Stablecoins are a relatively novel form of digital currency, where each token is linked to an asset such as fiat currency, gold or other real-world valuables. They have captured the attention of the banking world and hundreds of organisations have begun experimenting with using stablecoins.
The primary benefit that stablecoins offer is their stability. These tokens enable users to avoid volatility in traditional cryptocurrencies like Bitcoin by providing a way to invest and transact with a backed asset. Consequently, major banking authorities worldwide have begun casting an eye towards regulating support for stablecoins, ensuring proper measures for consumer protection and financial stability.
In this article, we will examine what major central banking authorities have expressed regarding their views on stablecoins and how they might be used or regulated in future years. We will also touch on some notes from several prominent central banks who have already issued statements related to stablecoins.
What are Stablecoins?
Stablecoins are a type of cryptocurrency whose value is pegged to other assets such as fiat currencies, commodities and, in some cases, even other cryptocurrencies. They offer all the benefits of cryptocurrency—such as decentralised control, low transaction fees and fast transactions—while helping to avoid the extreme price volatility typically associated with cryptocurrency prices.
Stablecoins have become increasingly popular with blockchain and non-blockchain users due to their stable value. But their use within different jurisdictions has created unclear legal implications for those involved in their trading, use and ownership. As such, many banking authorities have started looking into stablecoins more closely to determine the implications for users in different countries and regions.
Various jurisdictions have responded differently regarding understanding how they will regulate stablecoins moving forward. While some countries are beginning to embrace them and actively encouraging innovation, others remain wary of this new technology due to its link with cryptocurrency markets that remain unregulated or unregulated in practice due to lack of enforcement. As such, there is no global consensus yet on the best way to regulate stablecoins or understand their full implications across different jurisdictions.
We will likely see significant shifts in this area over the coming years as banking authorities work towards creating a unified approach that will better protect investors regardless of where they live within an international context. However, until this has been completed it is important for those interested in investing in stablecoins or using them for payments purposes to understand how specific regulations apply within their jurisdiction before taking any risks associated with this new technology moving forward.
Major banking authorities say stablecoin reserves pose liquidity risk
Major banking authorities have voiced their concerns over the risks of using stablecoins. Specifically, the reserves behind the tokens have been a big point of contention, with such authorities citing the lack of liquidity for these reserves as a major risk.
In this article, we will explore the views of major banking authorities on stablecoins, and what implications this may have for the industry.
European Central Bank
The European Central Bank (ECB) is the cognitive authority responsible for the monetary policy of the Eurozone. In different statements, it has noted its intent to closely observe stablecoins and evaluate possible implications on its monetary policy, banking supervision and its macro-financial risk assessment framework. Furthermore, the ECB supports legislative initiatives to regulate stablecoin projects, including paying particular attention to consumer protection and financial stability.
Furthermore, it encourages steps to strengthen consumer protection across all payment services, which often take a slower pace than technological developments. It thus calls for continued dialogue with stablecoin project operators, financial markets participants and stakeholders to evaluate further insurance needs and supervision of stablecoin projects at EU level.
In conclusion, while the ECB acknowledges the potential opportunities such technology could bring regarding cost savings and innovation in payment services, it will continue monitoring their development closely to ensure compliance with existing regulations and support enforcement actions as needed.
Bank of International Settlements
The Bank of International Settlements (BIS) is the oldest and most respected international banking authority. Established in 1930, the BIS is a forum for central banks worldwide to discuss financial policies and exchange best practices. In 2019, the BIS published a white paper on stablecoins that examines the implications of digital currency for global financial stability.
The BIS emphasises that greater cross-border payments innovation is needed to encourage economic growth, noting that current payment systems are “inadequate” and limited by speed and cost barriers. In addition, because regulation is often sluggish and technology continuously evolves, policymakers need to be proactive when understanding new technologies such as digital currency to effectively manage risk associated with them.
Regarding stablecoins, the BIS explains that their promise remains unproven, but provides guidance on what policies could help foster their success. Key policy considerations include:
- Prudent risk management of all stablecoin arrangements.
- Ensuring appropriate levels of financial transparency.
- Protecting users’ interests.
- Safeguarding against money laundering and other financial crimes.
The paper also states that each jurisdiction must decide whether any stablecoin arrangement should be subject to special regulation or supervision safeguards.
This white paper stresses that proper oversight will be crucial in ensuring successful adoption of digital currency, while maintaining financial stability for citizens worldwide. The mixed opinions about cryptocurrencies call for carefully balanced approaches from regulators—and as does not advise on how to address these innovative technologies but rather redirects attention away from broad categorizations like “cryptocurrency” towards individual projects subject to “granular assessment” when formulating regulations around them.
Financial Stability Board
The Financial Stability Board (FSB) was established in 2009 in the wake of the global financial crisis, to coordinate responses to challenges that may emerge from the global financial system. It is an international forum for authorities responsible for financial stability in significant international markets.
