Stabilising Stablecoins: Why Regulation Matters
Introduction
Stablecoins have come under increased government and regulatory scrutiny as their global adoption has accelerated in recent years. Add to this the recent USD $40 billion collapse of the Tera/Luna stablecoin, and calls for their regulation have become increasingly vocal.
Stablecoins Defined
A stablecoin is defined by the following characteristics:
· a unique form of cryptocurrency or digital currency
· blockchain-based
· pegged to/price parity with a low volatility reserve/underlying asset
· value of the stablecoin is not based upon forces of supply and demand
· global and borderless in its operation
· absence of a central bank
Stablecoin Purpose
A stablecoin is designed to achieve three (3) key goals:
· a medium of exchange — stable exchange value for other goods and services
· a store of value — maintains its value over time
· unit of account — precise measurement of unit
In addition, stablecoins are a programmable currency. They can be designed to cater for a myriad of needs, requirements and use cases.
Importance of Stablecoins
Stability in the value of money over time is fundamental to meaningful economic planning and to facilitating commerce. Predictability of value enables contracts and agreements to be denominated in a meaningful and reliable manner.
Applying this to cryptocurrencies which have been inherently volatile and subject to much short-term speculation, the importance of stablecoins becomes readily apparent.
Stablecoin Global Market Size
According to CoinMarketCap, the Global Market Cap for stablecoins was USD $221 Billion, with a daily trading volume of USD $128 Billion. The unique number of stablecoins was 105. This is shown in Figure 1 below:
Figure 1: Stablecoin Market Capitalisation[1]
Emerging Technology
Are stablecoins an emerging technology?
Rotolo et al[2] define “emerging technology” in terms of a framework that includes five (5) key attributes;
1. radical novelty
2. relatively fast growth
3. coherence
4. prominent impact
5. uncertainty and ambiguity
1. Radical Novelty (rating — 5/6)
Radical novelty for stablecoins was assessed through Google searches between 2018 and 2022 and via Google Scholar between 2017–2022, using 2014 as a reference year (the same year the Tether stablecoin was released). The significant interest that is developing for stablecoins is clearly shown in Graph 1 and Table 1 below:
User-based Google Searches from 2018–2022
Graph 1: Google Searches for Stablecoins 2018–2022[4]
Scholar-based Published Articles — Google Scholar
2. Relatively Fast Growing (rating — 5/6)
The information shown in Figure 3 below demonstrates the rapid growth in market capitalisation of multiple stablecoins. This trend is especially prominent from October 2020 onwards.
Figure 3: Growth in Market Capitalisation — Stablecoins[6]
3. Coherence (rating — 4/6)
Coherence was measured according to the number of recent Google searches, the emergence of new terminology to describe stablecoins and the number of listed stablecoins at CoinMarketCap.
a) Google Search (21st July 2022) — 19,200,000 results
b) Emergence of new terminology to describe stablecoins:
· Commodity-backed — use a commodity such as precious metals, diamonds and oil as a stable to preserve value in a centralised reserve
· Crypto-collateralised — use a (or basket) cryptocurrency or digital assets as a reserve. Usually held in smart contracts.
· Fiat-collateralised — use a (or basket) fiat currency as a stable reserve. Tokens are usually issued on a 1:1 basis of the underlying fiat value
· Algorithmic/Non-collateralised/Seigniorage — an algorithm automatically adjusts the supply of coins to stabilise the token price. They have no reserve collateral
· Central Bank Digital Currencies (CBDCs) — act as a tokenised representation of a specified fiat currency
c) Number of Stablecoins[7] — 105
4. Prominent Impact (rating — 5/6)
The Prominent Impact of stablecoins is described as follows:
“A global stablecoin would revolutionise the international monetary system. It would promote greater access to the financial system globally.”[8]
Stablecoins, on the other hand, would reduce central banks’ capacity to control monetary policy.”[9]
Use Cases
The Prominent Impact of Stablecoins is further demonstrated by the myriad of use cases that derive from them as outlined in Figure 4 below:
Figure 4: Stablecoin Use Cases
5. Uncertainty and Ambiguity (rating — 5/6)
Regulatory confusion and uncertainty has been used as a measure of Uncertainty and Ambiguity. This is confirmed by the following report from the Presidents Working Group (PWG)[10]:
“First, the PWG had trouble defining a stablecoin. The report said that “stablecoins, or certain parts of stablecoin arrangements, may be securities, commodities and/or derivatives.”[11]
It appears that the PWG report raises more questions than it answers.
