The Inevitability of Stablecoins Deserves Attention

In a previous post, my colleague presented a view of the near future, when stablecoins and central bank digital currencies (CBDCs) are ubiquitous in the financial sector and where they enjoy extensive acceptance across all markets. Many people working in finance today would likely agree with that vision, but few see the same path to it. Significant questions remain about what role regulation should play in the future of stablecoins and CBDCs.

Stablecoins are cryptocurrencies the value of which is pegged, or tied, to that of another currency, commodity or financial instrument and pursue price stability by maintaining reserve assets as collateral or through algorithmic formulas that are supposed to control supply.1

1Hayes, A.“What is a stablecoin?” https://www.investopedia.com/terms/s/stablecoin.asp

In the U.S., governing entities have mobilized to formulate a regulatory framework, but they have few results to show for their efforts. Looking back to June 2021, when Maxine Waters led U.S. House Financial Task Force hearings on the topic, to U.S. Senator Pat Toomey’s draft of a new regulatory framework, to recent activities led by U.S. Senators Kirsten Gillibrand and Cynthia Lummis, most everyone seemed aligned on the need for regulation, while not always agreeing on the substance of those regulations. Not surprisingly, stablecoin regulation is stuck in a cycle of starts and stops.

As we see the growth of the industry play out globally, it puts even more pressure on the U.S., as the world’s dominant economic force, to take on a leading role in defining the future of stablecoin regulation. 

 

Embracing primary prudential oversight for stablecoin’s long-term success

Though no one knows for sure how this plays out, a closer look at how stablecoins work provides a window into the need for prudential regulation.

When stablecoins’ value is directly pegged to the value of the U.S. dollar, with the amount of “reserve” dollars equaling the number of stablecoins outstanding, then one stablecoin is always equivalent to the one dollar it represents. This helps stabilize price, and for this reason stablecoins hold much of the promise for mainstream adoption of crypto in the United States. Stablecoins possess the ability to connect legacy finance to the future – a digital economy that can be more inclusive and accessible.       

At the moment, there are both regulated and unregulated stablecoins. Though many stablecoin providers profess to be regulated, simply put, only those providers subject to primary prudential oversight, where reserve asset maintenance requirements are clearly defined and overseen, can claim to be properly covered. For stablecoins without a primary prudential regulator, reserve assets and reserving practices remain widely unrestricted. History is instructive that if left unregulated or in some cases under-regulated, the capital that underlies these unstable stablecoins presents unreasonable risk in a volatile market. 

Increasing stablecoin and crypto adoption will be contingent upon building trust with users. Trust can only be built through clearly stated regulations focused on consumer protection.

Regulation should establish trust and transparency by:

  • Requiring that stablecoin issuers have a primary prudential regulator
  • Allowing the issuance of stablecoins only when underlying stablecoin assets are held in transparent cash and cash equivalents; and
  • Reserve assets are held in bankruptcy remote, segregated accounts such that customer assets are redeemable on demand at any time.

What can investors, institutions and consumers alike expect to see in crypto’s future? For the moment, many within the industry are anticipating the slow-walking of any major steps forward as legislators get up to speed and as more complexities emerge. As we tackle these challenges, it’s worth noting that the challenges related to regulating novel financial technologies are not new; they are simply reminders of the power and fragility of our existing financial system and of the ongoing need to keep consumer trust front and center.

Learn more about regulated stablecoins today.

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