Regarding stablecoins, the FSB has released multiple statements detailing its views and opinions on cryptocurrency and its various networks, emphasising the need for greater oversight and regulatory guidelines related to financial stability. In addition, it has called upon relevant authorities to appropriately assess stablecoins as a potentially systemic risk, reiterating its call for more effective regulatory approaches for evaluating stablecoin initiatives domestically and internationally given their potential implications for global payments systems. Specifically, it has focused on compliance with Anti-Money Laundering/ Combating Financing of Terrorism (AML/CFT) standards; compliance with applicable data privacy laws; operational resilience sufficient to eliminate operational risk; appropriate accounting frameworks; and sound minimum capital requirements.
The FSB will continue assessing potential risks associated with stablecoins globally and issue reports as needed.
Potential Risks of Stablecoins
Major banking authorities are raising concerns over the popularity of stablecoins, suggesting that their reserve requirements pose a liquidity risk.
Stablecoins are digital currencies designed to maintain a stable value and sometimes back their value with a reserve asset, such as fiat currencies. As a result, a large amount of capital is often held in reserve, raising the risk of liquidity problems should there be a sudden outflow of capital.
In this article, we will explore the potential risks of stablecoins and the warnings being issued by major banking authorities.
Liquidity Risk
Liquidity risk comes with holding an asset that cannot readily be sold for cash at a price close to its intrinsic value. Liquidity has become a particular focus of regulators and market participants due to concerns about exit-related risks associated with the increasing usage of stablecoins.
Stablecoins are:
- Digital representations of either fiat money.
- Other types of international currencies (such as gold or commodities).
- Derivatives.
While these digital tokens are intended to be liquid investments and useful units of exchange, many regulators are uncertain whether they will generate sufficient liquidity for investors and holders alike. Some banking authorities, such as the Bank for International Settlements (BIS) have even stated that “stablecoins do not appear to have any natural ability to generate sufficient liquidity”.
This lack of liquidity associated with stablecoins could put investors at risk, particularly if they need access to their funds quickly and cannot promptly convert their stablecoin holdings into cash due to low demand or limited market depth. As such, there are various long-term implications attached to this issue — from systemic risk avoidance measures implemented by banks down to individual investor protection requirements – which must be considered when evaluating the safety and stability of any stablecoin investment.
Counterparty Risk
Counterparty risk is an important consideration for investors when assessing stablecoins. There is a counterparty default risk as certain unspecified assets back the coin, such as precious metals or foreign currency. This can potentially lead to a depreciation of the stablecoin. Additionally, investors could be exposed to fraud or price manipulation due to the decentralised nature of these coins and lack of oversight by a trusted authority.
Regulators have warned consumers about the potential risks associated with stablecoins, emphasising that this type of currency does not have consumer protection like traditional banking systems. They have also highlighted that users should undertake sufficient research before investing in any form of cryptocurrency and be aware that any digital asset is subject to market volatility and cyber-security threats like hacking or other cyber-related crime.
The Federal Reserve Board has established “Principles for Regulation of Stablecoins” which recommends controls and safeguards should be designed to ensure consumer protection, efficient settlement, infrastructure resilience, prudent management of operational risk, sound governance practices and adherence to relevant regulation and law.
Regulatory Risk
Stablecoins, often issued on a blockchain, present new challenges for financial regulators due to their complex nature. Stablecoins are unlike traditional assets, as they are subject to global money flows and payments regulatory challenges. Since stablecoins link traditional payments with digital assets and do not usually fall into existing categories of regulated financial instruments, regulatory bodies worldwide have difficulty finding how to regulate them properly.
Regulatory risk refers to the potential disruption or complete withdrawal of trust in a digital asset caused by regulators or changes in law or regulations. Regulatory risk is ever-increasing with the growth of each digital asset and its associated services. However, no unified regulatory framework currently oversees blockchain-based products, services and activities; jurisdictions differ greatly when it comes to implementing legal frameworks governing this space.
In light of these challenges, governments worldwide have begun taking steps towards establishing more uniform regulation for stablecoins. Major banking authorities such as Bank for International Settlements (BIS), European Central Bank (ECB) and Monetary Authority Singapore (MAS) have already issued specific guidance for cryptocurrency custodians, exchanges and other service providers related to these assets. To ensure responsible use of these assets some major authorities also actively promote standards such as Payment Services Directive 2 (PSD2), Global Legal Entity Identifier System (GLEIS) and Common Referral Data Standard (CRDS). In addition, regulatory bodies like U.S. Securities & Exchange Commission (SEC), Financial Conduct Authority (FCA) in Europe, etc., regularly promulgate updates on rules & regulations related to cryptocurrencies & derivatives markets accordingly applicable in their respective jurisdiction thus ensuring that compliance standards are met while using these digital assets.