_________________
Based upon the analysis of the five (5) key attributes, stablecoins can be classified as an emerging technology.
Implications of Stablecoins — Ethical, Economic and Legal
Some of the key considerations and implications regarding Stablecoins are outlined in Figure 5 below:
Figure 5: Ethical, Legal and Economic Mapping for Stablecoins[12]
Social Issues and Risks
A large percentage of consumers have little understanding of cryptocurrencies and stablecoins[13]. This could potentially expose them to unknown risks and significant financial loss. Without proper asset reserves for stablecoin, the financial risks associated with asset devaluation or collapse become very real — loss of savings and investments leading to financial hardship.
A digital divide may develop between individuals who are savvy and educated with regard to digital assets, including stablecoins. This could potentially create knowledge and wealth inequalities.[14]
Users may begin to change their behaviour with regard to savings and wealth and choose to keep their assets and wealth stored outside the present fiat-based banking systems. Users may begin to trust stablecoins over government-issued currency. A shift to stablecoins for use as money and payment mechanisms could de-stabilise national monetary systems[15] and result in the compromise of the operation of government and monetary policy.
Ethical Issues and Risks
Stablecoin operators can still freeze digital accounts or access to tokens and limit their ability to be transferred or redeemed.[16]
Stablecoin operators hold a responsibility to prevent their stablecoin from being used for illicit activities. Stablecoin issuers have a role to enforce compliance standards through KYC/AML/CTF processes and promotes protection against illegal activities. Regulation still lags behind with regard to these requirements.
Stablecoin operators have a duty and obligation to maintain token stability and purchasing power. Independent, certified audits of asset reserves which are transparent to users, investors, and regulators need to be established.
Legal Issues and Risks
· consumer protection for data privacy, storage, and retention
· regulation and laws are required to establish reserve segregation and coin holder claims in the case of bankruptcy or insolvency[17]
· regulatory compliance for capital asset protection and reserves could limit the spread of financial contagion in the event of a stablecoin collapse and enable some protection for the integrity of financial and monetary systems and for users and investors[18]
· operating across multiple jurisdictions and their global nature make it very difficult to regulate uniformly and limit regulatory arbitrage — AML/KYC/CTF[19] and taxation
· difficult to police and enforce regulations and compliance across multi-jurisdictional borders[20]
Stablecoin Regulation
Regulation Defined
“Regulation is any rule endorsed by government where there is an expectation of compliance.”[21]
According to Lawrence Lessig “code is law”[22]. Lessig goes on to describe four (4) forces that which constrain actions in a regulatory context. These are code/architecture, market, law and norms and are outlined below in Figure 6 for Stablecoins:
Figure 6: Lessig’s Four Forces
Baldwin et al.[23] argue the term ‘regulation’ is capable of being used in the following different senses:
• “As a specific set of commands”[24]
• “As deliberate state influence including the use of economic incentives (taxes or subsidies) contractual powers, deployment of resources, supply of information”[25]
• “As all forms of social or economic influence — where all mechanisms affecting behaviour are deemed regulatory”[26]
Theories & Approaches to Regulation
Outlined below in Figure 7 are the various theories and approaches to regulation:
Figure 7: Theories and Approaches to Regulation[27]
As governments, policymakers, and regulators grapple with new regulatory challenges presented by emerging technologies, four key questions are critical to addressing this[28]:
· What’s the current state of regulation in the area?
· What’s the right time to regulate?
· What’s the right approach to regulation?
· What has changed since regulations were first enacted?
