A detailed guide about regulating stablecoins.
Many governments have been trying to regulate cryptocurrencies for a while now to protect financial markets. At first, the focus was on big cryptocurrencies like Bitcoin, but now regulators are also looking into how to handle stablecoins. This has caused mixed reactions in the crypto industry, as some feel that regulation will do more harm than good. To help you see the bigger picture, we have created a detailed guide about regulating stablecoins. Read on to learn.
What Are Stablecoins?
Stablecoins are cryptocurrencies backed by assets such as fiat currencies, cryptocurrencies, and precious metals. They are intended to provide consistent value in the cryptocurrency market. Most are tied to fiat currencies like the U.S. dollar, which means that their value stays the same. Therefore, you can easily interchange between stablecoins and fiat currency without losing any value. So, if you want a volatile-free cryptocurrency for performing daily online transactions, then stablecoins are what you need.
You can also get the best of both fiat currency and crypto with these digital currencies because they make transactions safe, fast, and anonymous.
Are Stablecoins Regulated?
There are currently no major regulations specifically targeting stablecoins. But regulators like the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) have paid a lot of attention to stablecoins. Therefore, there will likely be clear regulations by the end of 2022. However, most digital asset trading platforms are regulated.
Stablecoins make it easy for crypto traders and investors to do business, so regulating them would help capture a big chunk of the industry's transactions. This would help regulate the crypto industry without directly regulating every digital asset.
Why Do Stablecoins Need to Be Regulated?
You are probably wondering why stablecoins should be regulated if they make transactions more secure and faster. Well, there are a few reasons why governments feel regulating stablecoins is necessary for the benefit of the broader financial system.
Cryptocurrencies are mostly used anonymously, which governments are afraid might encourage illegal activities and break federal securities laws. Therefore, the regulation would reduce criminal activity in the stablecoin space.
Also, stablecoins need enough backing reserves to maintain stability. If the stablecoin issuer doesn't have enough assets in reserve, that could easily make the stablecoin less stable. As a result, stablecoin issuers must show sufficient backed assets. However, not all of them do so. This can be pretty misleading because crypto investors use stablecoins because they believe they’re a safe way to store value without worrying about price fluctuations. So, rules would make sure that stablecoin issuers have the money they need to back their coins and don't put their clients' investments at risk.
The State of Stablecoin Regulations in the UK
The Bank of England (BoE) recently asked policymakers to add more regulatory laws to help capture transactions from the crypto industry. The BoE was worried since even huge financial institutions such as investment firms and banks were considering jumping into the crypto market, which might affect the country’s financial stability.
Also, crypto companies in the UK have to register with the Financial Conduct Authority (FCA). However, many digital asset trading platforms are failing to meet the FCA’s anti money laundering requirements, meaning they’ll have to shut down their operations in the UK.
So, the UK government is still thinking about how to regulate stablecoins and the cryptocurrency industry as a whole. So, although the government has started taking some measures to regulate the industry, clear regulations have yet to be released.
The State of Stablecoin Regulation in the US
The U.S. federal government has been more active in trying to regulate stablecoins. One of the most recent efforts to do so was releasing a report on stablecoins on November 1, 2021. The President's Working Group (PWG), the Office of the Comptroller of the Currency (OCC), and the Financial Deposit Insurance Corporation (FDIC) all came out with this detailed report.
This section will discuss what this report is about and what the involved agencies suggest. Note that we will be collectively referring to them as "agencies."
In the PWG report, these agencies said that laws should be made right away to control stablecoins so that they don't hurt the financial system. This decision was mostly triggered by stablecoins’ growth from $29.06 billion to $152.12 billion from January 2021 to January 2022, a whopping 523%.
What Issues Does the PWG Report Address?
The agencies believe that regulating stablecoins would help ensure the following:
Consumer and investor protection from crypto scams
Using insurance to minimize losses from cyberattacks
Minimizing illegal activities such as money laundering
What the PWG Report Recommends
The regulatory bodies made different recommendations to custodial wallet providers, stablecoin issuers, and any other institution that handles crucial activities to the functioning of the payment stablecoin arrangements.
If Congress implements the PWG report’s suggestions, here is what to expect:
Stablecoin issuers must be Insured Depository Institutions (IDI) subject to regulatory bodies such as the Federal Deposit Insurance Corporation (FDIC), Federal Reserve Board (FRB), and The Office of the Comptroller of the Currency (OCC).
