The regulation of stablecoins, has been at the forefront of recent discussions given their rapid growth, increased use cases, and their potential for financial risk contagion[i]. 

Jurisdictions have been gradually introducing policy and legislation to address the issuance, arrangement, and use of these innovative assets; guided by recommendations from international standard setting bodies[ii]. 

As the regulatory framework for these assets continue to emerge, it is useful to consider their nature and relevance and the various approaches that have been adopted/proposed by several jurisdictions to date.

What is a stablecoin?

A stablecoin is a type of crypto asset that is pegged to a reference value in order to maintain stability. Stablecoins were introduced to, inter alia, address the volatility of [unbacked] crypto assets such as bitcoin. As at June 10, 2023, the market cap for stablecoins was $128.06billion[iii].

Stablecoins can be centralized or decentralized and are often categorized by their stability mechanism, i.e., off-chain collateralization, on chain collateralization or through algorithmic means. Stability mechanisms may also be hybrid encompassing various aspects of the three main types identified.

Types of stablecoins

Off chain collateralization

Off chain collateralized stablecoins are backed by traditional assets such as cash or other financial instruments (securities and/or commodities)[iv]. Since the collateral itself does not reside on the blockchain, but rather is held with a [centralized] custodian they are referred to as “off chain” collateral. Collateral is typically pegged one to one. Examples of off-chain collateralized stablecoins include Tether (USDT), USDC, Binance USD and True USD.

On chain collateralization

On chain collateralized stablecoins are generally backed by crypto assets that are held in smart contracts on a blockchain (instead of a centralized custodian). They are typically over collateralized to account for volatility and to protect the stability of the stablecoin. Examples include DAI, Frax[v] and Liquity USD (LUSD). 

Algorithmic

Algorithmic stablecoins maintain stability through the utilization of algorithms that control demand and supply. Tokens are either burned or minted to maintain a fixed value. The main algorithmic mechanisms employed are the rebase model and the coupon model[vi]. With the rebase model, the supply of tokens contract or expand across wallets which changes the number of tokens individually owned at regular intervals while ensuring that the proportional value held, remains the same. The coupon model operates through an incentive system, based on rewards that encourages the sale or purchase of stablecoins in order to manage the supply and price of same. Examples of algorithmic stablecoins include AMPL, UXD[vii] and the well-known controversial Terra USD.

The stablecoin trilemma

The trilemma[viii] is based on the premise that there is no perfect stablecoin. A stablecoin is likely to lack one of three key characteristics, namely, capital efficiency, price stability or decentralization. With off chain collateralized stablecoins, decentralization is traded off in order to ensure price stability and capital efficiency. Traditional assets are matched one to one with the value of the stablecoin; but are held by a centralized custodian raising concerns such as transparency and counterparty risks. On chain collateralized stablecoins, tend to sacrifice capital efficiency (due to overcollateralization) to ensure price stability and decentralization. Algorithmic stablecoins arguably sacrifice price stability for decentralization and capital efficiency given the lack of collateralization.

Uses of stablecoins

Stablecoins have been promoted as having many uses, including:

Facilitating crypto asset trades/acting as a store of value: stablecoins are used for the trading of various crypto assets (in lieu of fiat in the crypto ecosystem)[ix]. They act as a bridge between fiat and crypto assets allowing traders to maintain value in the crypto ecosystem[x], utilizing same to sell or purchase different crypto assets, without the need to off ramp conversion to fiat.

Digital means of payment/remittance: stablecoins may also be considered as an efficient means of conducting peer to peer and cross border payments and remittances. Stablecoin use provides the potential to lower payment barriers that currently exist in the traditional payment sector (e.g., third party exchange & transfer fees, transaction delays, financial exclusion etc)[xi]. However, it has been argued that stablecoins may not be a practical means of payment[xii] and do not adequately substitute traditional payment arrangements[xiii].

