Stablecoin regulation looks on the way

A new set of stablecoin regulation proposals are out. But what do they say?

Contents

Regulators have called for stablecoins to be subject to the same regulations as other settlements, payments and clearing services in what seems to be a growing move towards stablecoin regulation.

First, though, a quick definition. If you want to know “what is a stablecoin?”, then it is a cryptocurrency that is pegged to a fiat currency.  Stablecoins are Ethereum (ETH) tokens designed to stay at a fixed value, even when the price of ETH changes.

If you want to know “how are stablecoins regulated?”, the answer is that they are not – at least, not yet, although that might change.

Stablecoin regulation report

The Committee on Payments and Market Infrastructures (CPMI) of the Bank for International Settlements (BIS) and the International Organization of Securities Commissions (IOSCO) set out earlier in October how current rules for major clearing, settlement and payments services should also be applied to ‘systemic’ or heavily used stablecoins.

In a statement, the two bodies said: “Stablecoin arrangements should observe international standards for payment, clearing and settlement systems.”

The report argued that, since stablecoins and stablecoin arrangements – abbreviated to SA in the jargon – used the same principles as other kinds of financial market infrastructure, then they should, ideally, be subject to the principles for financial market infrastructure. 

It said that a “systemically important” stablecoin arrangement should have “appropriate governance arrangements”; it should provide a clear final settlement and the stablecoin it backed should have very little or even no credit or liquidity risk.

The statement added: “A systemically important SA should determine whether the credit and liquidity risks of the stablecoin that it uses for money settlements are minimised and strictly controlled, and the stablecoin is an acceptable alternative to the use of central bank money.”

A stablecoin operator would, if the rules are agreed, have to establish a legal entity that would set out how it would deal with the likes of cyber attacks, as well as to explain how the coin was governed.

Stablecoin regulation
What makes a stablecoin systemic? - Credit: Currency.com

Systemic stablecoins

In terms of whether a stablecoin was judged to be systemically important, the report set out a number of factors. These included:

  • The size of the SA, both in terms of how many users it had and also in terms of how many transactions it had carried out. The number of coins in circulation would also be a factor.
  • Risk profile. This takes into consideration what the coin is used for and the profile of its users.
  • How well connected it is to the real-world economy.
  • Whether there were any available alternatives to using the coin as a means of payment or settlement.

The report also addressed the issue of a stablecoin forking (when the blockchain protocol diverges into two potential paths), saying that a fork could lead to a deal being reversed in what it described as “misalignment between technical settlement and legal finality”.

In addition, it said SAs should make it clear as to when a settlement was final and make it transparent to the coin’s users if there was a possibility a transaction could be reversed.

It further added: “A systemically important SA should… ensure proper transparency regarding mechanisms for reconciling the misalignment between technical settlement and legal finality, and have measures in place to address the potential losses that could be created in case of reversal stemming from the misalignment between technical settlement and legal finality.”

Regulating stablecoin?

The report argued that the use of stablecoins for settlements caused a level of risk, which should be monitored and regulated.

It stated: “The safety of an SA’s money settlements will depend on the credit and liquidity risk stemming from the entity performing the issuance and redemption of the stablecoin, on the assets used to support the value of the stablecoin, and the relevant custody and investment arrangements. 

“It also depends on the ability of the users to have access to these assets. Money settlements play a crucial role in an FMI’s [financial market infrastructure’s] operation.”

Ashley Alder, chair of the IOSCO board and chief executive of the Hong Kong Securities and Futures Commission, said: “This report marks significant progress in understanding the implications of stablecoin arrangements for the financial system, and providing clear and practical guidance on the standards they need to meet to maintain its integrity. We look forward to receiving submissions to further enhance our insights and recommendations.”

Sir Jon Cunliffe, chair of the CPMI and deputy governor for financial stability at the Bank of England, said: “The payments landscape has undergone rapid transformation in recent years and continues to evolve at pace. This is happening at the same time as financial innovation offers the prospect of new payment services and greater competition in payments, but also potential risks to the financial system.

“This consultation document is part of an ongoing commitment by the international regulatory community to ensure the principle of ‘same risk, same regulation’, to identify potential risks and to help develop appropriate oversight to safeguard financial stability.”

The Bank of International Settlements (BIS) said that the overall legality of stablecoin usage and the questions about whether stablecoins are regulated should be down to individual countries and their central banks, but if they did and the particular stablecoin did become systemic, then the rules set out in the Principles for Financial Market Infrastructures (PFMI) should also apply to them as a way to regulate stablecoins.

The proposals in the report are now subject to consultation, with a final version of the document expected to come out at some point in 2022. Both the CPMI and IOSCO said it could carry out their own investigations into any issues that might come up as part of the consultation. 

Regulating stablecoin in the US

US legislation

The news comes after a group American politicians and progressive first-term lawmakers called for stablecoins to be subject to banking charters before being allowed to trade earlier this year.

In a statement, US Representative Rashida Tlaib, (D–Michigan), a member of the group, has called for stablecoin regulation. She said: “From the OCC [Office of the Comptroller of the Currency] to the Federal Reserve to those peddling stablecoins, the protections the STABLE Act would make possible are more needed than ever amid a pandemic that will breed riskier financial decisions out of necessity because our federal government continues to fail us all by not providing adequate relief legislation.”

Also in the United States, earlier this summer the President’s Working Group on Financial Markets, chaired by US Treasury Secretary Janet Yellen, met to discuss stablecoins and the potential regulation of stablecoins.

In a statement, the working group said: “In the meeting, participants discussed the rapid growth of stablecoins, potential uses of stablecoins as a means of payment, and potential risks to end-users, the financial system and national security. The Secretary [Yellen] underscored the need to act quickly to ensure there is an appropriate US regulatory framework in place.

“The group also heard a presentation from Treasury staff on the preparation of a report on stablecoins, which would discuss their potential benefits and risks, the current US regulatory framework, and the development of recommendations for addressing any regulatory gaps. The PWG [President’s Working Group on Financial Markets] expects to issue recommendations in the coming months.”

It is not yet known what the upshot of either of the working groups’ meetings was, nor what the congressional groups’ calls for stablecoin regulation will amount to, nor if [or when] we will find out how stablecoins will be regulated in the future.

FAQs

The best stablecoins are the ones that are genuinely stable and properly backed by a reserve asset. If you want to know what those are, you will have to do your own research and make a decision that is best for you. 

Stablecoins are important because they are a useful tool when it comes to trading cryptocurrencies. They also, at least in theory, keep their value pegged to a fiat currency. 

You can trade stablecoins at a variety of exchanges, including currency.com. However, you will need to remember that stablecoins can quite often be unstable and that their prices can go down as well as up, also that you should never invest more money than you can afford to lose.

Ethereum to US Dollar
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High: 3884.28

Further reading: Fitch ratings predicts stablecoin sector will grow

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