As anticipated by our CEO, Rhom Ram, in his 2021 September blog post 'Are Stablecoins a threat to Capital Markets Incumbents?', the speed of market acceptance of stablecoins has been remarkably quick and therefore constitutes a financial stability concern for regulators.
As legislative frameworks are currently under construction, stablecoin arrangements - particularly because they depend on the receipt of fiat currency to issue corresponding digital tokens in exchange - look soon to be fully treated like depositary institutions.
Unlike a stablecoin, each Fnality Payment System doesn’t create or issue novel payment instruments, but is instead designed to be the 'system operator' of assets backed 1-to-1 by central bank money and held in a central bank account. This is why Fnality Global Payments expects to be designated and regulated as an innovative systemically important payment system.
Stablecoin legislation is unlikely to apply to Fnality, but stablecoin adoption has accelerated discussions on how best to authorise and regulate the 'Decentralised Finance' (DeFi) ecosystem. The positive result of this is that regulators now really understand the growing industry need for tokenised cash and assets.
In this blog, we explore and explain concerns from regulators, and share our view on what the future looks like for stablecoins.
Regulatory concerns on stablecoins
Before delving into the different initiatives, the main topics that regulators aim to oversee are summarised below:
Addressing regulatory concerns on stablecoins
While a universally agreed definition is still missing, the market generally refers to stablecoins as a digital asset designed to maintain a stable value relative to a sovereign currency, in particular the U.S. dollar.[1]
This is why the USA President’s Working Group on Financial Markets released a long-awaited report to enact legislation aiming to ensure that stablecoins are subject to appropriate oversight, to ensure that such digital assets require further regulation to safeguard market integrity, to protect investors, and to prevent illicit finance. Key requirements include:
We anticipate to see a growth in attempts from stablecoin initiatives to become regulated entities (see Circle’s filing application).[3]
Digitisation and new technologies like DLT and blockchain have the potential to introduce significant innovation into financial markets. However, to bring new payment solutions at scale, and to fully unlock the potential of DeFi, achieving regulatory approval is key.
Where this is not achieved, the consequences have already been evidenced. The largest permissioned blockchain-based stablecoin payment system, Diem (formerly known as Libra) launched by Meta Platforms (formerly known as Facebook) has been shut down after hitting regulatory opposition.
Coming up in Part 2 of this series:
The emergence of stablecoins has pushed central banks around the world to develop and test Central Bank Digital Currency (CBDC) options.
Why? Which jurisdictions are leading the way? Are these endeavours borne out of hype, or do they have hope of becoming live, fully functional systems?
Find out more in our next blog post on The Evolution of Regulated DeFi.
[1] The 5 largest stablecoins - Tether, USD Coin, Binance USD, Dai, and TerraUSD - have reached a combined market capitalisation of around 150$bn. If ranked purely by asset size, the market would be equivalent to a top 30 US bank).
[2] Risks: Failure of stablecoins to maintain a stable value could expose stablecoin users to unexpected losses and lead to stablecoin runs that damage financial stability. Disruptions to the payment chain that allow stablecoins to be transferred among users could lead to a loss of payments efficiency and, depending on the extent to which stablecoins are used, undermine functioning in the broader economy.
[3] For more info, please read the Financial Stability Oversight Council 2121 Report on stablecoin recommendations – page 173).