DeFi: stablecoins act as a bridge between the Traditional Finance and Decentralised Finance spaces. They are generally built on protocol standards that are programmable and allow for composability (i.e. to be used as building or Lego blocks); which facilitates their use for the conduct of payments and various other financial services[xiv]. Such services include collateralized lending, asset management, market making, etc. Stablecoins are also used as a means of generating yield in various DeFi applications[xv], act as a source of liquidity to the crypto markets and serve as collateral for market participants to fund additional activities[xvi].

Concerns about stablecoins

Risk of runs and interconnectedness within the DeFi ecosystem: confidence is a key factor in ensuring stablecoins maintain price stability. If concerns arise as to redeemability, this could lead to a surge of conversion requests and panicked liquidations. Unexpected conversions could consequently result in breaking the peg and an ensuing negative spiral[xvii] affecting the DeFi ecosystem (and potentially the traditional financial sector[xviii]). The interconnectedness of DeFi applications and the pivotal role stablecoins play therein, means that a run could impair, inter alia, the collateral and liquidity of DeFi protocols[xix] resulting in serious operational failures and significant losses for investors[xx],and the broader crypto-asset ecosystem. For the traditional financial sector, a surge of redemptions of offchain [non-cash] collateralized stablecoins, may require a fire sale of reserves in order to meet demands. This could lead to negative effects on the value of these assets, causing disruptions and inadvertent financial shocks to the market[xxi]. 

Counterparty risk: this refers to the possibility of default by a stablecoin issuer in meeting redemption requests and is generally associated with off chain collateralized stablecoins.

Cyber security: like unbacked crypto assets, stablecoins are susceptible to hacks and other cybersecurity threats.

Lack of regulation and information asymmetries: lack of regulation means that there are no requirements for standardized disclosures, among other things. This could lead to inter alia, unfair practices, transparency and consumer protection concerns as well as illegal activities. This is slowly changing given the implementation of regulatory regimes for stablecoins being introduced by various jurisdictions.

Regulation of stablecoins

Standard setting bodies

International Standard Setting Bodies[xxii] have been actively involved in discussions in the last few years on the growth of stablecoins, their issuance, arrangements, use and the need for regulation to mitigate risks. In the main, recommendations highlight key elements that should be incorporated into an appropriate regulatory regime.

The Financial Stability Board, International Monetary Fund, Financial Action Task Force, International Organization of Securities Commissions, Bank for International Settlements have all offered views on the regulation of [global] stablecoins, having regard to the risks they pose.

Key risks include:

[Potential] financial stability risks[xxiii] - this could arise as a result of mass adoption of stablecoins across multiple jurisdictions[xxiv] and the use of stablecoins as a means of payment and/or store of value[xxv] without adequate regulation. Contagion channels include financial sector exposures, lack of confidence (which could lead to runs and extend to the broader financial system) and the extent of use in payments, etc.

Consumer protection and market integrity risks - information asymmetry has also been highlighted as a key issue. The apparent lack of disclosure relative to issuances, the functioning of stabilization mechanisms, governance arrangements and redemption rights, among other things, raise concerns in relation to the protection of investors, market integrity, operational resilience, market manipulation, fraud, etc.

The conduct of illicit activities - stablecoins arguably also pose threats in relation to the conduct of illicit activities as a result of mass adoption and person to person transfers[xxvi]; including the conduct of money laundering and terrorist financing[xxvii].

Runs - a stablecoin’s inability to maintain a stable value could expose investors to unexpected losses, and would trigger runs that may consequently damage financial stability[xxviii]. Since stablecoins engage in maturity transformation[xxix], in a similar manner to banks and other financial institutions, they are susceptible to loss of confidence and the risk of runs on either the issuer or the reserve assets. Confidence in a stablecoin is necessary in order to mitigate the risk of system wide stress and contagion.

Stabilization mechanism and redemption risks - It is not always clear that the stabilisation mechanism of a stablecoin will maintain price stability. With off chain and on chain collateralization, concerns may arise as to the quality of reserve assets and the ability to liquidate same in a timely manner to honour redemption requests[xxx]. The use of algorithms, as a stability mechanism, to derive value and price stability, along with enabling arbitrage activities with market participants[xxxi] has come into question particularly in light of the Terra/Luna fiasco. Furthermore, there appears in many instances to be a lack of clarity around the nature and enforceability of redemption rights and the process for redemption[xxxii].