The four key questions are depicted graphically below in Figure 8:
Figure 8: The Four Key Questions[29]
Regulatory Challenges
“In the wake of these developments, regulatory leaders are faced with a key challenge: how to best protect citizens, ensure fair markets, and enforce regulations, while allowing these new technologies and businesses to flourish?”[30]
These regulatory challenges are depicted below in Figure 10:
Figure 10: Challenges to traditional regulation[31]
In the face of emerging technologies such as stablecoins, traditional regulatory frameworks will come under increased pressure to adapt and change. New types of regulatory frameworks are outlined below in Figure 11:
Figure 11: Principles for the future of regulation
Australian Regulation — Stablecoins
The Council of Financial Regulators (CFR) is the coordinating body for Australia’s main financial regulatory agencies and includes the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), the Reserve Bank of Australia (RBA), and The Treasury.
The CFR[32] has established a working group to consider the application of existing regulations to stablecoins. Its key objectives[33] are to:
· “identify key types of stablecoin arrangements that could affect the Australian financial system or Australian consumers”[34]
· “assess how these arrangements would be treated under existing regulatory frameworks”[35]
· “develop recommendations to address emerging regulatory gaps and risks”[36]
· “provide a forum to share information and coordinate Australian contributions on international work related to stablecoins”[37]
Conclusion
With the recent rapid growth and adoption of stablecoins globally, this emerging technology presents regulatory bodies and governments across the globe with a major headache. Stablecoins represent numerous issues and risks when considered from a social, ethical, and legal perspective.
Stablecoins are unique in that they transcend sovereign borders making coordination and cooperation for the purposes of regulation, legislation, taxation, monitoring, and cross-border enforcement very difficult. Add to this the goals of protecting users, investors, and national and global financial market integrity and preventing or limiting potential stablecoin financial contagion (e.g. Terra Luna), this task seems almost insurmountable.
Clearly, new ways of regulating and legislating for stablecoins will soon be required.
[1] CoinMarketCap, Top Stablecoin Tokens by Market Capitalization (21st July 2022) (Web Page) < https://coinmarketcap.com/view/stablecoin/>.
[2] Daniel Rotolo, Diana Hicks and Ben Martin, What is an emerging technology? (2015) Research Policy 44, 1839.
[3] Royal Melbourne Institute of Technology, LAW 2571 Law and Policy for Emerging Technologies (July-Dec 2022) 3.1.2 Characteristics of emerging technology.
[4] Google, Google Trends: Stablecoins (22nd July 2022) (Web Page) <https://trends.google.com/trends/explore?date=2018-07-01%202022-07-21&q=stablecoins>.
[5] Google, Google Scholar: Stablecoins (22nd July 2022) (Web Page) <https://scholar.google.com.au/scholar?hl=en&as_sdt=0%2C5&q=stablecoins&btnG=>.
[6] statista, Market capitalization of the ten biggest stablecoins from January 2017 to June 19, 2022 (22nd July 2022) (Web Page) <https://www.statista.com/statistics/1255835/stablecoin-market-capitalization/>.
[7] CoinMarketCap, Top Stablecoin Tokens by Market Capitalization (22nd July 2022) (Web Page) <https://coinmarketcap.com/view/stablecoin/>.
[8] Aakriti Shoree, Paths to the Future: What Stablecoins and the CBDC Mean for the Global Financial System (9th May 2022) UNSW Sydney <https://www.unsw.edu.au/news/2022/05/what-stablecoins-and-the-cbdc-mean-for-the-global-financial-system>.
[9] Ibid.
[10] Presidents Working Group on Financial Markets, Federal Deposit Insurance Corporation, Office of the Comptroller, Report on Stablecoins (November 2021) U.S. Department of the Treasury < https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf>.
[11] Jan van Eck, What the Government’s Recommendations for Stablecoins Got Wrong, and How to Do Better (9th February 2022) Barron’s <https://www.barrons.com/articles/what-the-governments-recommendations-for-stablecoins-got-wrong-and-how-to-do-better-51644419137>.
[12] Royal Melbourne Institute of Technology, LAW 2571 Law and Policy for Emerging Technologies (July-Dec 2022) 1.2.4 Legal.
[13] Nicolas Vega, More than 1 in 3 cryptocurrency investors know little to nothing about it, survey finds (4th March 2021) CNBC <https://www.cnbc.com/2021/03/04/survey-finds-one-third-of-crypto-buyers-dont-know-what-theyre-doing.html>.
