In 2019, when a Facebook-led consortium announced its plans to launch the global stablecoin ‘Libra’, many – including politicians and high-level representatives of the G7 - thought that a new international financial system, arguably outside of the realm of regulators was about to emerge. This conclusion was mainly rooted in a mindset that the blockchain technology underpinning stablecoins would compromise the reach and effectiveness of regulators. In hindsight, such fears have turned out to be unfounded. Even though the Libra project has been wound down, the international standard-setting bodies under the auspices of the Financial Stability Board (FSB) have been developing and refining recommendations for the regulation, supervision and oversight of global stablecoin arrangements (FSB 2020 and FSB 2022).
Focusing on the economic functions of stablecoins and not the technology, it was rather straightforward to identify the areas which regulators should emphasize. In essence, sound regulation of stablecoin arrangements should concentrate on three areas. As part of this series, I’ll focus on the issuance and redemption of stablecoins, before then looking at how the industry can regulate payments made with stablecoins and how stablecoin trading and post-trade arrangements should be supervised.
The Financial Stability Board (FSB) defines a stablecoin as “a specific category of crypto-assets that aim to maintain a stable value relative to a specified asset (typically US dollars).” The promise of a stable price of exchange is credible if the issuer of the stablecoin provides trustworthy assurance that a holder of the stablecoin (the creditor) can redeem their coin at any time without discount (at par) against the specified asset, typically money denominated in a sovereign currency.
The property of ‘promised redeemability’ makes stablecoins very similar to (if not identical to) a deposit at a commercial bank. Both, a stablecoin and a bank deposit are liabilities of the issuer and represent a claim on the assets of the issuer. Thus, stablecoins are best thought of as ‘tokenized deposits’ or ‘tokenized e-money'. As with tokenized deposits, stablecoin holdings could be remunerated in the same way as deposits.
For commercial bank deposits and stablecoins, the credibility of the convertibility at par into fiat currency depends on the quality of the assets and the ratio of the assets to the liabilities of the issuer. The issuer needs to hold sufficient liquid assets to accommodate large scale redemptions or withdrawals (‘liquidity requirements’ in the traditional banking world). Its assets have to exceed the liabilities by a certain buffer to protect all creditors (including the holders of stablecoins) from valuation losses on assets due to price fluctuations (‘capital requirements’ in the traditional banking world). Both capital and liquidity requirements are cornerstones of banking regulation and should also be applied in a similar way to stablecoin arrangements. Furthermore, stablecoin issuers that are regulated like (or similar to) banks, should also have to demonstrate that they adequately manage their operational risks (including wallets) and make provisions for recovery and resolution. From a public policy perspective, access to central bank money and deposit insurance protection would need to be considered for supervised stablecoin arrangements.
Recent legislation or proposals for stablecoin legislation, for instance by the European Union (MICA), the US President’s Working Group (PWG) on Financial Markets as well as the New York State Department of Financial Services all build on the similarities between bank deposits, e-money and stablecoins, as discussed in a previous article.
Increasing confidence in the quality of the balance sheet of the stablecoin issuer and how stablecoins are redeemed and issued via the creation of a bank-like regulatory standards, will be a necessary, but not sufficient element if stablecoins are to become a legitimate means of payment for retail purposes.
Coming up in Part 2 of this series:
The second key area of regulation are the rules and procedures governing the transfers of stablecoins among the users of the network; in other words the regulations which will need to apply to stablecoins to enable their usage by customers to make payments?
Find out more in our next blog post on: Regulating payments made with stablecoins publishing on Thursday this week.
 Some argue (e.g. Panetta) that the stablecoins are “more vulnerable to runs” than bank deposits because the latter are protected by deposit insurance and emergency lending by the central bank. Of course, this is only the case as long as stablecoin arrangements are not granted access to these facilities.