Other risks - Other relevant risks include, risks to operational resiliency, cybersecurity, and data protection.

The common message emanating from standard setters is that an appropriate regulatory framework for stablecoins should address, inter alia, financial stability; consumer protection; credit; market; liquidity; operational, financial, market integrity, illicit activities (e.g. anti-money laundering/ terrorist financing) and concentration risks.

In that regard, a regulatory regime for stablecoins should contain, at minimum:

• Appropriate licensing and registration for the issuance, transfer and arrangements of stablecoins.
• Governance and control requirements for stablecoin arrangements, including clear and direct lines of responsibility and accountability for all functions and activities within the arrangement.
• Robust systems for collecting, storing and safeguarding data; ensuring adequate controls that will maintain integrity and security of pertinent data (both on chain and off chain). 
• Requirements for the issuance and redemption of stablecoins, the composition of reserve assets (which should consist of only conservative, high quality and highly liquid assets), as well as disclosure and transparency.
• The obligation to ensure a comprehensive risk management framework is in place that addresses material risks associated with activities conducted.
• Compliance requirements for key players in stablecoin arrangements including those providing custody or trust services, trading and exchanging stablecoins, or storing the keys providing access to stablecoins.
• Submission of appropriate recovery and resolution plans for stablecoin arrangements.
• Appropriate settlement arrangements that must be clear, certain and final with low liquidity and credit risks; and
• Sufficient powers and tools [for regulators] to effectively regulate and supervise stablecoins activities; as well as cross border sharing of information to mitigate risks such as regulatory arbitrage and other cross border issues.

Jurisdictions

Below is a summary of the some of the regulatory approaches that have been adopted/proposed by various jurisdictions. 

European Union

The European Union has introduced a key piece of legislation relevant to the regulation of crypto assets and associated activities, including stablecoins. The Markets in Crypto Assets Regulation (MiCA) sets out a regulatory framework for crypto assets based on distributed ledger technology.

MiCA’s classification of crypto assets includes two types of stablecoins. Namely:

a.    Asset referenced tokens which are crypto assets backed by reserve assets comprised of fiat, various commodities and/or several crypto assets, to maintain a stable value.

b.    Electronic money tokens are crypto assets backed by a single fiat currency to maintain the asset’s stability.

MiCA requires stablecoin issuers to be authorised to issue or admit stablecoins for trading. Key requirements regarding stablecoins also include, the publication of an approved white paper by issuers as well as conduct and prudential obligations for those involved in stablecoin issuance or arrangements[xxxiii]. MiCA contains requirements that cover matters such as marketing and communication with investors, managing complaints, conflicts of interests, governance arrangements, reserve assets[xxxiv] (including custody of same), etc[xxxv]. It also prohibits the paying of interests to stablecoins holders. For significant stablecoins, additional requirements for liquidity maintenance, recovery and redemption planning are applicable.

Japan

In Japan, amendments to the Payment Services Act (PSA) and other relevant laws[xxxvi] address the regulation of stablecoins. The main focus of the regulatory regime is in relation to fiat backed stablecoins[xxxvii], which are regulated as electronic payment instruments[xxxviii]. The two main areas of focus for fiat backed stablecoins are issuance and transaction management (i.e. intermediary activities). The regime restricts issuers of fiat backed stablecoins to banks[xxxix], fund transfer service providers[xl] and trust companies[xli]. Intermediary activities include: (i) buying, selling, exchanging, and intermediating fiat backed stablecoins; (ii) custody of stablecoins; and (iii) transferring stablecoins on behalf of the issuer[xlii].

Other off chain collateralized stablecoins as well as on chain collateralized and algorithmic stablecoins are not covered by the PSA regime and are instead covered by other laws that are applied to crypto assets and security tokens[xliii]. Intermediaries of these types of stablecoins are subject to advertising and solicitation regulations along with other requirements applicable to crypto-asset exchange service providers. Notwithstanding, the Financial Services Agency of Japan may designate such stablecoins as digital-money type stablecoins if they are widely used as a means of payment[xliv]. 

