of risks and information sharing; and (iii) regular principal-level engagement between federal regulators and state commissioners on framework implementation. Targeted engagement with private industry, academics, and other stakeholders would also be critical in identifying any shortcomings in the payments framework, including regulatory roadblocks that could unduly stifle competition. 

The mixing (or swirls) of federal and state regulatory spheres are the hallmark of cooperative federalism. Shifting our payments policy is increasingly important in a world where technology and competitive forces continue to unbundle traditional bank activities and push them outside the regulatory perimeter. 

Cooperation is elegant in concept, but tricky in implementation. To work, a future US payments framework needs careful federal and state balance, strong homogeneity, and a whole-of-government commitment.

The opinions shared in this article are the author’s own and do not reflect the views of any organization they are affiliated with.

^[1] I am a former FDIC executive and now Partner in the Financial Services practice of Troutman Pepper Hamilton Sanders LLP.  The views expressed here are my own, not of any colleagues or clients of my firm.  

^[2]  This piece addresses only payment stablecoins (“stablecoins”), as that term is generally understood to mean a digital bearer instrument entitling the holder to redemption at par for one U.S. dollar. 

^[3] Nellie Liang, Under Secretary for Domestic Finance, U.S. Dept. of the Treas., Remarks at the Chicago Payments Symposium (Oct. 9, 2024); see also Michael J. Hsu, Acting Comptroller of the Currency, Statement Before the Comm. on Fin. Servs., U.S. House (Nov. 20, 2024) (“I support the Treasury Department’s call for federal payments regulation and a chartering regime for nonbanks. If well designed, such a system – which could be modeled on the dual banking system with distinct roles for federal versus state authorities – would provide the guardrails necessary to close regulatory gaps, protect consumers, and promote more responsible innovation and competition.”) (internal citation omitted). 

^[4]  John Heltman, OCC’s Hsu endorses federal standards for money transmission licenses, Am. Banker (Oct. 22, 2024, 11:42 AM).

^[5]  Brandon Milhorn, CSCS President & CEO, Statement on the United States Department of the Treasury Remarks at Chicago Payments Symposium (Oct. 10, 2024).

^[6] See, e.g., Consent Order to Payoneer, Inc., N.Y. State Dept. Fin. Serv. (Nov. 2, 2023).

^[7] See Hamilton, Cabinet Battle #1 from HAMILTON, YouTube (Feb. 18, 2020) (Jefferson: “In Virginia we plant seeds in the ground. We create, you just wanna move our money around…”)

Hamilton: “Thomas, that was a real nice declaration. Welcome to the present, we’re running a real nation. Would you like to join us? Or stay mellow, doing whatever the hell it is you do in Monticello…”).

^[8] Cantero v. Bank of America, N.A., 602 U.S. 205 (2024) (available at https://www.supremecourt.gov/opinions/23pdf/22-529_1b7d.pdf).

^[9] Morton Grodzins, The Federal System, in Goals for Americans (1960); Paul E. Peterson, The Price of Federalism (1995); Deil S. Wright, “Policy Shifts in the Politics and Administration of Intergovernmental Relations, 1930s–1990s,” in Annals of the American Academy of Political and Social Science 509, 11–30 (May 1990).

^[10] Grodzins, supra note 12. “Marble cake” federalism is a close cousin to the “tailored supremacy” model proposed by Dan Awrey in Money and Federalism. Dan Awrey, Abstract, Money and Federalism, Cornell Law School: European Corporate Governance Institute (2024). Awrey’s “tailored supremacy” model “envisions the introduction of federal law and regulation specifically targeting the shortcomings of existing state-level regulatory frameworks.  This more targeted federal intervention would preempt only those elements of state law that undermine monetary stability, while otherwise leaving state-level chartering, regulatory, and supervisory frameworks fully intact.” Id. at 58.  

^[11] Jennifer J. Schulp & Jack Solowey, The Fed Is the Wrong Regulator for Stablecoins, Cato Institute (Oct. 23, 2024).

^[12] See also, Aaron Klein, Abstract, Structural Conflicts in Central Banking: Regulator or Operator of a Payment System?, Wharton Initiative on Financial Policy and Regulation (2023), (analyzing the multiple and sometimes conflicting roles facing central banks and payment systems).

^[13] Draft Bill to Provide for the Regulation of Payment Stablecoins, and for Other Purposes (2024), available at https://www.hagerty.senate.gov/wp-content/uploads/2024/10/Stablecoin-Draft-Text.pdf) (“Hagerty Draft”).

^[14] Cf., Alan Greenspan, Remarks at the Annual Convention of the Independent Bankers Association of America (Mar. 22, 1997), (“Just as important as the fostering of innovation is the protection the dual banking system affords against overly rigid federal regulation and supervision. The key to protecting against overzealousness in regulation is for banks to have a choice of more than one federal regulator”).

^[15] See generally, Gov. Michelle W. Bowman, Tailoring, Fidelity to the Rule of Law, and Unintended Consequences, Speech at the Harvard Law School Faculty Club (Mar. 5, 2024), (noting “cliff effect” concerns with guidance applicable to banks with over $100 billion in consolidated assets). See also section 14(b)(3) of the Hagerty Draft, which includes an override of the $10 billion threshold in cases where federal regulators simply “decide” to require a stablecoin issuer to transition to the Federal regulatory framework.

^[16] Alternative quantitative metrics could be helpful in developing a “risk-based indicator” framework for stablecoin issuers (similar in concept to the risk framework for the largest US Banks) – e.g., a combination of gross payment flows, total amounts held in reserves, reserve composition, extent of any “critical operations.” “Critical operations” refer to a company's operations that, if discontinued or failed, could threaten the financial stability of the United States. Critical operations include the associated services, functions, and support.  

^[17] While this process is loosely outlined in Section 14(b)(3) of the Hagerty Draft, two alternative approaches would be to update the MTMA consistent with such a Federal regulatory framework, or for states to adopt a uniform framework (similar in concept to the Uniform Commercial Code).

^[18] See Section 5(a)(6) of the Hagerty Draft.

^[19] To meet the objectives of a cooperative federalism approach, these master accounts would actually need to be obtainable. State-chartered depository institutions have found it challenging to obtain master accounts, and currently there is no master account pathway for stablecoin issuers. Two district courts recently found that Federal Reserve Banks have the discretion to deny master account applications on the basis of the Federal Reserve’s three-tiered system for assessing applications (Guidelines). Custodia Bank, Inc. v. Fed. Rsrv. Bd. of Governors, No. 1:22-cv-0012-SWS, 2024 WL 4172782 (Feb. 2, 2024); PayServices Bank v. Fed. Rsrv. Bank of San Francisco, No. 1:23-cv-00305-REP, 2024 WL 1347094 (Mar. 30, 2024). Ensuring that this discretion does not become a form of discrimination against state charters may be another area for Congress to consider.

^[20] The extent of these costs is currently unknown, but could potentially be mitigated by a supervisory framework that is tailored to relatively limited activities of stablecoin issuers (as compared to banks).

^[21] Preserving benefits of the dual banking system also makes sense given what ultimately befell the OCC’s Special Purpose National Bank Charter for Fintech Companies.  See Alex Johnson, Why Can’t We Have a National Fintech Charter?, Fintech Takes (Jul. 12, 2024), (explaining how state regulators successfully pushed back on the OCC fintech charter, as well as their economic motivations–citing the CSBS’ complaint–for why they were so stridently opposed).

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