Stablecoins are cryptocurrency that are pegged to a traditional asset, such as a fiat currency or gold. Other stablecoins are linked to an asset pool. By pegging the reference value to a stable asset, stablecoins aim to avoid or minimise price volatility.
In an October 2019 Report the Bank for International Settlements (BIS) stated that, “Stablecoins might be more capable of serving as a means of payment and store of value, and they could potentially contribute to development of global payment arrangements that are faster, cheaper and more inclusive.”
However, the BIS noted that these potential benefits can only be realised where the legal, regulatory and oversight challenges and risks can be addressed. The main risks being a lack of legal certainty, governance, money laundering and terrorist financing, integrity and safety, cyber security, market integrity, data protection, consumer protection and tax compliance.
Implications for the Financial System
In a recent speech by Fabio Panetta, member of the executive board of the ECB, additional concerns were outlined, focusing on the possibility that wide acceptance in the EU of stablecoins offered by foreign countries could leave European citizens and merchants dependent on technologies which are designed and governed elsewhere.
Mr Panetta commented that stablecoins, if widely adopted, could threaten financial stability and monetary sovereignty.
The main risks outlined are:
- Safeguards governing bank deposits and e-money, such as deposit insurance schemes and prudential regulation, do not apply to stablecoins. Without these safeguards, stablecoins are vulnerable to runs, where users expect a decrease in the redemption price of the stablecoin or where users perceive an issuer to be incapable of absorbing losses.
- Improper management of liquidity, settlement, operational and cyber risks could threaten the functioning of stablecoin arrangements and lead to systemic instability.
- Large investments in safe assets by stablecoin issuers could influence the level and volatility of real interest rates.
Potential Policy Reforms
Mr Panetta indicated that European authorities needed to respond to the ongoing transformation of the payments landscape by promoting competition and innovation while also developing a regulatory and oversight framework.
Complimentary policy measures which may be introduced by European authorities in the near future include:
- The Eurosystem Retail Payments Strategy, which will enable consumers and merchants to have easy access to efficient payments and harmonise electronic identity and electronic signature services and their use in payments
- The possible introduction of a digital euro, which will provide EU citizens with access to a simple, risk-free and trusted digital form of central bank money
- The ECB’s innovative payment oversight framework, which will redefine the scope of the ECB’s oversight activity to allow for technological and market changes
- The proposed Regulation on Markets in Crypto-assets (MiCA)
- A multi-sectoral response from central banks, financial regulators, data protection authorities and competition authorities is necessary and the European Commission is examining the need for further legislation in this area as part of its Digital Payments Strategy
The aim of these initiatives is to guarantee that stablecoins will be subject to the same standards that currently exist for payment systems and instruments.
What next for stablecoins?
The risks and opportunities inherent in stablecoin offerings are likely to make it inevitable that issuers will become subject to regulation. The EU Commission’s Digital Finance Package includes legislative proposals for an EU regulatory framework on crypto-assets and a regulatory framework on digital operational resilience.