United States

In the United States, no specific regulatory regime for stablecoins at the federal level has yet been enacted. Several bills have been introduced to Congress that are relevant to the regulation of stablecoins. These include the draft bill by Senator Pat Toomey on the regulation of payment stablecoins[xlv] as well as Senators Kirsten Gillibrand and Cynthia Lummis’ 'Responsible Financial Innovation Act[xlvi], which creates requirements for payment stablecoins and issuers to “maintain high-quality liquid assets…equal to 100 percent of the face amount” of the issued stablecoins’ value[xlvii].

Recommendations have also been made for stablecoin regulation by bodies such as the Financial Stability Oversight Council (“FSOC”) and the President’s Working Group on Financial Markets.

The President’s Working Group on Financial Markets, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency published a report on stablecoins in November 2021. The report recommends inter alia, the enactment of legislation to ensure that payment stablecoins are subject to a federal prudential framework; and notably to “limit stablecoin issuance, and related activities of redemption and maintenance of reserve assets, to entities that are insured depository institutions”[xlviii].

The FSOC’s October 2022 report recommends comprehensive legislation for stablecoin issuers and intermediaries having regard to the risks posed by stablecoins such as market integrity, investor and consumer protection, and payment system risks.

Coordination of Federal and State regulators will be key to implementing an appropriate regulatory regime for stablecoins in the United States. In the interim, states like New York have chosen to issue guidelines in relation to fiat backed stablecoins. The New York Department of Financial Services issued ‘Guidance on the Issuance of U.S. Dollar-Backed Stablecoins’[xlix], in 2022 which focuses on three main areas. Namely, redeemability; reserves; and attestations.

United Kingdom

In the UK, the regulation of stablecoins will be covered via two phases. The UK’s Phase 1 regulatory regime will cover, inter alia, fiat backed stablecoins. Phase 2 of the UK’s regulatory approach would address on chain and algorithmic stablecoins, as well as commodity backed stablecoins, among other things.

For Phase 1 (currently being implemented), the Financial Services and Markets Act has been revamped to include, among other things, a regime for regulating digital settlement assets[l] (including fiat backed stablecoins[li] ) and appropriate powers (including rule making powers) for the relevant authorities. The legislation covers the issuance, custody and use of fiat-backed stablecoins for payments; having regard to their specific risks, benefits and potential use cases[lii].

Regulatory requirements for stablecoins issuers, custodians and payment service providers will include maintenance of own funds, liquidity management, governance, operational resilience, data reporting, consumer protection, and other conduct of business requirements (e.g., managing conflicts of interest and mandatory disclosures to customers). Disclosure obligations also form a key element in this regime along with addressing market abuse. Phase 1 does not address the exchange and trading of stablecoins, which is intended to be captured in Phase 2.

Phase 2 proposals include treating non-fiat backed stablecoins as unbacked crypto assets and focusing on the financial activities they are used for (i.e. trading/exchange, investment, intermediation, public offers and custody). This would require adherence to inter alia, financial promotional rules [requiring marketing of same to be clear, fair and not misleading], money laundering requirements, disclosure obligations and market abuse rules. It is also the intention that such stablecoins are not permitted to be marketed as “stable” or as “payment instruments”. It is worth noting that unlike some jurisdictions, there is no proposal to ban or prohibit algorithmic stablecoins or leave them outside of the regulatory perimeter. 

Hong Kong

The Hong Kong Monetary Authority has indicated its intention to regulate stablecoins. Like the UK, the priority would be to focus on the regulation of fiat backed stablecoins[liii] having regard to the monetary and financial stability risks they may pose. The regulatory regime will be developed in a flexible manner to facilitate the regulation of other types of stablecoins at a later stage. Regulatory requirements will cover key elements that include, ownership, governance and management, financial resources, risk management, anti-money laundering and counter-terrorist financing (“AML/CFT”), user protection, composition of reserve assets, regular audits and disclosure. The intention is to implement a regulatory regime for stablecoins in 2023/2024. It is still to be determined whether the proposed regulatory regime will be implemented via new legislation or through amendments to existing laws.