[14] David DiMolfetta, Crypto advocates warn of new digital divide as regulators begin inquiries (5th May 2022) S&P Global Market Intelligence <https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/crypto-advocates-warn-of-new-digital-divide-as-regulators-begin-inquiries-69819590>.
[15] Victoria Guida, Treasury, Fed fear stablecoins could disrupt financial system (20th September 2021) (Web Page) Politico <https://www.politico.com/news/2021/09/20/stablecoin-cryptocurrency-regulation-513209>.
[16] Brett Hemenway Falk, Sarah Hammer, Meltdown in the Wild West: The Stablecoin Collapse of 2022 and Consumer Protection Considerations (2nd June 2022) SSRN <https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4119627>.
[17] Christian Catalini and Jai Massari, Stablecoins and the Future of Money (10th August 2021) Harvard Business Review < https://hbr.org/2021/08/stablecoins-and-the-future-of-money>.
[18] International Monetary Fund, Global Financial Stability Report: COVID-19, Crypto, and Climate: Navigating Challenging Transitions (October 2021) International Monetary Fund, 44 < https://www.imf.org/en/Publications/GFSR/Issues/2021/10/12/global-financial-stability-report-october-2021>.
[19] Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth).
[20] World Economic Forum, Navigating Cryptocurrency Regulation: An Industry Perspective
on the Insights and Tools Needed to Shape Balanced Crypto Regulation (September 2021) World Economic Forum, Global Future Council on Cryptocurrencies, 7–8 < https://www3.weforum.org/docs/WEF_Navigating_Cryptocurrency_Regulation_2021.pdf>.
[21] Australian Government, Department of the Prime Minister and Cabinet, Regulatory Impact Analysis (RIC) Massive Open Online Course (MOOC) (Web Page) <https://www.pmc.gov.au/ria-mooc/introduction/what-do-we-mean-regulation>.
[22] Lawrence Lessig, Code and other laws of cyberspace (New York, Basic Books, 1999).
[23] Robert Baldwin, Martin Cave and Martin Lodge, Understanding Regulation: Theory, Strategy, and Practice, (Oxford University Press 2012) 3.
[27] Royal Melbourne Institute of Technology, LAW 2571 Law and Policy for Emerging Technologies (July-Dec 2022) 2.2.1 — Public interest theory.
[28] William Eggers, Mike Turley and Pankaj Kamleshkumar Kishnani, The future of regulation. Principles for regulating emerging technology (19th June 2018) Deloitte Centre for Government Insights analysis. Deloitte Insights <https://www2.deloitte.com/us/en/insights/industry/public-sector/future-of-regulation/regulating-emerging-technology.html>.
[29] William Eggers, Mike Turley and Pankaj Kamleshkumar Kishnani, The future of regulation. Principles for regulating emerging technology (19th June 2018) Deloitte Centre for Government Insights analysis. Deloitte Insights <https://www2.deloitte.com/us/en/insights/industry/public-sector/future-of-regulation/regulating-emerging-technology.html>.
[31] William Eggers, Mike Turley and Pankaj Kamleshkumar Kishnani, The future of regulation. Principles for regulating emerging technology (19th June 2018) Deloitte Centre for Government Insights analysis. Deloitte Insights <https://www2.deloitte.com/us/en/insights/industry/public-sector/future-of-regulation/regulating-emerging-technology.html>.
[32] Council of Financial Regulators, Regulation of Stored-value Facilities in Australia (October 2019)
[33] Australian Securities and Investment Commission, Senate Select Committee on Australia as a Technology and Financial Centre: Third issues paper (July 2021) 7 <https://asic.gov.au/media/cmvhlkeg/selectcommitteeausfintechcent-asic-submission-july-2021.pdf>.
Nathan van den Bosch is a Behavioural Economist, Tokenomics Specialist and Blockchain Strategist, with more than 30 years of experience in emerging and disruptive technologies. Nathan has degrees in Economics, Commerce, Behavioural Economics and Applied Blockchain.
Nathan specialises in designing the reward and incentive schemas for gamified metaverses, digital ecosystems and digital economies. His focus is based upon understanding the behavioural drivers that spur adoption and sustained usage in blockchain-based network environments.
