Recently, the Financial Stability Board (FSB), an international G20 financial watchdog under the auspices of the Bank of International Settlements (BIS), published a report with recommendations on “Global Stablecoin” (GSC) oversight around the world.
The report was widely received as a veiled examination of Facebook’s proposed Libra project, which was originally a private corporation, consortium-backed stablecoin pegged to a basket of underlying assets—similar to the IMF’s Special Drawing Rights (SDR).
However, Facebook recently yielded to the overt regulatory pressures it received following Libra’s announcement and has shifted to a multi-currency model that heavily favors support for central bank digital currencies (CBDCs).
Despite Facebook bending the knee to regulators, the FSB’s report also allocated oversight recommendations to countries to re-evaluate the role of global stablecoins. In particular, the report outlines some of the implications of stablecoins on disrupting current financial markets and how to coordinate a unified regulatory response across nations—a response that sounds troublesome for the future of stablecoins.
A tale of two models
Stablecoins are cryptocurrencies, digital tokens issued on a blockchain, that are designed to maintain price parity with a fiat currency, like the USD. They’re basically crypto-dollars that perform the role of a stable asset for trading crypto on exchanges but have expanded to sundry other applications in recent years due to their fast global settlement, liquidity, and accessibility.
There are primarily two forms of stablecoins:
The first type, fiat-collateralized, is the most straightforward. For example, USDC, one of the more popular stablecoins, is issued on the ethereum blockchain as a digital token that functions with some of the same advantages of a cryptocurrency. However, USDC tokens are redeemable at a 1:1 ratio with the USD because Coinbase and Circle, the two firms behind USDC, hold an equivalent amount of USD in an FDIC-insured bank account as the USDC tokens that are in circulation.
Fiat-collateralized stablecoins expand and contract their supply based on demand. Higher demand for USDC would drive up its price, but that demand is countervailed by more injecting more USDC into the system (meeting demand with supply) to maintain the 1:1 parity with the USD.
Another important aspect to recognize from a regulatory context is that many of the fiat-collateralized stablecoins are issued by centralized entities. USDC, issued by Circle and Coinbase, is fully regulated in the US and may fall under the recommendations outlined by the FSB as the companies are subject to regulation as for-profit businesses. Similar to Libra, these companies have faces that appear before Congress.
However, the picture is cloudier when it comes to understanding the real velocity of stablecoins in the crypto market. For example, Tether, the long-standing king of stablecoins with a market cap over $7 billion right now, intentionally plays regulatory arbitrage to avoid the jurisdictional reach of the US government, which has already had bouts within New York. In fact, Tether’s hardline stance on not bending to regulators is speculated as to the primary reason for its consistent popularity.
For instance, Tether does not even back its stablecoin 1:1 with the USD. Instead, it’s only backed by 74 percent cash, with the remaining 26 percent consisting of a basket of assets. Most Tether users were entirely unaware of this development until it was announced, but went on without caring anyways. Since then, Tether’s supply has only accelerated in growth.
“Nobody actually cares if Tether is backed or not,” said Konstantin Plavnik, COO of Moscow-based crypto derivatives exchange Xena, to Coindesk in their case-study of the Chinese-Russian OTC avenue.
Much of that sentiment is driven by the fact that Tether has demonstrated a willingness to struggle with banking relationships as long as it enables them to play regulatory arbitrage— avoiding the ire of Uncle Sam.
“I am sure that the G20 regulators will not seek to destabilize the situation in the financial markets through a ban on stablecoins as hedging tools for calculated risks and especially so given that the Chinese authorities have already released the Digital Yuan,” details Alexei Blagirev, Digital Investor and Relations Director at Sensorium Corporation.
And while it is unlikely that Tether would succumb to regulatory pressures like Libra, it remains a remote possibility. Tether is a centralized entity holding assets in reserve for its depositors, earning interest on those deposits. As a result, it’s ultimately subject to scrutiny as a trusted third party. That’s where the second model of stablecoins makes an appearance, crypto-collateralized stablecoins.
Crypto-collateralized stablecoins are designed with the explicit goal of a decentralized stablecoin—one not subject to regulatory scrutiny. MakerDAO’s Dai stablecoin is undoubtedly the most popular as Ethereum’s DeFi flagbearer. In the crypto-collateralized model, rather than holding assets in 1:1 reserves, another cryptocurrency is used to over-collateralize the issuance of the stablecoin into the network.
For example, users that want Dai can purchase it openly on an exchange for one USD, since it is designed to maintain a 1:1 parity with the USD. However, MakerDAO users can also unlock Dai (increasing its circulating supply) by locking up ETH in a smart contract that returns Dai. The ETH locked up has to be over-collateralized, however, to prevent liquidation in the case of a sharp drop in the price of ETH, something that has happened already on several occasions.
Crypto-collateralized stablecoins are not explicitly highlighted in the FSB report, although they are “global” in the sense that you only need an internet connection to access them.
Expect a backlash
And while crypto-collateralized coins like Dai are susceptible to scaling problems, they are stable and largely outside the reach of any heavy-handed regulation—obsoleting any FSB recommendations.
“If anything the backlash here perhaps only underscores the effectiveness of blockchains,” says Yusaku Senga, Founder of Swingby Protocol. “I think we are perhaps in the later stages of banks fighting against the crypto movement in this latest development, and welcome the point at which these changes to one of deeper cooperation similar to that we see in China today.”