United Arab Emirates (Dubai and Abu Dhabi)

In the UAE, the international financial centres in Dubai and Abu Dhabi have also implemented a regulatory regime for stablecoins. Like many jurisdictions, the Financial Services Regulatory Authority (FSRA) in Dubai and Abu Dhabi have chosen to focus on the regulation of fiat backed stablecoins[liv] and prohibit the use of algorithmic stablecoins[lv].

In the Abu Dhabi Global Market, fiat stablecoins are treated as e-money tokens, and issuers as money service businesses. Financial services permission from FSRA is required for stablecoin issuers, custodians and multi-lateral trading facilities. There are several regulatory requirements that must be met in relation to the conduct of business, prudential and anti-money laundering compliance. Stablecoins must also meet the criteria for ‘accepted virtual assets’ which is based on seven key factors. Namely, maturity/market capitalisation, security, traceability, exchange connectivity, type of distributed ledger technology, innovation and functionality[lvi].

In Dubai, the FRSA also takes a similar approach requiring fiat backed stablecoins to be ‘recognised crypto tokens’. Matters considered in determining whether a stablecoin would be a recognised crypto token include:

• the regulatory status of the crypto asset in other jurisdictions,
• transparency,
• the size, liquidity and volatility of the market for the crypto asset globally,
• the adequacy and suitability of the technology used,
• risks associated with the crypto asset are adequately mitigated.

Furthermore, stablecoins must meet certain reserve criteria including, that the value and composition of the reserves backing the fiat stablecoins is published at least quarterly, and verified by an independent professional third party. Reserves must also be at least equal to the value of circulating stablecoins and the price of the stablecoin must remain stable, relative to the fiat currency it references. A responsible person must also be identified as being liable to investors. Prudential, conduct of business, financial promotions and AML requirements also apply.

Bahamas

In April 2023, the Bahamas Securities Commission published, for consultation, proposed amendments to the Digital Assets and Registered Exchanges (DARE) Act[lvii]. The amendments include the implementation of a regulatory framework for stablecoins including requirements for registration, composition of reserve assets, custody, management and segregation.

The proposed regime specifically prohibits algorithmic stablecoins but will cover on chain and off chain collateralised stablecoins. Issuers of stablecoins will be required to disclose information in relation to the method used to calculate the value of reserves, the value and composition of reserves, the stabilisation mechanism used, details on purchase and redemption, details on the custody and management arrangements for reserve assets, the rights of stablecoin holders, etc. The amendments also include a specific requirement that redemption of stablecoins will be “subject to reasonable, non-burdensome conditions”.

The exclusion of algorithmic stablecoins

Based on the above, it appears that many jurisdictions are focusing on fiat backed stablecoins. Some have cast a wider net that covers most on chain and off chain collateralised stablecoins; but a great number of jurisdictions have specifically prohibited or excluded algorithmic stablecoins.

A key concern of the private sector has been the tendency of regulators to narrow their focus on the use of conservative assets to back stablecoins. It has been argued that to do so risks negative consequences for the continued evolution on stablecoins and how they can be used. Instead, regulatory focus should be on ensuring there are adequate and effective risk management strategies to, inter alia, protect investors regardless of the way a stablecoin is supported. The Crypto Council for Innovation for example, proposes that in relation to algorithmic stablecoins, regulators ought to consider “enacting narrowly tailored collateralization requirements that allow for the development of safe software code”.[lviii] They point out that excluding algorithmic stablecoins from the regulatory perimeter could have the negative consequence of facilitating regulatory arbitrage and/or the conduct of harmful unregulated practices since, it would be almost impossible to remove these types of stablecoins entirely from respective markets.

While it is agreed that the risks associated with the issuance and use of algorithmic stablecoins may be greater than that of other stablecoins, there is merit in considering how one could regulate same rather than excluding them from the regulatory perimeter.

Stablecoins and Deposit Insurance

There are many potential benefits of a deposit insurance scheme for stablecoins such as, boosting investor confidence as well as mitigating systemic risks and runs on stablecoins.

