Remember Laszlo Hanyecz? The guy who bought two Papa John’s pizzas for 10,000 Bitcoins (BTC), which at the time was only worth $30? Today, those same Bitcoins are worth around $550 million. You can probably see the problem with this. A currency should act as a medium of monetary exchange and a mode of storing monetary value, which ideally, should remain relatively stable. But because of instability in their value, cryptocurrencies such as BTC and Ethereum (ETH) for instance, suffer serious price fluctuations that make them hard to adopt. Would you adopt a cryptocurrency if you knew that tomorrow you could end up like the pizza guy? Certainly not, which is why there is another type of ‘cryptocurrency’ called stablecoins.
Stablecoins are digital coins that promise to maintain their worth by attaching their value to the U.S. Dollar or any other asset. Basically, they mimic the U.S. Dollar digitally through blockchain technology, and hence serves as a safe and stable coin. The largest stablecoins: Tether, USDC, and Binance USD all try toback against fiat currency (USD). However, other types of stablecoins are backed by gold, oil, cryptocurrencies, or through algorithms (by controlling the supply and demand). These stablecoins do hold advantages to consumers, such as instant transactions as opposed to banks. Since it maintains its value against the U.S. Dollar, people can use it to transact with each other 24/7 without a bank acting as an intermediary.
The current market cap of stablecoins is exponentially increasing, it currently rests around $130 billion, where they are backed by assets such as the U.S. Dollar, US Treasuries certificates of deposit, short-term debt, corporate bonds, and more. Given such size and potential impact to the financial system, stablecoins continue to come under scrutiny by regulators. Regulators fear that Stablecoins are vulnerable to a ‘bank run’, where large number of investors rush to redeem them, forcing sponsors to sell the assets at fire sale prices and consequentially stressing the financial system, similar to what happened to money market mutual funds during the 2008 financial crises. Therefore, regulators are rushing to put into place robust legal and economic frameworks to protect the financial market as well as consumers.
Stablecoin regulation should include essential components to protect the financial system such as creating types of reserve assets, ensuring issuers honor direct redemption claims, and establishing limits on risk maturity transformation activities. In addition, reserve segregation and coin holder claims in bankruptcy or insolvency should be honored. But questions remain on how we should regulate Stablecoins, and indeed, who should even regulate them– questions that have proven especially challenging in consideration of the need to balance the interests of different stakeholders and the financial system itself.
For Stablecoins to be regulated, they need to be classified into a certain category. However, creating a new category for crypto assets altogether may be more ideal. Because Stablecoins are not treated as deposits, the Federal Reserve (Fed) and the Office of the Comptroller of Currency have limited oversight. The Securities and Exchange Commission (SEC) also has limited authority unless the Stablecoins are classified as securities. If they are, they will be subject to bigger disclosure requirements. But paradoxically, such classification might not be of importance due to the Fed’s willingness in issuing a Central Bank Digital Currency (CBDC) or more simply a digital dollar, which might be introduced to a separate category of regulation. The CBDC would make money directly available to the public, hence, increasing outreach to people with no access to the financial system. The CBDC’s innovations however, can coexist with the current Stablecoin market, as the Fed can issue coins, while the private sector can build rails and applications. But the magnitude of dealing with millions and maybe billions of users is increasingly over the Feds power and capabilities. Therefore, this might also indicate a radical change to commercial banking soon if they do not adjust accordingly.
The US needs to catch up as China has already cleared over $5.3 billion in transactions through its digital renminbi. While it may be tempting to preserve the status quo, blockchain technology can reshape market structure and improve competition if regulated properly. Adopting digital currencies, such as Stablecoins, provides ease in transactions, convenience for unrepresented minorities in the financial system, and acts as a direct bridge between central banks and people. Maintaining the status quo within the era of rapid technological innovation, hampers competition and innovation, forcing individuals to shift to the new unregulated financial system. The question for central banks and regulators is which approach can improve competition, lower cost, and increase access to the financial system. Afterall, regulatory frameworks will define if and when the technology can deliver on its potential.