Stablecoins are now attracting regulatory attention
SHARE:
US regulatory gaze on Cryptos and Stablecoins
- The story: Bitcoin was launched in January 2009, and it evolved into a standalone global ecosystem. Thousands of cryptocurrencies followed. After standing aside for years as this system grew into a volatile and widely embraced innovation, US federal regulators are now addressing the potential risks for consumers and financial markets.
- What are cryptocurrencies: A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. It doesn't require any official state sanction or permission, and is a peer to peer system.
- Focus on stablecoins: A stablecoin is a digital currency that is linked to an underlying asset such as a national currency or a precious metal such as gold. Issued by a variety of firms that are lightly regulated through state rules, "stablecoins" serve as something of a bridge between cryptocurrency markets and the traditional economy. Now, the US Treasury Department has stablecoin on its target, for more regulation.
- Value of stablecoins - The value is "pegged" one-to-one to the US dollar, gold or some other stable asset. Stablecoins hold a bundle of assets in reserve, usually short-term securities such as cash, government debt or commercial paper.
- Logic - The idea is to make it easier for people holding cryptocurrency — which is notorious for its frequent price swings — to carry out transactions like purchasing goods and services, or to earn interest on their crypto holdings.
- The worry - The use of stablecoins is surging rapidly, and regulators are concerned that they are not in fact stable, and could lead to a digital-era bank run.
- Types of stablecoins: The world’s most popular stablecoin is USDT, issued by Hong Kong-based Tether; it represents more than half the global stablecoin supply. There are four major types -
- Fiat-collateralized Stablecoins - They are collateralized by fiat money, such as the US dollar, euro or the pound, on a 1:1 ratio. Examples: Tether, Gemini Dollar, and TrueSD.
- Stablecoins Backed by Other Assets - There are a few stablecoins, which are backed by a basket of multiple assets (commercial papers, bonds, real estate, precious metals, etc). The value can fluctuate over time subject to movement in commodity and precious metal prices. Example: Digix Gold, backed by physical gold.
- Crypto-Collateralized Stablecoins - These are more decentralised than their peers and are backed by cryptocurrencies. The flipside is price volatility and to address the risk of price volatility, these stablecoins are over-collateralized. Example: Dai.
- Non-collateralized stablecoins - These do not have any backing and are decentralized in the true sense and the supply of non-collateralized stablecoins is governed by algorithms. Example: Basis.
- Story of Tether: Just in 2021, dollar-tied stablecoins such as Tether token, USD Coin and Pax Dollar have jumped from $30 billion in circulation in January to about $125 billion as of mid-September '21. The first stablecoin, created in 2014, was Tether. Such stablecoins now underpin a growing share of cryptocurrency transactions globally, at a time when the total value of outstanding crypto tokens like Bitcoin is about $2 trillion — roughly the same value as that of all United States dollars in circulation.
- The problems: Many stablecoins are backed by types of short-term debt that are prone to periods of illiquidity, meaning that they can become hard or impossible to trade during times of trouble. Then, not all stablecoins are really 100% price-stable. Their values are dependent on their underlying assets. There are potential asset contagion risks linked to the liquidation of stablecoin reserve holdings. A contagion is the spread of an economic crisis from one market or region to another and can occur at both a domestic or international level.
- The risks are primarily associated with collateralised stablecoins, varying based on the size, liquidity and riskiness of their asset holdings, as well as the transparency and governance of the operator.
- While stablecoins have the potential to enhance the efficiency of the provision of financial services, they may also generate risks to financial stability, particularly if they are adopted at a significant scale.
- Lack of accountability: They are not transparent or auditable by everyone and are operated just like non-bank financial intermediaries that provide services similar to traditional commercial banks, but outside normal banking regulation. International coordination of regulatory efforts across diverse economies, jurisdictions, legal systems, and different levels of economic development and needs is another regulatory challenge. There is not (yet) a uniform regulatory approach of regulators worldwide relating to stablecoins.
- Summary: Stablecoins do not stand for a uniform category but represent a variety of crypto instruments that can vary significantly in legal, technical, functional and economic terms. To be effective in limiting risks and not disturbing innovations the stablecoin industry must work together with the regulators to come up with a framework that helps put them at ease while protecting this nascent industry from overregulation. The push by the Biden administration to exert some control over stablecoins is likely to grow into an expansive debate over regulating cryptocurrencies.
- EXAM QUESTIONS: (1) Distinguish between cryptocurrencies and stablecoins. (2) What are the risks with 'stablecoins', if they are linked with underlying mainstream financial assets?
* Content sourced from free internet sources (publications, PIB site, international sites, etc.). Take your own subscriptions. Copyrights acknowledged.
COMMENTS