In the US, there have been proposals for stablecoin issuers to be banks, which could then result in insurance coverage for stablecoins[lix], in the same way as bank deposits. Suggestions have also been made in relation to considering whether stablecoins issued by non-banks could potentially be included in the federal deposit insurance scheme.

In exploring the idea of deposit insurance for stablecoins, one would have to consider how same could be implemented. A potential solution could be to allow registered/licensed issuers to opt in to the scheme if certain criteria are met[lx].

Assessment of the stablecoin’s stability mechanism, reserve assets (where applicable), performance, ability to maintain a stable value could be key factors considered in determining whether a stablecoin issuer could opt in. Risks of the stablecoin (and its issuer) and the adequacy of mitigation tools could also assist in the assessment of the stablecoin. The assessment would determine, whether an issuer is eligible to opt in and the contribution that should be made by the issuer towards the insurance scheme. The funds collected could be placed in a special investment fund maintained by the relevant Deposit Insurance Authority.

However, there may be a number of challenges in implementing this solution, including lack of adequate resources, specialized knowledge and skills, information on the ownership of all crypto wallets holding the insured stablecoins, determination of an insurance ceiling for each wallet, how to pay out insurance claims[lxi], etc. Such matters may take time to work through and it is not yet clear whether jurisdictions have the appetite to pursue same.

Conclusion

Stablecoins have been growing in significance, as a store of value and for payments. Regulators recognising the increase in use cases and potential risks (if left unregulated) have begun implementing appropriate regimes for these assets.

Most jurisdictions have chosen to regulate fiat backed (or a narrow group of collateralised) stablecoins. The regulation of algorithmic stablecoins remains a controversial matter, with some jurisdictions opting to specifically prohibit its use, having regard to the concerns expressed by international standard setters in relation to algorithms and arbitrage activities.

One matter that remains a challenge is ensuring a comprehensive and consistent approach across jurisdictions. While standard setting bodies, like the FSB, have proposed recommendations to achieve same; consistency may arguably be seen as an elusive goal given the varying approaches that are being implemented by several jurisdictions.

References

[i] ‘Stablecoins’ role in crypto and beyond: functions, risks and policy’- Prepared by Adachi, et al- European Central Bank.

[ii] See IOSCO, FSB, IMF and FATF discussions on stablecoins.

[iii] See https://defillama.com/stablecoins.

[iv] See also European Central Bank https://www.ecb.europa.eu/pub/financial-stability/macroprudential-bulletin/html/ecb.mpbu202207_2~836f682ed7.en.html#toc6  

and the Federal Reserve https://www.federalreserve.gov/econres/notes/feds-notes/the-stable-in-stablecoins-20221216.html for other discussions on stablecoins. 

[v] https://www.coindesk.com/markets/2023/02/22/frax-finance-votes-to-fully-collateralize-its-1-billion-stablecoin/

[vi] ‘The stable in stablecoins’, Garth Baughman, Francesca Carapella, Jacob Gerszten, and David Mills, December 16, 2022: https://www.federalreserve.gov/econres/notes/feds-notes/the-stable-in-stablecoins-20221216.html

[vii] https://uxd.fi/

[viii] Some stablecoins such as UXD https://uxd.fi/and Hoard USDH https://docs.usdh.finance/motivation/the-hoard-solution are promoted as having solved the trilemma.

[ix] “The properties of price stability, decentralization, security, and immutability enable stablecoin to effectively act as a trading medium”: by Li et al, ‘On Stablecoin: Ecosystem, architecture, mechanism and applicability as payment method’. (2023).

[x] Stablecoins can store trillions of dollars of value, helping investors survive periods of intense market fluctuations relative to unbacked crypto assets.

[xi] “The use of stablecoins may enhance financial inclusion, both in developed and developing markets, boost overseas payments in general and remittances in particular”: European Parliament, European Parliamentary Research Service- ‘Stablecoins -Private-sector quest for crypto stability’ November 2021.