Stablecoin issuers will be examined and supervised by the FRB (at the holding company level), and any affiliation with commercial entities will be limited.
Custodial wallet providers will be forced to meet the set capital, risk management, and liquidity requirements. They will also be restricted from lending their clients’ stablecoins.
Let’s now discuss these recommendations in more detail.
Recommendations to Stablecoin Issuers
The agencies suggested that Congress only let insured depository institutions issue, buy back, and keep reserve assets for stablecoins. The agencies think that if they do this, it will help get rid of the financial risks that stablecoins pose. A bank that is insured to hold deposits would also be better able to keep enough backing assets on hand to provide the expected stability.
Recommendations to Wallet Providers
The agencies also suggested laws subjecting custodial wallet providers to federal oversight. The PWG report says that this would help make sure that wallet providers meet certain requirements for capital, liquidity, and risk management. It would also prevent them from lending their customers’ digital assets.
The agencies mentioned that stablecoins also present the issue of concentration of economic power. To fix this, they pushed for laws that would limit how custodial wallet providers could use their customers' transaction data and how closely they could work with commercial banks.
Recommendations to Institutions Handling Crucial Activities to the Functioning of the Payment Stablecoin Arrangements
The agencies also suggested that Congress give a watchdog group like the FDIC, OCC, or FRB the power to demand that any institution that handles important activities for the agreement meet the set standards for risk management. They also said that the agencies should have the power to examine and enforce any stablecoin activities that these institutions do.
Recommendations to the Financial Stability Oversight Council (FSOC)
The agencies also suggested that if Congress doesn’t provide a way forward, the FSOC should have the authority to do whatever is in its power to curb the risks outlined in the PWG report. If the stablecoin supply keeps growing quickly or if a stablecoin issuer or wallet provider starts doing a lot more business quickly, you can expect the FSOC to start taking direct regulatory action. This would aim to prevent the financial risks that stablecoin growth would cause.
Those are the recommendations the different agencies made regarding regulating stablecoins. So, it's likely that the agencies will be in charge of putting in place risk management measures for financial institutions that do important payment, clearing, and settlement (PCS) activities. This means that the agencies will set requirements for asset backing and stablecoin arrangement operations.
Pros and Cons of Regulating stablecoins
Regulating stablecoins is a good way to bring some order to the crypto industry, but it has some downsides as well. Below are the major pros and cons of regulating stablecoins you should be aware of.
Advantages of Regulating Stablecoins
Regulating stablecoins helps reduce scams. Stablecoin regulation sets strict requirements that every stablecoin issuer must meet to start operating. Doing so might help kick out fake tokens from the market.
It would attract more investors to the industry. Many investors shy from investing in stablecoins because they aren’t really regulated. Therefore, they aren’t sure if a trading platform might easily disappear with their funds. So, having regulations would help make the stablecoin industry more legitimate and easier to invest in. This would attract more people to invest their digital assets, boosting the market’s liquidity.
Regulation would eliminate dishonesty. Stablecoins require backed assets to remain stable. However, some stablecoin issuers might use their backing assets for other purposes, risking the token’s stability. Therefore, the regulation would keep stablecoin issuers accountable, ensuring they always have the claimed backed reserve assets.
Regulating stablecoins would also reduce the losses when hacks occur. Regulated stablecoin issuers and lending platforms would be insured, ensuring they can easily compensate clients if their digital assets get stolen.
It would help reduce illegal transactions.
Disadvantages of Regulating Stablecoins
Some investors might withdraw their crypto assets. Most people use stablecoins because they offer some anonymity. Therefore, introducing more regulations would mean that the federal reserve and federal government would be accessing lots of information, eliminating the privacy people crave. This might cause some people to change their minds and turn to riskier assets, such as Bitcoin.
The high risk management standards would limit many stablecoin issuers and lending platforms from entering the market.
Stablecoin regulation has been a major discussion in the financial markets for some time now and is bound to happen at some point. As you have seen, the regulation would bring different changes to the industry. Fortunately, the advantages outweigh the disadvantages. Therefore, it is clear that regulating stablecoins would improve the industry by far. However, overregulation would also be problematic.