[xii] Stablecoins may not be a practical means of payment due to concerns with, inter alia, redemption, transaction costs, etc: ECB’s article “Stablecoins’ role in crypto and beyond: functions, risks and policy”: https://www.ecb.europa.eu/pub/financial-stability/macroprudential-bulletin/html/ecb.mpbu202207_2~836f682ed7.en.html

[xiii] See Bank of Canada article: https://www.bankofcanada.ca/2022/12/staff-discussion-paper-2022-21/

[xiv] Liao, Gordon Y. & John Caramichael (2022). “Stablecoins: Growth Potential and Im- pact on Banking," International Finance Discussion Papers 1334. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/IFDP.2022.1334.

[xv] Parma Bains, Arif Ismail, Fabiana Melo, and Nobuyasu Sugimoto: ‘Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangement’. https://www.elibrary.imf.org/view/journals/063/2022/008/article-A001-en.xml

[xvi] President’s Working Group on Financial Markets, FDIC and OCC- Report on Stablecoins- November 2021.

[xvii] “The mere prospect of a stablecoin not performing as expected could result in a “run” on that stablecoin – i.e., a self-reinforcing cycle of redemptions and fire sales of reserve assets”: President’s Working Group on Financial Markets, FDIC and OCC- Report on Stablecoins- November 2021.

[xviii] See discussion “Stablecoins’ role in crypto and beyond: functions, risks and policy’- by Adachi et al.

[xix] IOSCO (2022), Decentralized Finance Report.

[xx] Deutsche Bank note ‘Stablecoins DeFi, Libra and beyond’, March 25, 2022.

[xxi] For example, a sudden mass redemption of Tether could affect the stability of short-term credit markets, or cause runs. The liquidation of assets to cover redemptions could have negative contagion effects on the financial system. 

[xxii] See previous articles on Regulating the CryptoAsset Ecosystem for highlights that are relevant to stablecoins: https://kmafiles.com/

[xxiii] The Bank of Canada notes that “stablecoins can contribute to risks to financial stability by facilitating the buildup of leverage and liquidity mismatches in decentralized finance.” ‘Stablecoins and Their Risks to Financial Stability’, 2022: https://doi.org/10.34989/sdp-2022-20,  

[xxiv] This in turn raises potential cross border issues.

[xxv] Review of the FSB High-level Recommendations of the Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Consultative Report (Global Stablecoin Report, October 2022) https://www.fsb.org/2022/10/review-of-the-fsb-high-level-recommendations-of-the-regulation-supervision-and-oversight-of-global-stablecoin-arrangements-consultative-report/.

[xxvi] FATF (2020), FATF Report to the G20, FATF, France,

www.fatf-gafi.org/publications/virtualassets/documents/report-g20-so-called-stablecoins-june-2020.html

[xxvii] The FATF identified anonymity, global reach and layering as being particular ML/TF vulnerabilities for “so-called stablecoins”.

[xxviii] FSB High-level Recommendations of the Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Consultative Report (Global Stablecoin Report, October 2022)- Annex 4.

[xxix] “The perception that SCs (stablecoins) can be redeemed on demand is enough for them to create vulnerabilities from liquidity and maturity transformation, as SC reserve assets could be illiquid or have longer maturities”: per the Federal Reserve Bank Report: “The Financial Stability Implications of Digital Assets” (September 2022)

[xxx] There are risks that the reserve assets supporting a stablecoin might either be insufficient, or unavailable, to fund redemption requests, either when the issuer is a going concern, or when it is insolvent.

[xxxi] FSB Global Stablecoin Report, October 2022

[xxxii] Ibid.

[xxxiii] Issuers of ARTs are also required to maintain a recovery plan providing for measures to be taken by the issuer to restore compliance with the requirements applicable to the reserve of assets: Clifford Chance, ‘Crypto Regulation: The Introduction of Mica into The EU Regulatory Landscape’. December 2022. 

[xxxiv] Reserve assets should comprise of highly liquid financial instruments.

[xxxv] European Parliament, European Parliamentary Research Service- ‘Stablecoins -Private-sector quest for crypto stability’ November 2021.

[xxxvi] Including the Act on Prevention of Transfer of Criminal Proceeds, Financial Instruments and Exchange Act (“FIEA”), the Banking Act, and other statutes all enacted on June 3, 2022 and effective in June 2023. The amendments are meant to, inter alia, promote financial innovation, ensure user protection, manage financial stability risks and AML/CFT compliance.

[xxxvii] The law requires that stablecoins — typically backed by one or more reserve assets — must be pegged to the yen or another legal tender and guarantee redemption to the holder at face value.

[xxxviii] The amendment defines these as "currency-denominated assets that can be used for remittance and settlement to unspecified persons and can be transferred using an electronic information processing organization”.

[xxxix] They are already “subject to prudential regulations and stablecoin holders are protected by deposit insurance in the same manner as conventional bank deposits”: ‘Regulatory Framework for Crypto-assets and Stablecoins’, Financial Services Agency, the Japanese Government. https://www.fsa.go.jp/inter/etc/20220914-2/02.pdf

[xl] They are “required to secure the obligation through either money deposits with official depositaries, bank guarantees, or entrusted safe assets, such as bank deposits and government bonds”. (Ibid).

[xli] They are “required to hold all the trusted assets in the form of bank deposits”: (Ibid).

[xlii] Per the Regulatory Framework for Crypto-assets and Stablecoins’, Financial Services Agency, the Japanese Government. https://www.fsa.go.jp/inter/etc/20220914-2/02.pdf

[xliii] which focus on intermediary activities such as crypto assets exchange business and securities dealing business - rather than issuance. 

[xliv] FSB Recommendations of the Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements Annex 4: Recent policy developments: October 2022.

[xlv] https://www.banking.senate.gov/imo/media/doc/the_stablecoin_trust_act.pdf

[xlvi] https://www.congress.gov/bill/117th-congress/senate-bill/4356/text.

[xlvii] Quoted from article ‘Blockchain & Cryptocurrency Laws and Regulations 2023 | The regulation of stablecoins in the United States’: Global Legal Insights. https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/08-the-regulation-of-stablecoins-in-the-united-states#_edn50

[xlviii] Page 16 of the Report on Stablecoins: https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf

[xlix] https://www.dfs.ny.gov/industry_guidance/industry_letters/il20220608_issuance_stablecoins.

[l] A digital settlement asset is defined as a digital representation of value or rights, whether or not cryptographically secured, that—

(a) can be used for the settlement of payment obligations, (b) can be transferred, stored or traded electronically, and (c) uses technology supporting the recording or storage of data (which may include distributed ledger technology).

[li] within the regulated perimeter of the UK payments system.

[lii] ‘Future financial services regulatory regime for crypto assets’ - Consultation and call for evidence: UK HM Treasury, February 2023.

[liii] Reference to one or more fiat currencies.

[liv] DFSA Rulebook, General Module: GEN 3A. Crypto Token Requirements | Rulebook (thomsonreuters.com) and FSRA Guidance – Regulation of Virtual Asset Activities in ADGM: https://en.adgm.thomsonreuters.com/rulebook/stablecoins-0

[lv] See Rule 3A, 2.3 of the DFSA Rulebook, General Module: GEN 3A. Crypto Token Requirements | Rulebook (thomsonreuters.com). 

[lvi] Para 25, FSRA Guidance – Regulation of Virtual Asset Activities in ADGM.

[lvii] https://www.scb.gov.bs/wp-content/uploads/2023/04/DARE-Bill-2023-Consultation-Document.pdf

[lviii] Submissions made by the Crypto Council for Innovation in response to the FSB’s recommendations. https://www.fsb.org/2023/01/public-responses-to-fsbs-proposed-framework-for-international-regulation-of-crypto-asset-activities/

[lix] Stablecoin Policy Issues for the 118th Congress: https://crsreports.congress.gov/

[lx] See article by Ezechiel Copic, ‘How to insure against the risk of stablecoin runs’ (May 2022), Official Monetary and Financial Institutions Forum: https://www.omfif.org/2022/05/how-to-insure-against-the-risk-of-stablecoin-runs/

[lxi] ‘Tokenized Deposits: How I Learned to Stop Worrying and Love Stablecoins’, Todd Phillips, 2022: https://ssrn.com/abstract=4152735